After reading this article you will learn about:- 1. Meaning of a Promoter 2. Functions of a Promoter 3. Legal Position 4. Rights 5. Duties 6. Liabilities 7. Preliminary Contracts.
Meaning of a Promoter:
The idea of carrying on a business which can be profitably undertaken is conceived either by a person or by a group of persons who are called promoters. After the idea is conceived, the promoters make detailed investigations to find out the weaknesses and strong points of the idea, to determine the amount of capital required and to estimate the operating expenses and probable income.
The term ‘promoter’ is a term of business and not of law. It has not been defined anywhere in the Act, but a number of judicial decisions have attempted to explain it.
According to L.J. Brown. “The term promoter is a term not of law but of business, usefully summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence.”
According to Justice C. Cockburn. “Promoter is one who undertakes to form a company with reference to a given object and to set it going, and who takes the necessary steps to accomplish that purpose.”
According to Palmer, “Company promoter is a person who originates a scheme for the formation of the company, has the memorandum and the articles prepared, executed and registered and finds the first directors, settles the terms of preliminary contracts and prospectus (if any) and makes arrangement for advertising and circulating the prospectus and placing the capital.”
According to Guthmann and Dougall. “Promoter is the person who assembles the men, the money and the materials into a going concern.”
From these definitions of promoter it is concluded that:
“Promoter is the person who originates the idea for formation of a company and gives the practical shape to that idea with the help of his own resources and with that of others.”
A person cannot be held as promoter merely because he has signed at the foot of the Memorandum or that he has provided money for the payment of formation expenses.
The promoters, in fact, render a very useful service in the formation of the company. A promoter has been described as ”a creator of wealth and an economic prophet.” The promoters carry a considerable risk because if the idea sometimes goes wrong then the time and money spent by them will be a waste.
In the words of Henry E. Heagland, “A successful promoter is a creator of wealth. He is an economic prophet. He is able to visualise what does not yet exist and to organise business enterprise to make the products available to the using public.”
A promoter may be an individual, a firm, an association of persons or even a company.
Functions of a Promoter:
The Promoter Performs the following main functions:
1. To conceive an idea of forming a company and explore its possibilities.
2. To conduct the necessary negotiation for the purchase of business in case it is intended to purchase as existing business. In this context, the help of experts may be taken, if considered necessary.
3. To collect the requisite number of persons (i.e. seven in case of a public company and two in case of a private company) who can sign the ‘Memorandum of Association’ and ‘Articles of Association’ of the company and also agree to act as the first directors of the company.
4. To decide about the following:
(i) The name of the Company,
(ii) The location of its registered office,
(iii) The amount and form of its share capital,
(iv) The brokers or underwriters for capital issue, if necessary,
(v) The bankers,
(vi) The auditors,
(vii) The legal advisers.
5. To get the Memorandum of Association (M/A) and Articles of Association (A/A) drafted and printed.
6. To make preliminary contracts with vendors, underwriters, etc.
7. To make arrangement for the preparation of prospectus, its filing, advertisement and issue of capital.
8. To arrange for the registration of company and obtain the certificate of incorporation.
9. To defray preliminary expenses.
10. To arrange the minimum subscription.
Legal Position of a Promoter:
The promoter is neither a trustee nor an agent of the company because there is no company yet in existence. The correct way to describe his legal position is that he stands in a fiduciary position towards the company about to be formed.
Lord Cairns has correctly stated the position of promoter in Erlanger V. New Semberero Phophate Co. “The promoters of a company stand undoubtedly in a fiduciary position. They have in their hands the creation and moulding of the company. They have the power of defining how and when and in what shape and under what supervision, it shall start into existence and begin to act as a trading corporation.”
From the fiduciary position of promoters, the two important results follow:
(1) A promoter cannot be allowed to make any secret profits. If it is found that in any particular transaction of the company, he has obtained a secret profit for himself, he will be bound to refund the same to the company.
(2) The promoter is not allowed to derive a profit from the sale of his own property to the company unless all material facts are disclosed. If he contracts to sell his own property to the company without making a full disclosure, the company may either repudiate/rescind the sale or affirm the contract and recover the profit made out of it by the promoter.
A promoter who wishes to sell his own property to the company must make a full disclosure of his interest.
The disclosure may be made:
(i) To an independent Board of Directors, or
(ii) In the articles of association of the company, or
(iii) In the prospectus, or
(iv) To the existing and intended shareholders directly.
If the promoter fails to discharge the obligation demanded of his fiduciary position the company may rescind the contract or may in the alternative choose to take advantage of the contract and sue the promoter for damages for breach of his duty to the company.
Secret profits on the sale of property can be recovered from a promoter only when the property was bought and sold to the company while he was acting as a promoter.
Rights of Promoter:
The rights of promoters are enumerated as follows:
1. Right of indemnity:
Where more than one person act as the promoters of the company, one promoter can claim against another promoter for the compensation and damages paid by him. Promoters are severally and jointly liable for any untrue statement given in the prospectus and for the secret profits.
2. Right to receive the legitimate preliminary expenses:
A promoter is entitled to receive the legitimate preliminary expenses which he has incurred in the process of formation of the company such as cost of advertisement, fee of solicitor and surveyors. The right to receive the preliminary expenses is not a contractual right. It depends upon the discretion of the directors of the company. The claim for expenses should be supported by vouchers.
3. Right to receive the remuneration:
A promoter has no right against the company for his remuneration unless there is a contract to that effect. In some cases, articles of the company provide for the directors paying a specified amount to promoters for their services but this does not give the promoters any contractual right to sue the company. This is simply an authority vested in the directors of the company.
However, the promoters are usually the directors, so that in practice the promoters will receive their remuneration.
The remuneration may be paid in any of the following ways:
(i) A commission may be paid to the promoter on the purchase price of the business or property taken over by the company through him.
(ii) The promoters may be granted by the company a lumpsum amount.
(iii) The promoters may be given fully or partly paid shares in consideration of their services rendered.
(iv) The promoter may be given a commission at a fixed rate on the shares sold.
(v) The promoter may purchase the business or other property and sell the same to the company at an inflated price. He must disclose this fact.
(vi) The promoters may take an option to subscribe within a fixed period for a certain portion of the company’s unissued shares at par.
Whatever be the nature of remuneration, it must be disclosed in the prospectus if paid within the preceding two years from the date of prospectus.
Duties of Promoter:
The duties of promoters are as follows:
1. To disclose the secret profit:
The promoter should not make any secret profit. If he has made any secret profit, it is his duty to disclose all the money secretly obtained by way of profit. He is empowered to deduct the reasonable expenses incurred by him.
2. To disclose all the material facts:
The promoter should disclose all the material facts. If a promoter contracts to sell the company a property without making a full disclosure, and the property was acquired by him at a time when he stood in a fiduciary position towards the company, the company may either repudiate the sale or affirm the contract and recover the profit made out of it by the promoters.
3. The promoter must make good to the company what he has obtained as a trustee:
A promoters stands in fiduciary position towards the company. It is the duty of the promoter to make good to the company what he has obtained as trustee and not what he may get at any time.
4. Duty to disclose private arrangements:
It is the duty of the promoter to disclose all the private arrangement resulting him profit by the promotion of the company.
5. Duty of promoter against the future allottees:
When it is said the promoters stand in a fiduciary position towards the company then it does not mean that they stand in such relation only to the company or to the signatories of memorandums of company and they will also stand in this relation to the future allottees of the shares.
Liabilities of Promoter:
The liabilities of promoters are given below:
1. Liability to account in profit:
As we have already discussed that promoter stands in a fiduciary position to the company. The promoter is liable to account to the company for all secret profits made by him without full disclosure to the company. The company may adopt any one of the following two courses if the promoter fails to disclose the profit.
(i)The company can sue the promoter for an amount of profit and recover the same with interest.
(ii) The company can rescind the contract and can recover the money paid.
2. Liability for mis-statement in the prospectus:
Section 62(1) holds the promoter liable to pay compensation to every person who subscribes for any share or debentures on the faith of the prospectus for any loss or damage sustained by reason of any untrue statement included in it. Sec. on 62 also provides certain grounds on which a promoter can avoid his liability. Similarly Sec. 63 provides for criminal liability for mis-statement in the prospectus and a promoter may also become liable under this section.
The promoter may also be imprisoned for a term which may extend to two years or may be punished with the fine upto Rs. 5,000 for untrue statement in the prospectus. (Sec. 63).
3. Personal liability:
The promoter is personally liable for all contracts made by him on behalf of the company until the contracts have been discharged or the company takes over the liability of the promoter.
The death of promoter does not relieve him from liabilities.
4. Liability at the time of winding up of the company:
In the course of winding up of the company, on an application made by the official liquidator, the court may make a promoter liable for misfeasance or breach of trust. (Sec. 543).
Further where fraud has been alleged by the liquidator against a promoter, the court may order for his public examination. (Sec. 478).
Preliminary Contracts/Pre-Incorporation Contracts Made by the Promoters:
Preliminary contracts are those contracts which are made by the promoters with different parties on behalf of the company yet to be incorporated. Such contracts are generally entered into by promoters to acquire some property or right for and on behalf of the company to be formed.
The promoters enter into preliminary contracts, generally as agents or trustees of the company. Such contracts are not legally binding on the company because two consenting parties are necessary to a contract whereas the company is nonentity before incorporation.
The company has no legal existence until it is incorporated. It therefore follows:
1. That when, the company is registered, it is not bound by the preliminary contract.
2. That the company when registered cannot ratify the agreement. The company was not a principal with contractual capacity at the time of contract. A contract can be ratified only when it is made by an agent for a principal who is in existence and who is competent to contract at the time when the contract is made.
3. That if the agent undertook any liability under the agreement, he would be personally liable notwithstanding that he is described in the agreement as an agent and that the company may have attempted to ratify the agreement.
4. The company cannot enforce the preliminary agreement.
The preliminary contracts made by promoters generally provided that if the company adopts the agreement the promoter’s liability shall cease and if the company does not adopt the agreement within a certain time either party may rescind the contract. In such a case promoter’s liability would cease after the lapse of fixed time.