Promoters Of Company : Definition, Legal Duties & Functions Explained

During the incorporation and functioning of a company, the role of the promoters are the most important. Primarily, promoters are responsible for the incorporation of the company, arrangement of capital, and bringing together different stakeholders to establish a business. 

Definition Of A Promoter

The Companies Act, 2013, provides a comprehensive definition, outlines the roles, responsibilities, and liabilities of the promoters within India. According to Section 2(69) of the Companies Act, 2013, “promoter” means:

• Named in Prospectus or Annual Return: Any person named as a promoter in the prospectus or the company has identified, in its annual return filed with the Registrar.

• Control over matters of the Company: Anyone having direct or indirect control over the company's affairs as a shareholder, director, or in any other capacity.

• Direct influence on the Board of Directors: A promoter is a person who influences a company's Board of Directors into making decisions on the advice, directions, or instructions from that individual. Such individuals, however, cannot include lawyers or accountants acting in professional capacity.

Roles And Functions Of A Promoter

The role of the promoter starts before the company is legally formed and often continues as the business grows. The key functions include:

• Concept formation for business idea: Normally the promoter forms the idea of the business and is involved in the incorporation of the company to carry on that business.

• Incorporation of the Company: To constitute the company, they follow various formalities such as preparation of Memorandum of Association and Articles of Association, completion of the process of company's registration with the Registrar, and ensure compliance with all the legal requirements.

• Raising Capital: It embraces the arrangement of initial capital for setting up the business, which, in most cases, is usually funding by investors or financial institutions.

• Recruitment of Initial Team: They may also be involved in recruiting the major management personnel and employees required to initiate and run the business.

• Entering into pre-incorporation contracts: A promoter can enter into contracts on behalf of the company well before it is incorporated. It can even lease office premises or buy office equipment.

Rights Of Promoters

Along with the responsibilities of the promoters, they have certain rights. These rights are as follows: 

• Right to Reimbursement of Pre-Incorporation Expenses: The promoters shall be entitled to claim reimbursement of all expenses for the incorporation process.

• Right to Compensation: If it is so provided in the Articles of Association of the company or agreed with the company, promoters may be entitled to compensation for their services.

• Right to Shares or Commission: In some cases, the promoters are considered entitled to rights in shares or commissions as a form of consideration for the role that they played in the formation of the company.

Legal Obligations Of Promoters

While promoters play an important part in the formation of a company, they also owe some duties and legal liabilities:

• Disclosure of Interests: The promoters are required to disclose all the interests in contracts or other property acquired in the course of formation of the company. It would thus prevent any conflict of interest arising in the business transactions.

• Duty of Good Faith: The duty of good faith requires the promoters, being fiduciaries, to act in the best interest of the company and avoid all situations wherein their personal interests would conflict with the interests of the company.

• Legal Compliance: The promoters ensure that the establishment of the company and commencement of business follow all the legal requirements related to incorporation.

Liabilities Of Promoters

The Companies Act casts certain liabilities upon the promoters, especially if they do not comply with their legal duties or engage in fraudulent practices :

• Liability for Misrepresentation: Where the prospectus contains any false statement or misrepresentation, the promoter may be held liable for damages suffered by investors based on their actions in reliance of the misleading information.

• Liability for Pre-Incorporation Contracts: A company does not exist unless incorporated and the promoters are personally liable for any pre-incorporation contracts entered into on behalf of the company unless such contract is also adopted by the company after incorporation.

• Liability for Fraudulent Activities: Liability for fraudulent activities can also attach to promoters in case of fraud or mismanagement during the process of formation. In this case, punishments range from fines to imprisonment.

Regulatory Framework Governing Promoters In India

Several legal and regulatory frameworks govern the actions of the promoters in India to ensure that they are working in line with ethical standards as well as meeting up to legal requirements:

• The Companies Act, 2013: The Companies Act, 2013 is the primary legislation that prescribes the roles, duties, and liabilities of promoters.

• SEBI Regulations: SEBI imposes disclosure obligations on the part of the promoters, mainly in those cases where the company is seeking a public listing. The respective promoter has to disclose his shareholding and any related party transactions.

• Listing Obligations and Disclosure Requirements (LODR): If the company is listed at a stock exchange, promoters need to be in consonance with LODR requirements like restrictions on selling of shares and disclosing material events.

Case Laws

Erlanger vs. New Sombrero Phosphate Co. Ltd. (1878)

In this case, Cairns LJ said that, “The promoters undoubtedly stand in a fiduciary position. They have in their hand the creation and moulding of the company. They have the power of defining how and when and in what shape and under whose supervision it shall come into existence and begin to act as a trading corporation.”

The Weavers Mills Ltd., Rajapalayam vs. Balkis Ammal And Ors. (1967)

In this case, the Court explored the role of a promoter, especially concerning the purchase of immovables on behalf of a yet-to-be-incorporated:

• The Court noted that there was no specific guidance on the issue in the Companies Act of 1913 and the new Act.

• While promoters are not, strictly speaking, agents or trustees of the company prior to incorporation, the Court held that they are, nonetheless, fiduciaries toward the company.

• This fiduciary position arises because the promoters act in the interest of the company prior to its coming into existence.

• Stating that legal precedent including Halsbury's Laws of England held that promoters cannot deny the company the benefit of acts done on its behalf, such as purchase of property.

• Therefore, the Court held that when a company is incorporated, it inherits the advantages of such transactions.

• The Court discussed the concept of adoption, whereby a company formally adopts the advantages from the actions of the promoter post incorporation.

Probir Kumar Misra vs. Ramani Ramaswamy (2009)

The Court here distinguished between the role of a promoter in the pre-incorporation stage of a company and the term “promoter” used in the SEBI Guidelines, which was largely related to post-incorporation activities like capital issuance:

• Pre-incorporation: It mentioned that the Companies Act does not define what a “promoter” was. It provides that promoters play a crucial role in the incorporation of a company, such as formulating its objectives, arranging finance, and preparing the memorandum and articles of association.

  • The Court observed that promoters are not necessarily signatories to such documents or even first shareholders or directors. They are more like “midwives” to the company, responsible for their actions and contracts entered during the pre-incorporation phase.

  • The Court emphasised that though a newly formed company is not bound by the act performed by a promoter during pre-incorporation activities, it can hold the promoter liable for any wrongful or detrimental conduct based on the principles of breach of trust.

• Post-incorporation: The Court explained the SEBI (Disclosure & Investor Protection) Guidelines uses “promoter” in relation to capital issuance, outlining their respective obligations and liabilities, including contribution to public issues and lock-in periods for shareholdings.

  • These guidelines are primarily instructions to merchant bankers for issuing of capital, imposing particular obligations upon promoters toward the protection of investors.

  • Underlining the point that an SEBI guidelines' definition of “promoter” differs from the broader concept of promoter in corporate law, which embraces pre-incorporation activities and liabilities.

Pramod Jain And Ors vs. SEBI (2016)

The Court in this case highlighted certain aspects of a promoter's role and responsibilities through its judgement in the context of a hostile takeover bid. The key observations are as follows: 

• Promoters' actions can affect takeover bid: The Court acknowledged the facts that the promoters may take all actions which could affect a takeover offer, including “Poison Pills” in order to make the acquisition less attractive or “Shark Repellents” in order to avoid unwanted takeovers.

• Decisions of promoters on assets: The Court recognised that the promoters are empowered to make decisions in regard to the company assets if the decisions are made after the prescribed statutory procedures and proper approvals are taken. 

• Remedies against promoter's misconduct: The Court observed that legal remedies can be available against the illegal, unjustified, or mala fide acts of the promoters. It ensures accountability to their decisions. 

• Activities of promoters subject to scrutiny: The Court holds that SEBI has the power to investigate the activities of promoters if there are any potential violations of any regulations. 

Promoters And Corporate Governance

In the area of corporate governance, the promoters hold an important part of the shareholding of a company. It is especially in cases of family-owned businesses in India. Therefore, concentration of ownership gives room to opportunities as well as challenges. These are as follows:

• Having Control over Decision Making: The promoters may have significant control over decisions within the company. This is good for stability but may often lead to issues related to conflict of interest.

• Related Party Transactions: The issue of related party transactions arises from the fact that promoters are also often directors or key managerial personnel of a company. Transactions between the company and the entities related to the promoter should be carefully monitored to prevent misuse of company resources. 

• Promoter Pledge of Shares: In some scenarios, the promoters pledge shares to raise funds. This affects the company's stock price and financial stability in case of a default by the promoters.

Recent Developments Affecting Promoters

With the latest legal amendments and regulatory updates, the liabilities and responsibilities of the promoters have been altered in the following scenario.

• Stricter SEBI Regulations: SEBI has reinforced stringent disclosures for promoter shareholding and lock-in periods applicable to its shares. In this regard, the regulation acts to protect the interest of the investors by maintaining transparency.

• Reforms in Corporate Governance Norms: Whereas corporate governance norms have been increasingly promoted, regulators have brought some initiatives to curb the exploitation of promoter power, like regulations regarding independent directors and related party transactions.

• Declassification of Promoters: SEBI has allowed companies to reclassify promoters as public shareholders subject to certain conditions. This is an attempt to ease the process of change in ownership structure by such companies yet in conformity with the regulatory requirements.

Promoter Influence In India

• Family-owned businesses: Most Indian prominent companies are family-owned, wherein the promoters hold a position both as directors and significant shareholders. This dual role can be quite effective for management but poses risks of nepotism and control concentration.

• Corporate Scandals Involving Promoters: There have also been instances where promoter-led mis-management gave rise to corporate scandals, which led to regulatory interventions. Some high profile cases like the Satyam scandal called for the need for rigid regulation over the promoter.

Also Read : Corporate Fraud in India

Conclusion

Promoters play an important role in formation and growth of companies in India. Promoters are held to high standards through the Companies Act, 2013, and other regulatory frameworks regarding transparency and accountability. Though they have rights and control over the company, the duties and liabilities are drafted in a way that prevents misuse of power and, therefore, protects both the company and its stakeholders.

The roles of promoters keep changing because of changing regulations with an increased corporate governance focus and the best global practices. It is quite crucial for the promoters to be updated about the legal requirements and maintain ethical standards in their dealing. This helps in fostering trust and ensure long-term business sustainability.