In the Companies Act 2013, the term "Promoter" is clearly defined under Section 2(69) as follows:
A "Promoter" is someone who:
- Is named as a promoter in the prospectus or identified by the company in the annual return filed under Section 92, or
- Exercises control over the company’s affairs, either directly or indirectly, whether as a director, shareholder, or otherwise, or
- Provides advice, directions, or instructions that the Board of Directors of the company typically follows.
However, this definition specifically excludes individuals acting purely in a professional capacity.
This definition is shaped by various SEBI regulations and judicial decisions. Essentially, if a person is identified in the prospectus or annual return as a promoter, or if they control the company’s affairs as a shareholder or director, or exert influence over the Board of Directors, they are considered a promoter of that company. However, professionals like Company Secretaries, Lawyers, Merchant Bankers, and Lead Managers who provide services in a professional capacity are not considered promoters.
A promoter is the individual or entity that initiates the formation of a company. This could be a single person, a group, a firm, or even a corporation. Promoters can be classified into various categories based on their involvement and expertise:
- Professional Promoters: These are individuals specializing in promoting new business ventures. They possess extensive experience in establishing companies and often act as intermediaries between investors and entrepreneurs. Once the company is up and running, they typically hand over management to the shareholders.
- Occasional Promoters: This category includes individuals who promote companies on a less frequent basis. They may have their own professions and become involved in company formation due to personal interests or specific opportunities.
- Financial Promoters: These are typically financial institutions that aid in the creation of new businesses. They provide financial assistance and guidance and often play a role in promoting the company.
- Entrepreneurial Promoters: These are individuals who conceive and execute the formation of a company. They are often the founders and take an active role in managing the business.
Since the promoters are like the parents of a company, they conceptualize everything and then start working to make it a reality. Here are the functions of promoters:
- Promoters identify potential business ventures, which could involve new products, services, market channels, or product enhancements, conceptualize the idea, and start working towards converting the idea into reality.
- The promoters conduct a comprehensive analysis that includes costs, resources, and, most importantly, the market demand. This analysis is crucial in determining the practicality of turning the opportunity into a successful business venture.
- Promoters select a name for the company and submit an application to the Registrar of Companies for approval. Three names are typically submitted in order of preference.
- Promoters choose the individuals who will sign the Memorandum of Association, and these individuals usually become the company's first directors. Each signatory must provide written consent to act as a director and to acquire the required qualification shares.
- Promoters hire professionals, such as lawyers, accountants, and auditors, to assist in preparing the necessary documents for registration and then submit these documents to the registrar.
- Promoters decide the location of the company's head office where it will commence business during its initial phase or in future.
Promoters who are involved in forming a company have specific duties and obligations toward the company. A key aspect of their role is the fiduciary relationship they establish with the company. This relationship requires the promoter to act in the best interests of the company and disclose all material information.
Fiduciary Duties:
- Disclosure of Material Facts: Promoters must disclose all relevant information regarding the company's formation, including any conflicts of interest or personal benefits.
- Avoidance of Secret Profits: Promoters cannot profit secretly from transactions with the company. For example, they cannot buy property at a lower price and then sell it to the company at a higher price without disclosure.
- Due Diligence: Promoters must exercise due care and diligence in their activities, ensuring that the company's interests are protected.
Case Study of Fiduciary Relationship
Shriram Transport Finance Company Ltd., a non-banking financial company involved in financing commercial vehicles, brought a suit against V.G.S.V. Transport Finance Private Limited, a company promoted by individuals who were also the directors of Shriram Transport. The defendant company entered into a business relationship with the plaintiff involving vehicle financing. However, the directors, who were also promoters of the defendant company, breached their fiduciary duty by diverting business opportunities and funds from the plaintiff to benefit the defendant company. The Delhi High Court ruled in favor of the plaintiff, finding that the promoters had violated their fiduciary duty and ordered them to account for the profits gained at the expense of the plaintiff.
- Right to Indemnity: When multiple promoters are involved in forming a company, one promoter may seek indemnity from another for expenses or damages incurred during the process. Promoters are jointly and severally liable for any false statements made in the prospectus and for any undisclosed profits. This shared liability underscores the importance of transparency and accountability among promoters.
- Right to Recover Preliminary Expenses: Promoters are entitled to reimbursement for legitimate preliminary expenses incurred in establishing the company, such as advertising, legal fees, and surveys. However, this right is not based on a contractual obligation; it depends on the discretion of the company's board of directors. Typically, supporting documentation, such as vouchers, is required to substantiate these expenses.
- Right to Remuneration: Promoters generally have no automatic right to remuneration from the company unless there is a contract in place. The company's articles of association may empower the directors to pay promoters for their services, but this does not guarantee a contractual right to payment. In practice, promoters often receive remuneration as they typically serve as directors as well.
Promoter Liability for Prospectus Misstatements
Section 26 of the Companies Act pencils the required contents of a prospectus, including financial statements and reports. Promoters can be held liable if they fail to comply with this section.
Civil Liability:
- Section 35 imposes civil liability on promoters for false statements in a prospectus.
- Shareholders who subscribe based on a misleading prospectus can sue promoters for losses or damages.
- Section 62 provides defenses for promoters to avoid liability under certain circumstances.
Criminal Liability:
- Section 34 addresses criminal liability for issuing a prospectus with false statements.
- Promoters can face imprisonment or fines if they knowingly publish a misleading prospectus.
- A promoter can avoid criminal liability by proving the statement was immaterial or made in good faith.
Public Examination:
- Section 300 allows courts to order a public examination of promoters found guilty of fraud in company formation.
- This can occur if the liquidator's report reveals fraud during the company's winding up.
Personal Liability:
- Promoters can be held personally accountable for pre-incorporation contracts.
- They are responsible for ensuring the accuracy of the prospectus and may face civil or criminal penalties for false statements.
- A promoter's liability extends to any person who subscribes to shares or debentures based on misleading information in the prospectus.
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