By Prem Bashani J
Entrepreneurs are the engines of growth and economy. Therefore, it became prudent for some countries to place the thrust of their economic policies on encouraging entrepreneurs to start/promote new verticals to multiply businesses. The innovations of entrepreneurs often stir exponential growth. Breath-taking transformations in growth and progress come from out of box ideas. Great ideas and robust entrepreneurship skills make successful business. And those that own the ideas and exercise the entrepreneurial skills eventually come to be known as the promoters of the business.
So, a promoter is the person who holds a business vision and execute his plans to put his ideas in commercial practice. He is associated with the business from the beginning. He converts the ideas into action. He plans and organises the business, works out the finances, mobilise the resources, build the team and engages with the legal frameworks to give life to the business. Owing to his dominant presence in the life of a business, he wields enormous clout and powers in the company. This position in the business puts his name in all important documents and records of the business.
Besides, he christens the name of the company in symphony with the governing statutes to get the company incorporated. He is fundamental to the formation of the Articles of Association and the Memorandum of Association. It’s the promoter who nominates the board of directors, bankers and auditors for the company. He also appoints the under writers and brokers whenever necessary. And he files the documents for incorporation.
This unique position of the promoter, the privileges he has over the affairs of the company in the pre-incorporation stages, the dominance he holds over the Board of the Company and the fiduciary relationship he enjoys with the company necessitated the Companies Act, 2013 to postulate the standard conduct of a business promoter. The idea to identify a promoter and codify the ethics of a business promoter is a part of the corporate governance framework of The Companies Act, 2013.
In India, the companies Act, 2013 has adopted a broad definition for a promoter and attempts to identify a promotor of a company objectively. Under the Act, he is seen as someone who plans, incorporates, organises and raises capital for the company. He is seen as the one who is named as promoter in the prospectus or the annual returns of the company. He is seen as one who has the control over the company directly or indirectly whether or not he is a shareholder or director. He is seen as the one under whose advice, guidance or instructions the directors of the company are accustomed to act. Law does not deem it necessary to recognize an exalted position for him in the company. Also, the definition specifically excludes a person who has participated in the promotion of a company exclusively in his professional capacity.
The Company law recognises the rights and liabilities of the promoter weighing the benefits that come with his contributions and the vulnerabilities of the company in the fiduciary pre-incorporation relationship vis a vis the conflicts of interest that arise on account of his pivotal position in the company. Accordingly, it codifies the rights and liabilities of the Promoter for his acts of commission and omission. While on the one hand, law contemplates stringent punishments for wrong doings, it also protects the actions of the promoter done in good faith. The law recognises his entitlement for reasonable remuneration as stated in the Articles of Association on a rider that the Articles of Association is not unduly skewed in his favour. He can hold an option to buy future shares, or charge lumpsum fees. There can also be a written pre-incorporation contract between the promoter and the company. The Specific Relief Act, 1963 validates such contracts if the same are warranted in the articles.
The essence of the postulations and the judicial pronouncements on the subject matter is that a promoter shall not make a secret profit in the discharge of his functions. He owes duties of good faith and honesty to the company. In other words, he is entitled to make reasonable and just profits in the course of promoting companies. He can enter into mutually beneficial contracts. The only caveat is that he is expected to disclose the profits made by him in the pre incorporation transactions and he shall be transparent about disclosing his interests and transactions with the company and its business. The object of the law is to ensure that a promoter enters into a contract for the benefit of the company. To cover this probable conflict of interests, companies often have an indemnity clause against the misappropriations of the promoter so that the acts and breaches of the promoter shall not befall the company. Companies are also entitled to rescind shady contracts and recover the profits from the promoter.
The law fastens criminal liability on promoters who authorise issue of prospectus that contain statements which are not true or misleading in form or context or if they omit to include any matter that may mislead. Promoters who cause issue of such prospectus are treated as fraudulent acts and are liable to a punishment of imprisonment running to several years with a fine which may extend up to three times the amount involved in the fraud. His culpability and liability however depend on his conduct and the contracts he has entered into during the pre-incorporation stage.
Notwithstanding the criminal liability, the subscriber of securities acting
on such untrue and misleading statements or omissions and sustaining any loss or damage, the promoter is liable to pay compensation to every such person the damage and loss sustained by such subscribers. In the same breath, the law protects a promoter who can prove that the prospectus containing the misleading statements/omissions is issued without his knowledge. This protection however, will not be available in a case where it is proved that the prospectus is issued with the intention to defraud, and in such a situation a promoter will be liable without any limitation for all or any of the losses or damages that may have been incurred by any person who subscribed to the securities on the basis of such misleading statements in the prospectus. In such situations, the company will not be liable for the losses.
A promoter shall ensure that a company before making public offer should obtain the permission from one or more recognized stock exchange to deal with the securities and mention the same in the prospectus. A failure to do so is incurable. If such a permission is not taken, and the monies are not dealt with in a manner prescribed under the law, the promoter shall be liable for imprisonment and/or with fine running to a few lakhs of rupees.
As an exit option, companies wind up upon failure of business. During winding up of a company, if a Company Liquidator in his opinion finds that a fraud has been committed by any person in the promotion, formation, business or conduct of affairs of the company since its formation, he may cause an investigation into the affairs of the company and the promoter shall be examined before the Tribunal to evaluate his conduct and dealings in relation to the promotion or formation or the conduct of the business of the company. The law provides for the arrest of the promoter in the event he evades such examination before the Tribunal. So, it casts accountability on the promoter even after the winding up of the company against the popular notion and belief that the role of the promoter ends with the appointment of board of directors. In such cases constituting frauds, the promoter becomes personally liable.
To conclude, the company law strikes a perfect balance between the roles, rights and freedom of promoters of companies, the vulnerabilities of the company in the relationship with the promoter and the best interests of the shareholders who had acted in trust and confidence of the statements of the prospectus and Annual Returns published by the company through its promoters, directors and officials by a system of scrutiny, transparency, fair play, adjudication of disputes and punishments providing the niche business environment for a good promoter to thrive and succeed.
The Author is a consultant Goods and Services Tax, Customs, SEZ and Foreign Trade Policy. He is a former Superintendent of Central Excise & Customs, Government of India. He is currently pursuing Master of Business Laws from the National Law School of India University, Bangalore.