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.”

ADVERTISEMENTS:

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:

ADVERTISEMENTS:

“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 w

hen 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.

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Pre-incorporation contracts and the promoter

In order to get the benefits of a ‘corporate personality’ [1] , it is very necessary for ‘an
association of persons’ to become incorporated under the Companies Act, 1956. After the
incorporation of association of persons the company comes in existence, and it can start its
business operations as company only after that [2] . The simple reason behind it is that before
incorporation company do no has any legal existence before incorporation [3] , and if the
‘association of persons’ enters into an agreement in the name of company before incorporation;
the agreement would be void ab initio [4] .

It would be a matter of inconvenience that ‘an association of persons’ cannot perform any
official business operation in the name of company before its incorporation or the issue of
certificate of commencement of business; they may have to make arrangement for office, place
of work, worker, etc. In order to do away with these inconveniences, the promoter [5] can enter
into the agreements in the benefit of ‘association of persons’ or prospective company; these
agreements are known as pre-incorporation contract.

Under the strict principles of contract law, the promoter is solely liable for the breach of contract.
The reason behind is that the promoter is party who enters into the contract, and not the
company. The rule of privity of contract keeps away the company from pre-incorporation
contract. But recent development in corporate law and contract law makes the company liable for
pre-incorporation contract.
Research Question

Whether the promoter is liable for pre-incorporation contract or not? If he is liable, under what
circumstances he can be held liable?

Whether there is any difference among Indian Law, American Law and English Law concerning
the liability of promoter in relation to pre-incorporation contract?

Chapter I: Meaning of Promoter and Nature of Pre-incorporation Contract

Promoter

The Company Act, 1956, does not provide a common definition of Promoter. Although few
section like 62, 69, 76, 478, 519 of Company Act and SEBI Guidelines 2000 Chapter VI
Explanation I to III to clause 6.4.2(k) does discuss about promoter, but definition provided under
those section would be restricted to the area of those section. Resent Company Bill does have the
definition of Promoter in the definition clause under section 2(zzq), it says that “promoter means
a person who has (a) been named as such in a prospectus; or (b) control over the affairs of the
company, directly or indirectly whether as a shareholder, director". But this Bill is not in force
till now, so the old Act of 1956 would be applicable in present day, which does not has the
common definition clause of promoter. Even the English law does not provide the definition [6] .
Joseph H. Gross in his celebrated article ‘Who is a Company Promoter?’ found that it was rather
intentional to not providing definition in English Legislation, because if legislation try to define
it then someone might escape from the liability who enjoy the place of promoter but not come
under the definition of promoter [7] . In this situation, where the legislature if silent about the
definition, it is necessary to see the judicial interpretation.

According to Bowen J., the ‘Promoter’ is not the term of law but it is a term of business [8] , who
play main role in the setup of a company. Whereas Cockburn CJ in Twycross v Grant observed
that a promoter is ‘one who undertakes to form a company with reference to a given project and
to set it going and who takes the necessary steps to accomplish that purpose’.

In conclusion, one can say that promoter connote any individual, syndicate, association,
partnership or a company, which takes all the necessary steps to create company and mould a
company and set it going [9] .

Pre-incorporation Contract

The promoter is obligated to bring the company in the legal existence and to ensure its successful
running,; and in order to accomplish his obligation he may enter into some contract on behalf of
prospective company. These types of contract are called ‘Pre-incorporation Contract’.

Nature of Pre-incorporation contract is slightly different to ordinary contract. Nature of such

contract is bilateral, be it has the features of tripartite contract. In this type of contract, the
promoter furnishes the contract with interested person; and it would be bilateral contract between
them. But the remarkable part of this contract is that, this contract helps the perspective
company, who is not a party to the contract.

One might question that ‘why is company not liable, even if it a beneficiary to contact’ or one
might also question that ‘doesn’t promoter work under Principal-Agent relationship’.

Answer to all those question would be simple. The company does not in legal existence at time
of pre-incorporation contract. If someone is not in legal existence, then he cannot be a party to
contract, and ‘Privity to Contract’ doctrine excludes company from the liability. In Kelner v
Baxter, Phonogram Limited v Lane

In pure common law sense, Pre-incorporation contract does not bind the company. But there are
certain exceptions to this contract, and these exceptions were developed in USA, India and later
in England.

Chapter II: Liability of Promoter Concerning Pre-incorporation Contract

Before the passing of the Specific Relief Act 1963, the position in India, regarding pre-
incorporation contract, was similar to the English Common Law. This was based on the general
rule of contract where two consenting parties are bound to contract and third party is not
connected with the enforcement and liability under the terms of contract. And because company
does not come in existence before its incorporation, so the promoter signs contract on behalf of
company with third party, and that is why the promoter was solely liable for the pre-
incorporation contract under the established ruling of Kelner v Baxter.

Liability of Promoter

Promoters are generally held personally liable for pre-incorporation contract. If a company does
not ratify or adopt a pre-incorporation contract under the Specific Relief Act, then the common
law principle would be applicable and the promoter will be liable for breach of contract.

Whether Promoter is personally Liable for Pre-incorporation Contract?

In Kelner v Baxter, where the promoter in behalf of unformed company accepted an offer of Mr.
Kelner to sell wine, subsequently the company failed to pay Mr. Kelner, and he brought the
action against promoters. Erle CJ found that the principal-agent relationship cannot be in
existence before incorporation, and if the company was not in existence, the principal of an agent
cannot be in existence. He further explain that the company cannot take the liability of pre-
incorporation contract through adoption or ratification; because a stranger cannot ratify or adopt
the contract and company was a stranger because it was not in existence at the time of formation
of contract. So he held that the promoters are personally liable for the pre-incorporation contract
because they are the consenting party to the contract.

In Newborne v Sensolid (Great Britain) Ltd, Court of Appeal interpreted the finding of Kelner v
Baxter in a different way and developed the principle further. In this case an unformed company
entered into a contract, the other contracting party refused to perform his duty. Lord Goddard
observed that before the incorporation the company cannot be in existence, and if it is not in
existence, then the contract which the unformed company signed would also be not in existence.
So company cannot bring an action for pre-incorporation contract, and also the promoter cannot
bring the suit because they were not the party to contract.

This case created some amount of confusion that, if the contract was sign by the agent or
promoter, then he will be liable personally and he has the right to sue or to be sued. But if a
person representing him as director of unformed company enters into the contact then the contact
would be unenforceable. This distinction was found objectionable by the Windeyer J in Black v
Smallwood and this was also criticized by Professor Treitel in the Law of Contract. Later in
Phonogram Limited v Lane, Lord Denning settled the position, he found that if an unformed
company enters into the contact, then it cannot bind the company, but the legal effect of contract
does not entirely lack. And even in that situation the promoter or representor are personally liable
for the pre-incorporation contract.

In Phonogram Limited v Lane, a person was attempting to from a company which was going to
run a pop artists group and that person arranged financial assistance from a recording company.
But this company never came in existence, and the amount was due. The recording company
brought an action against the person who represented the unformed company. Lord Denning
analyzed Kelner v Baxter, Newborne v Sensolid, Black v Smallwood and the section 9(2) of the
European Communities Act, 1972 [10] , and found that the promoters are personally liable for
the pre-incorporation contract.

These principles were found applicable in Indian case. In Seth Sobhag Mal Lodha v Edward Mill
Co. Ltd., the High Court of Rajsthan followed the approach of Common Law regarding liability
of pre-incorporation contract. This case was criticised by A. Ramaiya in Guide to Companies Act
(Sixth Edition), he found that learned judges did not noticed the Specific Relief Act [11] .

How can promoter shift his liability and right to company

Although under common law promoter is personally liable for the pre-incorporation contract, but
there are some scope where the promoter can sift his liability to company. He can shift to
company his liability under the Specific Relief Act 1963 or he can go for novation under contract
law.

Under Specific Relief Act

Under the Specific Relief Act 1963, section 15(h) and 19(e) are the two important sections for
pre-incorporation contract. Section 15 is about stranger’s right to sue if he entitled to a benefit or
has any interest under the contract, although it has certain limitation. Section 15(h) talks about
the company, being a stranger to pre-incorporation contract, has the right to sue to the other
contracting party. But the necessary condition is that the contract should be warranted by the
terms of its incorporation. This provision clearly negates the common law doctrine [12] which
says that the company cannot ratify or adopt the pre-incorporation contract [13] . Under this
provision promoter can give his right to sue to sue to the company. In Vali Pattabhirama Roa v
Sri Ramanuja Ginning and Rice Factory Pvt. Ltd.
On the other hand, section 19(e) states that the company can be sued by the other party of pre-
incorporation contract, if the terms of incorporation warrant and adopt the contract. This
provision reduces the promoter of liability of pre-incorporation contract.

Under Novation of Contract

Novation of contract is defined in Scarf v Jardine [14] as, ‘being a contract in existence, some
new contract is substituted for it either between the same parties (for that might be) or different
parties, the consideration mutually being the discharge of the old contract’ [15] .

Novation is different from the Ratification [16] ; because in Novation, a new contract is made on
the same terms but this time between the company and the third party [17] , whereas in
Ratification, dates back to the time of the act ratified, so that if the company ratifying, who is not
in existence, cannot itself have then performed the act in question its subsequent ratification of it
is ineffective [18] .

In the situation of Novation of Contract, the Company can replace the promoter from the pre-
incorporation contract. But one might say that such contract would not be called pre-
incorporation contract, but it should be called post-incorporation contract; because novation of
contract result into a new contract.

In Howard v Patent Ivory Manufacturing [19] ,

Doctrine of equity

Intension

Chapter III: Brief Comparison between Indian and other countries Law
regarding Promoter’s Liability for Prep-incorporation Contract

Conclusion