Promoters and preincorporation contracts

ARUN VERMA (C)

1. PROMOTERS AND PREINCORPORATION CONTRACTS Arun Verma 1 (C) Arun Verma

2. PROMOTERS Under Section(Section 2(69) Companies Act 2013 “Promoters” is not a term of art, nor a term of law, but a term of Business. Promoter is a person who brings about the incorporation and organisation of a corporation. He brings together the persons who become interested in the enterprise, aids in procuring subscriptions, and in motion the machinery which leads to the formation itself. Whether a person is a promoter or not is a question of fact in each case. (C) Arun Verma 2

3. Test to Determine – Who is Promoter One who works from the very beginning One who formed scheme to build a company One who provisionally formed company One who prepare Prospectus One who is being paid for printing and advertising and other incidental to formation of a company i.e. Attorney's fee One who is discharged from his liabilities as soon as governing body, like board of directors starts functioning [ Twycross v Grant (1877) 2CPD 469 CA] In USA, the Securities Exchange Commission Rule 405(a) defines promoter as a person who, acting alone or in conjunction with other persons directly or indirectly takes the initiative in founding or organizing the business enterprise. (C) Arun Verma 3

4. PROMOTERS UNDER SECTION 2 (69) COMPANIES ACT, 2013 “promoter” means a person— ( a ) who has been named as such in a prospectus or is identified by the company in the annual return referred to in section 92; or ( b ) who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or ( c ) in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act: Provided that nothing in sub-clause ( c ) shall apply to a person who is acting merely in a professional capacity; i.e. CA, Attorney (C) Arun Verma 4

5. In  Lagunas Nitrate Co. v. Lagunas Syndicate  [1889] 2 Ch. 392 (p. 428, C.A.), it was stated that “to be a promoter one need not necessarily be associated with the initial formation of the company; one who subsequently helps to arrange floating of its capital will equally be regarded as a promoter. Duties of Promoter The promoters occupy an important position and have wide powers relating to the formation of a company. It is, however, interesting to note that so far as the legal position is concerned, he is neither an agent nor a trustee of the proposed company . But it does not mean that the promoter does not have any legal relationship with the proposed company. The promoters stand in a fiduciary relation to the company they promote and to those persons, whom they induce to become shareholders in it. (C) Arun Verma 5

6. DUTIES OF PROMOTERS Duty to disclose secret profits Duty of disclosure of interest Promoter’s duties under the Indian Contract Act Termination of Promoter’s Duties Remedies available to the company against the promoter for breach of his duties Rescission of contract To recover secret profit (C) Arun Verma 6

7. LIABILITIES ON PROMOTERS A promoter is subjected to liabilities under the various provisions of the Companies Act. · Section 26 of the Companies Act, 2013 lay down matters to be stated in a prospectus. A promoter may be held liable for non-compliance of the provisions of the section. · Under section 34 and 35, Companies Act, 2013 a promoter may be held liable for any untrue statement in the prospectus to a person who subscribes for shares or debentures in the faith of such prospectus. However, the liability of the promoter in such a case shall be limited to the original allottee of shares and would not extend to the subsequent allotters. · According to section 300, a promoter may be liable to examination like any other director or officer of the company if the court so directs on a liquidator’s report alleging fraud in the promotion or formation of the company. A company may proceed against a promoter on action for deceit or breach of duty under section 340 , where the promoter has misapplied or retained any property of the company or is guilty of misfeasance or breach of trust in relation to the company. The Madras High Court in  Prabir Kumar Misra v. Ramani Ramaswamy  [2010] 104 SCL 174, has held that to fix liability on a promoter, it is not necessary that he should be either a signatory to the Memorandum/Articles of Association or a shareholder or a director of the company. Promoter’s civil liability to the company and also to third parties remain in respect of his conduct and contract entered into by him during pre-incorporation stage as agent or trustee of the company. (C) Arun Verma 7

8. Pre incorporation contracts These are contracts which the promoters of the company make before the company is incorporated, on the assumption the company will assume responsibility for the contract “ A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly” 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 these entire questions 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.

9. Under Section 19 (e) of the Specific Relief Act, 1963, Except as otherwise provided by this Chapter, specific performance of a contract may be enforced against the company, when the promoters of a company have, before its incorporation, entered into a contract for the purpose of the company and such contract is warranted by the terms of the incorporation. In  Weavers Mills Ltd. v. Balkies Ammal  [AIR 1969 Mad 462], the Madras High Court extended the scope of this principle through its decision. In this case, promoters had agreed to purchase some properties for and on behalf of the company to be promoted. On incorporation, the company assumed possession and constructed structures upon it. It was held that even in absence of conveyance of property by the promoter in favor of the company after its incorporation, the company’s title over the property could not be set aside. 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. (C) Arun Verma 9

10. PRE- INCORPORATION CONTRACTS A pre-corporation contract is one which is entered into when the Company is in the process of being incorporated but is not yet completed it. At common law such contracts were held to be void, as the Company is not yet in existence. Newborne v Sensolid [1954] IN the case of  Kelner x Baxter  [1866] certain individuals were purportedly acting on behalf of the Gravesend Royal Alexandra Hotel Co. Ltd which was in the process of being formed. The individuals entered into a contract for the purchase of wine from K. The wine was delivered to the Company after its formation but before K was paid the Company went into liquidation. The Court held that the Company was not liable but the individuals were personally liable as they had entered into contracts before the Company came into existence.

11. Braymist v Wise Finance Co Ltd [2002] Promoter personally liable for pre-incorporation contracts and Promoter can personally enforce a pre-incorporation contract. In conclusion we can say that, a promoter is personally liable for the pre-incorporation contract, because at the time of formation of pre-incorporation contract, the company does not come in existence, so neither the principle agent relationship exist not the company become the party. Company is not liable for the pre-incorporation contract when it come in existence, but under the arrangement of section 15(h) and 19(e) of the Specific Relief Act 1963, company can take the rights and liability of promoter. It is also found that promoter is personally liable for the pre-incorporation contract in American Law, English Law and Indian Law.. (C) Arun Verma 11

12. THANK YOU (C) Arun Verma 12