Promoters

The proviso. Nothing in limb (c) applies to a person acting merely in a professional capacity. Without it, every solicitor and chartered accountant whose advice a board habitually follows would be a promoter, which would deter exactly the professional advice the Act wants companies to take. Note the confinement: the proviso protects against limb (c) only, so a professional who also controls the affairs of the company is not saved by it.

The fiduciary position, and what it requires

The Act defines the promoter but does not codify his duties; those remain equitable, and the leading authority is named here without a citation, its report not having been read in this book's sources. In Erlanger v. New Sombrero Phosphate Co. a syndicate bought an island's phosphate rights and sold them to a company it had formed, whose board it had appointed, at a large profit, and the company was allowed to rescind: a promoter who sells his own property to the company must make full disclosure to an independent board, or to the members, and disclosure to a board he himself controls is no disclosure at all.

Three practical rules follow, and they are the answer to any problem question in this area.

Disclosure, not prohibition. The promoter is not forbidden to make a profit. He is forbidden to make a secret profit. A properly disclosed profit, approved by an independent organ, stands.

To whom disclosure must be made. An independent board, or the members as a body, or, where the company is to be floated, the prospectus, which is why s.26 requires prospectus disclosures and why the promoter's own interests must be stated.

The remedies. Where the duty is broken, the company may rescind the contract and recover the property against restoration of the price; or affirm the contract and recover the secret profit; or, where those are impracticable, claim damages for breach of fiduciary duty. The choice belongs to the company, and rescission is barred by delay, affirmation with knowledge, or the intervention of third-party rights.

A second case is traditionally cited for the promoter's position in India, and it is named here without a citation for the same reason. In Weavers Mills Ltd. v. Balkis Ammal two promoters bought land in their own names before the company was incorporated and the company later dealt with it; the title held, on the footing that the promoters held it in trust for the company and the vesting required no separate conveyance. The case is worth naming for a point of Indian practice, and worth flagging for a trap: the solved-paper audit for this subject recorded it being cited three times for the wrong proposition, separate property, when it is a promoters' case.

Where the Act itself uses the promoter

Formation and fraud. Section 7(5) makes a person liable for action under s.447 where false or incorrect information or a declaration is furnished in the incorporation documents. Section 7(6) extends liability to the promoters, the persons named as first directors and the persons making the declaration, and s.7(7), examined in [Incorporation and Its Conclusiveness], empowers the Tribunal to act where incorporation was so obtained, including by declaring the liability of members unlimited.

Prospectus. Section 26 requires the prospectus to state the prescribed information and reports; s.35 imposes civil liability for misstatements on, among others, every promoter of the company, treated in [Civil Liability for the Prospectus]; and s.34 imposes criminal liability. Section 102 requires the explanatory statement annexed to a notice to disclose the concern or interest of promoters, treated in [Calling a General Meeting].

Continuing identification. Section 92 requires the annual return to carry particulars of promoters, which is limb (a)'s second half operating year after year.

Winding up. Section 300 empowers the Tribunal to order the examination of promoters, directors and officers where the liquidator's report alleges fraud, and the delinquency provisions in [Delinquency and Public Examination] reach them.

A worked example

Kabir owns a small distillery valued at one crore twenty lakh rupees. He decides to float Deccan Spirits Limited to acquire it, appoints his brother and his accountant as the first directors, and sells the distillery to the company for two crore rupees, the price being paid out of the money raised from the public. The prospectus states that the company will acquire "a going distillery business" and that Kabir is the promoter, but says nothing about what he paid or when he acquired it.

Is he a promoter? Yes on limb (a), being named in the prospectus, and independently on limb (b), having control.

Has he breached his duty? Yes. He has sold his own property to a company whose board he constituted, at a profit of eighty lakh rupees, and disclosed neither the profit nor his acquisition cost. Disclosure to his brother and his accountant is not disclosure to an independent board, which is precisely what Erlanger decided.

What can the company do? On the reconstituted board, or at the instance of members, it may rescind the purchase and recover the two crore rupees against returning the distillery, if restitution is still possible and no third party has intervened; or affirm the purchase and sue Kabir for the eighty lakh rupee secret profit; or claim damages if neither is practicable. It cannot both keep the distillery at the inflated price and recover the whole price, and stating that election is what an examiner is looking for.

And what else follows. Subscribers who bought on the prospectus have their own remedy under s.35 against the promoter for the untrue statement, and, if the omission was fraudulent, s.34 exposes him to criminal liability under s.447; those are separate from the company's claim and belong to the investors.

Vary it once. Suppose Kabir had bought the distillery after agreeing to promote the company, had told the members in general meeting, before allotment, exactly what he paid and what he was charging, and the prospectus had carried the same particulars. The profit would then be lawful and unimpeachable, because the objection was never to the profit; it was to the silence.

Distinctions

What it does NOT mean

Not an agent or trustee of the company. The company does not exist when he acts, so he cannot be its agent; his position is fiduciary by analogy, which is why the remedies are equitable rather than contractual.

Not entitled to be paid for his services. A promoter has no claim against the company for his efforts unless the company, once formed, agrees to pay, and preliminary expenses are payable only if the company chooses to reimburse them.

Not confined to those named as promoters. Limbs (b) and (c) reach the person in control and the person whose instructions the Board follows, whatever the documents say.

Quick revision

s.2(69): named in a prospectus or identified in the s.92 annual return; or control over the affairs directly or indirectly as shareholder, director or otherwise; or the Board accustomed to act on his advice, directions or instructions; proviso for a person acting merely in a professional capacity, which protects against the third limb only. Fiduciary at common law: no secret profit; disclosure to an independent board or to the members; Erlanger, named uncited. Remedies: rescission, recovery of the profit, or damages, at the company's election. Statutory hooks: s.7(5) to (7) false information and Tribunal powers; s.26 prospectus contents; ss.34 and 35 criminal and civil liability; s.102 explanatory statement; s.92 annual return; s.300 examination in winding up.

Test yourself

1. A chartered accountant advises a board which invariably follows his advice. Is he a promoter? Not by reason of that alone: the proviso to s.2(69) excludes a person acting merely in a professional capacity from the third limb. He would be a promoter if he independently satisfied the control limb.

2. State the promoter's core duty in one sentence, and the case that established it. He must not make a secret profit out of his position and must disclose any profit to an independent board or to the members; Erlanger v. New Sombrero Phosphate Co., named here without a citation.

3. A promoter sells his land to the company at a profit, disclosing everything to a board he appointed. Sufficient? No. Disclosure to a board he controls is no disclosure; it must be to an independent board or to the members, and in a flotation the prospectus is the vehicle.

4. What are the company's alternative remedies, and can it have both? Rescission with restitution, or affirmation with recovery of the secret profit, or damages where neither is practicable. It must elect; it cannot keep the property at the inflated price and also recover the entire price.

5. Which provisions of the Act attach consequences to promoter status? Sections 7(5) to (7), 26, 34, 35, 92, 102 and 300, among others, covering false incorporation information, prospectus disclosure and liability, annual-return identification, explanatory statements and examination in winding up.