THE ROLE AND DUTIES OF COMPANY PROMOTER VIS-À-VIS PRE-INCORPORATION CONTRACTS — A CRITICAL ANALYSIS

By Chandan Kumar and Anushka Kashyap

Photo by Gabrielle Henderson on Unsplash

ABSTRACT

The promoters perform the incorporation function and bring the
company into existence. It also conceptualizes the idea of a company
and the purpose of its formation. But there is a number of legal
consequences in relation to the promoter and pre-incorporation
contract as it enters into a contract on behalf of a company before its
incorporation. The company is an artificial person and it can enter
into any agreement but it cannot enter into any agreement prior to its
incorporation or completion of the registration process. Therefore, the
contracts which are entered by the promoters for the purpose to
promote the company are concluded in their own names by the
promoters referred to as pre-incorporation contracts. The endeavour
of the present paper is to analyse the role and duties of a company
promoter in the light of the burry legal position of pre-incorporation
contracts in India. To accomplish this, the researcher would initially
understand the roles and duties of a company promoter while
contracting for the company before its formal registration. The
researcher also describes the complexities regarding the validity of
pre-incorporation contracts in India.

INTRODUCTION

Any contract must be executed by two competent parties in order to be valid.¹ The incorporation of a firm marks the beginning of its competence.² This grants it a separate legal personality³ and the duties and responsibilities of the contract fall entirely on the shoulders of the corporation rather than the director, member, or promoter.⁴ A corporation is run by a group of people working for the corporation as well as on behalf of the corporation. The problem emerges, however, when somebody claims to be operating on behalf of a corporation that is practically not a corporation considering the lack of incorporation/registration and contracts on behalf of the corporation while it is in the process of being incorporated. Such contracts are therefore referred to as pre-incorporation contracts.⁵

Typically, this contract includes three parties: the promoter, the party with whom the contract is made, and the company which will be deemed a party only when it’s incorporated. Such a contract’s legal standing is quite dubious. That is, how can someone contract on behalf of an entity that has not yet been founded? This brings us to the main issue with regard to the legal standing/recognition of such a contract. Besides the preceding point, another critical issue concerning the duties and responsibilities of parties can be posed in this respect. Various issues concerning the same are associated which will be dealt with in this paper. Looking into the provisions of the Indian legal system, it can be observed that the position of pre-incorporation contracts in India is ambiguous. There are several combinations of conditions that could arise, and the legality and enforceability of a pre-incorporation agreement in these various instances are uncertain.⁶

The Specific Relief Act, 1963 which establishes when corporations can sue and when they can be sued for a pre-incorporation contract, seems to be the only source of guidance.⁷ However, the corporation’s rights and duties are simply one component of the agreement. Furthermore, the Specific Relief Act, 1963 could only be used in limited cases.⁸ The lack of case law elaborating on this notion has been a key stumbling block in finding solutions to the many problems. Contract enforcement in India is regarded as a time-consuming process, leading to fewer case laws and little legal growth.

COMPANY PROMOTER: ROLES AND DUTIES

A promoter performs a vital role in the process of incorporation of a company. The promoters perform the incorporation function and bring the company into existence.⁹ The incorporation itself begins with the promotion. It also conceptualizes the idea of a company and the purpose of its formation. A promoter is said to be a person 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.”¹⁰ Before the company is founded, the promoters have a variety of responsibilities, including incorporation and pre-incorporation contracts. The term promoter has been defined in various places such as the Companies Act, 1956,¹¹ SEBI (Issue of Capital and Disclosure Requirements) Regulations 2011,¹² and many more; however, neither of these definitions relate to the role and duties of a promoter regarding the pre-incorporation contracts. Section 2(69) of the Companies Act, 2013 provides an inclusive definition of the term promoter rather than a descriptive definition that includes circumstances after incorporation, not before.¹³

Being a promoter, one does not have to be involved in the company’s primary inception; somebody who later assists with the flotation of its capital is also considered a promoter.¹⁴ A promoter is in charge of drafting the Memorandum of Association, Articles of Association, and Prospectus. It gathers capable directors who will represent the company, pays all of the initial costs, and furthermore seeks appropriate investors to stabilize the capital of the company. Aside from that, he holds responsibility for suppliers, legal representatives, and other individuals that are essential for the formation of a company. It undertakes the work of submitting the required documentation to the Registrar of Companies for the certificate of incorporation. In other words, a promoter helps a company stand on its own.¹⁵

Even though legal precedent and open debate on this topic have been complex and ambiguous, the legal position in India described the relationship between the two as a fiduciary relationship. It dismissed the promoter’s status in relation to the unincorporated corporation as one of the agencies or trustees.¹⁶ The court in the case of Weavers Mills v. Balkis Ammal¹⁷ determined that, even though the promoter did not expressly deliver properties to the unincorporated firm, all of the advantages of the pre-incorporation arrangement would go to the company since the promoter owed the company a fiduciary obligation. It should be remembered that a fiduciary relationship is one built on honesty, reliability, and faithfulness.¹⁸

A promoter enters into various agreements and contracts including a pre-incorporation contract while performing as the promoter of a company. There is a number of legal consequences concerning promoter and pre-incorporation contract as it enters into a contract on behalf of a company before its incorporation. The company is an artificial person and it can enter into any agreement but it cannot enter into any agreement prior to its incorporation or completion of the registration process. Therefore, the contracts which are entered by the promoters for the purpose to promote the company are concluded in their own names by the promoters.¹⁹

There’s no statutory provision in the Companies Act, 2013 that species any duty of the promoter. However, certain provisions impose certain liability as well as a punishment upon the promoter in case of any criminal or civil misconduct.²⁰ Nevertheless, the judiciary has contributed significantly to establishing promoters’ obligations because there have been multiple instances when promoters have attempted to gain personal benefits at the expense of other stakeholders.

The most typical strategy for promoters to gain secret profits has been by acquiring a business or property and afterward transferring it to a corporation for a greater price. It is not illegal for a promoter to generate profits, but it is illegal for him to generate income in secret. He could earn from promotion with the company’s permission, just as an agent can earn with his principal’s assent and shall disclose his interest and profits to the stakeholders of the company. Further, in addition to this duty, a promoter must also disclose to the corporation any stake he has in any contract or agreement it has signed into.²² After making a secret profit, a promoter can seek company consent through a variety of methods. Providing facts to an independent board of directors, disclosing information to each share subscriber, or ratification by vote are all options. Whatever path is chosen, it is worth remembering that the promoter’s eventual aim is to obtain corporate consent.²³

Furthermore, section 26 of the Companies Act, 2013 places liability upon the promoter to disclose all particulars regarding any legal action pending or taken against him in the last five years immediately preceding the year of issue of the prospectus.²⁴ All the above disclosure shall be made to an independent and competent board of directors (in case it is present) and to the initial capital providers (in case the board of directors is not present).²⁵ Considering the foregoing, the term promoter has no precise definition in India, and the promoter’s responsibilities are not listed anywhere. However, it has developed through time as a result of the Indian judiciary’s concerted efforts in deciding diverse cases in this area.

Pre-Incorporation Contracts In India: A Blurry Position

The promoters of a firm engage in contracts for a company that has yet to be established in order to complete the appropriate requirements and generate the vital resources for the foundation of the company. Such contracts are usually carried out by promoters in order to obtain certain assets or rights for the firm that they want to promote.

Even after incorporation, pre-incorporation contracts are still not legally binding on the company. Even though it has benefited from the services performed on its account under the contract, it cannot bind the company.²⁶ The rationale is that the company cannot enter into contracts until it is incorporated because it does not have a legal entity.²⁷ Not only that, but the business is unable to ratify such transactions after its incorporation since the principal must have existed back the promoters engaged in the contracts in order for ratification to be legal.²⁸ Because a company is a non-entity before it is incorporated, it cannot sue or be sued upon these contracts.²⁹

There are two issues with pre-incorporation contracts. On the one hand, the promoters are at peril because the company may circumvent such contracts after incorporation, claiming that they were outside the purview of incorporation and thus personally obligated, and on the other hand, service providers may be at risk because the contract may be overlooked by the company after incorporation, claiming that it was not authorized by it.³⁰

This situation was, however, before 1962. In 1962, Jenkins Committee presented a report recommending: “that a company may unilaterally adopt contracts which purport to be made on its behalf or in its name prior to incorporation and thereby become a party to the same extent as if the contract had been entered into after incorporation.”³¹ Working on this recommendation, the problem with regard to the pre-incorporation contract was removed under the English company laws, and subsequently, several provisions were incorporated under the Indian legal system by the way of enumeration under the Specific Relief Act, 1963.³²

According to an analysis of Sections 15(h) and 19(e) of the Specific Relief Act, 1963, a pre-incorporation contract must have been carried out for the interests of the prospective company and must have been authorized by the provisions of the incorporation for it to be legitimate before the law.³³ In addition, the acceptance of the contract must be made to the service provider. However, there are other ways to enforce a contract alongside express ratification and acceptance. If a company enjoys the advantages of a pre-incorporation contract, the contract isn’t completely null and void, and actions can still be assessed based upon that.³⁴ The Supreme Court of India has ruled that the term “warranted by the terms of incorporation” must be interpreted as a sign that it must not be in violation of the company’s interest and intent, and has rejected the argument that a pre-incorporation contract must be accepted under an express term outlined in the articles.³⁵

However, in India, a comprehensive standard under the Specific Relief Act, 1963 cannot be developed for all pre-incorporation transactions. It must be interpreted in light of other statutes and the appropriate context. There were multiple cases involving the same issue, and the courts reached different conclusions in each of them. Some upheld the validity, stating that it did not contradict any statutory provisions, while others stated that when interpreting a concept, precautions must be exercised to ensure that the contract is not only violative of the objects/interests but also contributes in some manner to the core activity for which the company is supposed to be incorporated.³⁶

As a result, the demarcation becomes quite hazy and convoluted, making interpretation extremely subjective. Therefore, it is proposed that the Supreme Court’s stance be upheld, which indicates that as long as it does not violate the Company’s objectives provision, it should be entrusted to the corporation to ratify the pre-incorporation contracts.

The problem is that, although the Specific Relief Act, 1963 addresses the requirements of execution between the firm and the related party, there remains a legal gap in India whenever it pertains to contractual implementation without any such ratification. Can the promoter be held liable for the contract in this case, or would the promoter be released from duty after the entity ratifies the contract? There are no provisions in the Indian legal system or remarks by the Indian judiciary that address this issue. However, the Common Law, as well as American jurisprudence, addresses the issue giving prime importance to the intention of the parties as well as placing strict liability upon the promoter in case the corporation is not incorporated.³⁷

There are various commentaries and pieces of literature suggesting that this issue shall be dealt with according to the provisions of the Indian Contract Act, 1872 discharging the promoter from liabilities under section 230 on any breach or refusal.³⁸ However, it should be noted that section 230 of the Indian Contract Act, 1872^³⁹ talks about the liability and responsibility of the agent when acting on behalf of the principal, and including the issue in this context will contradict the established position that a promoter is neither agent nor a trustee of the prospective company rather there is a fiduciary relationship between them.⁴⁰

The next issue that comes up with regard to the promoter’s liability is that will it continue even after the corporation has ratified the pre-incorporation contract or if the promoter will be relieved from the liability. Under the provisions of the Specific Relief Act, 1963, unilateral ratification of pre-incorporation contracts is permitted even without express assent by the third party. While doing so, it should be noted that the company’s adoption of the contract does not ensure that the promoter will be free of all responsibilities. The promoter seems to have no personal stake in the contract when the business is formed, and it is simply by virtue of the company. As a result, holding the promoter accountable is unjust. Hence, the provision should be introduced in India to protect promoters’ interests in such circumstances, making the situation better and more equitable for all parties.

Further, the issue arises of whether the promoter, as a fiduciary, compels the business to reimburse it for the pre-incorporation costs that the promoter pays on the company’s behalf. One argument is that if the corporation accepts the contract’s rewards, it must also take the contract’s burden, and thus must reimburse the promoter for any costs paid under the deal. The promoter, on the other hand, cannot demand compensation if the corporation does not ratify the contract.⁴¹

CONCLUSION

The promoter engages in a variety of activities. From preparing the prospectus to terminating a company, the promoter is engaged in practically every important phase of the way. An excellent promoter is someone who is interested in giving a company structure and undertakes all required steps to do so. In India, there has been great progress in the formation of businesses, and a promoter serves an important part in this.

Despite promoters having significant importance in a company, the legal standing of promoters with regard to pre-incorporation contracts is ambiguous in the Indian legal arena. There are certain provisions dealing with the promoter, rights, and liabilities, but they cannot be termed efficient to protect the interests of promoters and other parties. The solution to the liabilities of promoters lies somewhere in the Companies Act, 2013 and the Specific Relief Act, 1963 but that’s not sufficient to address the issue of the pre-incorporation contract. The primary issue concerning the enforceability of the pre-incorporation contract is summarily dealt with in the above act providing that if the agreements are warranted by terms of incorporation, then they can be enforced. This provision should be interpreted carefully to clear the ambiguity in the law.

Analyzing the above, it can be clearly stated that there is no legal position of the promoter in the company rather he has only fiduciary relation with the company which aims to shape the company and incorporate it in good faith. The provisions are clear as to whether he should not make secret profits, shall disclose every single detail in the prospectus as well as share subscribers, and ensure compliance with statutory provisions while incorporating a company. However, in India, the status of the pre-incorporation contract is unclear, and the Indian legislature must take several steps to incorporate elements in the law that make it obvious and advantageous to all.

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1. The Indian Contract Act 1872 § 10.
2. The Companies Act 2013 § 9.
3. The Companies Act 2013 § 21.
4. Salomon v. Salomon, [1897] AC 22.
5. A. Akshitha & M. Kannappan, Pre-Incorporation Contracts and Promoters -Theoretical and Practical Issues, 119(17) International Journal of Pure and Applied Mathematics 671, 674 (2018).
6. Prasidh Raj Singh, Promoter & Pre incorporation contract, SSRN Electronic Journal (2011).
7. The Specific Relief Act 1963 § 15(h) and 19(e).
8. The Specific Relief Act 1963 § 10.
9. Erlanger v. New Sombrero Phosphate Co, (1878) 3 App Cas 1218.
10. Twycross v. Grant, (1877) 2 CPD 469 (CA).
11. The Companies Act 1956 § 62.
12. The Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2011.
13. The Companies Act 2013 § 2(69).
14. Lagunas Nitrate Co. v. Lagunas Syndicate, (1889) 2 Ch. 392.
15. Sumit Kumar Suman, Position of Promoter in India: Critical Analysis, Academike-Lawctopus (Apr. 04, 2015), https://www.lawctopus.com/academike/position-promoter-india-critical-analysis/.
16. Supra note 9
17. Weavers Mills v. Balkis Ammal, AIR 1969 Mad. 462.
18. H.K. Saharay, Company Law 20 (5 ed., Universal Law Publishing 2010).
19. Shivam Krishnam, Roles and Responsibilities of promoters in Company Law, 3(2) International Journal of Law Management & Humanities 684 (2020).
20. The Companies Act 2013 § 34, 35, and 36.
21. Gluckstein v. Barnes, (1900) AC 240.
22. Dr. G.K. Kapoor & Dr. Sanjay Dhamija, Company Law & Practice 115 (25 ed., Taxmann 2021).
23. J.H.J., Corporations: Liability of Promoters for Secret Profits, 34(8) Michigan Law Review 1189 (1936).
24. The Companies Act 2013 § 26.
25. Lagunas Nitrate Co. v. Lagunas Syndicate, (1889) 2 Ch. 392.
26. Natal Land Co. Ltd. v. Pauline Colliery Syndicate Ltd., (1904) AC 120; Newborne v. Sensolid (Great Britain) Ltd., (1954) 1 QB 45; Re, Northumberland Avenue Hotel Co., (1886) 33 Ch D 16 CA.
27. Outmoded Concept Dominates Law of Promoters’ Pre-Incorporation Contracts, 2 Stanford Intramural Law Review 119 (1948).
28. Joseph Savirimuthu, Pre- incorporation contracts and the problem of corporate fundamentalism: are promoters proverbially profuse?, 24 Company Lawyer 196 (2003).
29. Kelner v. Baxter, (1866) 15 LT 213.
30. Lakshmi Dwivedi & Varun Byreddy, Pre-incorporation contracts: a legal puzzle in India, 5(1) NLIU Law Review 32 (2016).
31. Lord Jenkins, Report of the Company Law Committee, Board of Trade (1962), https://www.takeovers.gov.au/content/Resources/other_resources/downloads/jenkins_committee_v2.pdf.
32. H.R. Saviprasad, Pre-Incorporation Contracts: A Comparative Analysis of Indian and English Laws, 44(1) Journal of the Indian Law Institute 117, 127 (2002).
33. The Specific Relief Act 1963 § 15(h) and 19(e).
34. Supra note 17
35. Jai Narain Parasurampuria (Dead) v. Pushpa Devi Saraf, (2006) 7 SCC 756.
36. K.M. Ghosh & Dr. K.R. Chandratre, Company Law with Secretarial Practice (13 ed. Bharat Law House 2007).
37. Supra note 30
38. A. Ramaiya, Guide to the Companies Act (17 ed., LexisNexis 2010).
39. The Indian Contract Act 1872 § 230.
40. Supra note 9
41. Harry G. Henn & John R. Alexander, Law of Corporations (3 ed., West Publishing Co. 2007).

The first author is a Year IV B.Com. LL.B. (Hons.) student and the second author is a Year IV B.A. LL.B. (Hons.) student at the Tamil Nadu National Law University, Tamil Nadu.

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