This article is written by S.Aditya, an alumnus of KLE Society’s Law College, Bengaluru. This article focuses on the provisions regarding the Incorporation of Companies also analysing the functions, duties and liabilities of the Promoter under the Companies Act of India, 2013.

Introduction

The formation and incorporation of a company are very much similar to the birth of a human like it also goes through various stages of formation of its body parts during the womb stage. Various groundwork is carried out to bring a company into existence. The process of an idea converting into a company includes various stages, these crucial stages of the pre-incorporation and formation stages are discussed in detail as under. This article explains the functions, duties and liabilities of a promoter along with providing insights into cases regarding pre-incorporation contract. This article dwells into the integrated process of Company registration.

Promotion

As the name suggests this stage of incorporation deals with the promotions of the yet to be incorporated Company. It is the stage where the Promoter walks in the market of the potential investors to collect the investment towards an idea which might be his own brainchild or of someone else.

The Promoter induces the confidence on the idea, over the investors and tries to build upon the investment so as to be able to incorporate the company. Promoter has been defined under Section 2(69) of the Companies Act, 2013. Technically a promoter is a person so named in the prospectus of the Company. The Company shall also name their promoter in the annual return made under Section 96 of the Companies Act, 2013.

A Promoter is to a company, as Parents is to a child. The Promoter along with convincing investors towards the idea of the company also brings together the physical capital of the labour, raw materials, managerial ability, machinery etc. 

The Promoter although is passionate towards the company’s ideas, but has to SWOT analyse the idea with respect to the future prospects and feasibility with respect to the societal dynamics. 

The idea of promoter can be seen with having 3 different perspectives: 

• promoter is someone who is identified in the prospectus of the company or is mentioned as a promoter in the annual returns of the company, and/or 
• promoter is a person who has the power to appoint majority of members of board of directors or person having authority over making policies or making decisions for the company, and/or 
• promoter is a person on whose advice board of directors are accustomed to act.

Functions of a Promoter

(i) Spotting a Business Demand in the Market 

The promoter before promoting a company idea first identifies a potential business opportunity. The potential opportunity may be any new product or a new service or may even be the production or manufacture of an already established product by new means.

(ii) The practicality of the Idea

The promoter has to evaluate the idea of the new potential company under the magnifying glass of technical and financial feasibility. Therefore, it is but important that the promoters undertake detailed studies regarding all aspects of the business idea by using various tools such as the economic studies of the market, taking opinions of the technical experts of such products, opinions of the chartered accountants, economists etc. The idea which the promoter intends to use for perpetrating the market. The feasibility of the idea can be evaluated using the below mentioned three tests.

• Technical conceivability: the ideas of the business may be good but sometimes they may be technically difficult to conceive into reality given such hurdles regarding the raw material acquisition, the difficulty of making a product with limited funds, etc.
• Budgetary feasibility: Sometimes it may not be possible to gather a large fund required for the business being under the sword of limited means and sometimes stipulated time. Also, financial institutions may be hesitant to give huge loans to new ventures.
• Monetary feasibility: A business idea may be technically and financially feasible but not monetarily appreciable. It may not be gainful or may not return enough profits. In such a case, the promoters refrain from promoting the idea of business.

(iii) Name of the Company

The Promoter after fixing the launch of the idea intends to get a name to the Company. Promoter applies to the registrar of companies of that jurisdiction wherever the promoter intends to make the registered head office of the Company. Application to registrar contains three names “X or Y or Z” in the sequence of priority and Promoter adheres to Section 8 of the Companies (Incorporation) Rules, 2014.

(iv) Finalizing Signatories to MOA

The promoters decide who all will be the members signing the Memorandum of Association of the Company which is to be formed. Generally, the signatories of the MOA are the first Directors of the Company. The written consent of the signatories of the memorandum is essential to become Directors of the company.

(v) Hiring Professionals

Promoters are required to appoint certain professionals such as mercantile bankers, auditors, lawyers, etc. These professionals aid the promoter in the preparation of necessary documents that are to be filed with the Registrar of Companies during the registration of the Company.

(vi) Preparation of Necessary Documents

The promoters are the ones who are responsible to collect documents that are submitted to the Registrar of the Companies for getting the company registered. These documents are a return of allotment, Memorandum of Association, Articles of Association, consent of Directors and statutory declaration.

Duties of the Promoter 

The relation of promoter with the company cannot be described as a principal-agent relation as during pre-incorporation stage, the company has not even come into existence. Various judicial interpretations towards understanding the nature of relation between the promoter and the company has taken place in the common law Courts as well as Indian Courts and it has been decided that the relation between the promoter and the company is fiduciary in nature. Duties of the Promoter shall be discussed herewith: 

1. Duty to disclose secret profit

As mentioned earlier the promoters stand in a fiduciary relationship with the company which will be incorporated. The duty of a promoter is to disclose the secret profit made by him if any to the company. The Promoter has a right to claim expenses if any made during the incorporation stage from the company.

2. Duty to keep the company informed about the transactions

A promoter may intend to sell, lease or rent any property of the company. But if such a transaction is made without informing the company, the company may repudiate such contract of sale, lease or rent, the company may even claim the profit made by the promoter from the transaction by allowing such a contract made by the promoter.

3. Fiduciary duty towards the future Shareholders

The promoter is bound by a fiduciary relationship with the company, signatories of memorandum of association and also show the future allottees of share of the company. Relation of trust between promoter and future shareholders goes to show that the promoter shall uphold all the values expected of him by the Company.

4. Duty to disclose profits gained during promotion

The promoter during the promotion of the company may certain times be subjected to certain private arrangements leading to his personal profit, given the promoter stands in fiduciary relationship with the company he must disclose the profits gain during promotion as explained about to the company.

5. Duty to pay the company whatever received as trustee

The promoter stands in a fiduciary relationship with the company, and it is the duty of the promoter to make good to the company whatever he has obtained as the Trustee of the company.

Liabilities of the Promoter

A Promoter is subjected to liabilities under the various provisions of the Companies Act, 2013. The liabilities of the promoter are:

1. Liability to justify the transactions to the company

The promoter stands in a fiduciary relationship with the company, therefore the company has all rights to enquire into the transactions made by the promoter without the consent of the company. The company while dealing with such a transaction may either repudiate such an agreement made by the promoter with the third party or may even sue the promoter to recover the money along with profits so made by him behind the back of the company.

2. Liability against the misstatement made in the prospectus

Section 26 of the Companies Act, 2013 lists down the matters that are to be stated in the prospectus. The promoter may be held liable for not having complied with the provision. Section 63 of the Companies Act, 1956 also provided criminal liability for misstatement in prospectus and Promoter maybe made liable under this section. Section 63 prescribed imprisonment that may be extended to two years and fine that may be extended to 5000 Rs. for making untrue statements in the prospectus.

Under Section 34 and Section 35 of the Companies Act, 2013 promoter maybe held liable for any untrue statement made in the prospectus because of which a person subscribed for shares and debentures believing the prospectus statements to be true. However, the liability of the promoter is capped towards only the original allottees of the shares and not the subsequent ones.

3. Personal liability towards the contracts

All the contracts entered upon by the promoter during pre-incorporation stage of the Company, the promoter may be held personally liable for the aforementioned contracts till it’s discharged according to contract terms or when the company takes up the liability from the promoter after it is incorporated.

4. Liability of the promoter during the winding-up process of the company

In the process of winding up, the official liquidator under Section 340 of the Companies Act, 2013 may by application request the court to make the promoter liable for the misfeasance or breach of trust towards the Company. Also under Section 300 of Companies Act, 2013 promoter may be liable to examination, if it is alleged by the liquidator that there is fraud in the promotion or the formation of the company.

Status of Contract in pre-incorporation and the Principle of Promoter’s liability in pre-incorporation

The pre-incorporation contracts are the contracts entered upon by the promoter before the company is incorporated and these are essential for the successful running of the company in the future. The nature of these pre-incorporation contracts is however different to that of an ordinary contract. These contracts are Bipartite and effects of it are tripartite. The Promoter enters into a contract with the service providers or the interested persons and the consequential effect of these contracts help the prospective company which is still lingering in its non-incorporated stage. The instruments of Contract is essentially used for the quid-pro-quo transactions between two parties, but here it is remarkably used for the benefit of the non-party to contract as legally the company is non-existent. 

The Company is essentially the beneficiary of the pre-incorporation contracts as inferred from the above said para. Now it might stir up doubt as to why a company is not liable towards the pre-incorporation contracts, the answer to the question to be simply put is that one cannot make someone liable if they are non-existent and hence not a party to the aforesaid pre-incorporation contract. 

The non-liability of the company with respect to the pre-incorporation contracts was the same as the common law court in India until the passing of the Specific Relief Act, 1963. The Specific Relief Act, 1963 essentially under Section 15(h) and Section 19(e) makes the pre-incorporation contracts and agreement valid deviating from the trajectory followed under the common law.

Section 15(h) provides details as to who may obtain specific performance, wherein clause h provides that when a promoter gets into a contract before incorporation on behalf of the company and the company warrants such contract and such company must have sent a communication of acceptance to the other party of contract.

Section 19(e) provides that a party claiming relief under specific performance can be claimed when the promoter of the company before incorporation had entered into contract and if such contract was warranted during incorporation. The company must have accepted the contract and communicated such acceptance to the other party of contract.

The aforementioned provisions of the Specific Relief Act, 1963 changes the course of action in a case between parties where contract was made before incorporation, unlike the regular course of action against the promoter here the company can be made liable if it has accepted the contract and has communicated such acceptance to the other party of the contract.

Various cases have come before the judiciary in order to understand the liability of Pre incorporation contracts, we shall be discussing such cases below:

• The case of Weavers Mills v Balkis Ammal and others, wherein the promoter had agreed to purchase some properties on behalf of the company, after incorporation the company took possession of the properties and also constructed structures upon it. It was held that although no conveyance had taken place between the promoter and company regarding those properties. It was held that the company’s title over the properties was valid and couldn’t be set aside. The Madras High Court had extended the scope of interpretation of the principle mentioned above. Promoters are generally held liable personally for the pre-incorporation contract unless the company ratified the contract.
• Landmark case of Kelner v Baxter which is a case where “the principle of promoter’s liability in pre-incorporation contract”, was explained. The facts of the case is that, the promoter of a company was approached by one Mr. Kelner to purchase his wine wherein the promoter had agreed to purchase the same on behalf of the company. Later on the company was unable to pay Mr. Kelner who sued the promoter. It was interpreted whether the promoter was in a principal-agent relationship with the company and if the liability can befall upon the company. The learned judge interpreted that the principal agent relationship was not in existence as the principal of the agent cannot have existed without the incorporation, it was further added that company cannot take the liability of Pre-incorporation contract through adoption as the company is not privy to the contract, also the company was not even existent at the time of contract.
• In the case of Newborne v Sensolid Ltd. Wherein it had happened so that the appellate Court interpreted the findings of Kelner v Baxter, wherein an unformed company enter into a contract wherein the other party refused to do its duty under the contract. The judge had observed that before incorporation the company couldn’t have come into existence, neither could get into a contract and hence there cannot be an action for pre-incorporation contract. Confusion was then created that if a contract was signed by agent or a promoter then such promoter will be liable personally, but if the person representing him as representative of a non-formed company then the contract is unenforceable.

Finally, it can be concluded regarding the pre-incorporation contracts and Principle of Promoter’s liability in pre-incorporation that, common law clearly shows that the promoter shall be held personally liable for the pre incorporation contracts of the company and the same was followed in England and India prior to the legislation of the Specific Relief Act, 1963. It basically goes on to suggest that there is no escape from the liability of the promoter. But there are recognised ways in Indian law to shift the liability of the promoter to the company in case of the pre-incorporation contract wherein the first and foremost way is novation of contract which is also accepted by the common law courts regarding the shift of liability from Promoter to the company, India but uniquely legislated Specific Relief Act, 1963 providing provisions wherein if the contract was entered upon by the promoter during the pre-incorporation stage the party to such contract can make the company liable under Specific relief Act if the company ratify such contract and sends communication to such party of the ratification of the contract. But otherwise the promoter is held liable in case of Pre-incorporation contracts.

Registration/Incorporation of the Company

The Registration of the Company is legal recognition given to the body corporate under the Company Law. The procedure of registration has been clearly stated in Section 7 of the Companies Act, 2013. This provision clearly lays down the requirements for the incorporation of the company. The details of the documents namely:

• Memorandum of association, which is the constitution of the company wherein the signatories in case of a public company has been fixed to a minimum number of 7 and for a private company a minimum number of 2 this document is duly stamped; 
• Articles of Association, this is the document filed along with the MOA; 
• List of directors, wherein the details regarding their names, occupation and address is mentioned; 
• Written consent of the directors, the consent of the directors is to be submitted to the registrar of the companies; 
• Verification document, wherein such document is to be digitally signed by any recognised chartered accountant, Company secretary, Advocate.

Integrated Process Of Company Registration

In the website of the Ministry of Corporate Affairs, there are options using which one can register their company online whereby integrating various legal steps of the incorporation in the same portal. Further, the process of incorporation or registration requires first to apply for the unique name which shall be reserved for the proposed company against the payment of Rs. 1000.

The process then involves filling up the form online, the form is named “simplified proforma for incorporation”. The performa gives a viable option to incorporate a company online, which starts by filling up the details regarding the information of the promoter of the company. Secondly, the electronic performa in the form number INC-33 and INC-34 provides the option of filling up the e-MOA (Memorandum of association) and e-AOA (Articles of Association) respectively. The MOA as we know is the constitution of the company, it usually describes the object of the company and also describes the directors involved during the incorporation of the company. After the memorandum of association, the e-AOA option is provided so as to ease the process of incorporation even further, an e-AOA lays down rules and regulations of company affairs. E-AOA also lays down the powers, duties and rights of managers, officers and board of directors. 

The Article of Association may be made by the company according to its own requirements, or maybe selected by such company from the various options available in the schedule of Companies Act. AOA must be signed by all the directors and also attested by two witnesses. The articles of association of a company is also known as by-laws of the company or also named as the doctrine of indoor management since it deals with various issues such as:

• amount of share capital and kinds of share,
• rights of each kind of shareholders, 
• procedure for making allotment of shares, 
• procedure for issuance of share certificate, 
• transfer of shares, 
• procedure for conducting meetings, 
• procedure for appointing or removing directors of the company etc.

All the documents declared to be necessary under Section 7 of the Companies Act are supposed to be attached along with the digital signature of all the directors. The Ministry of Corporate Affairs has tried to simplify the process of getting a DIN number for the directors of the newly incorporated company by including such request form along with the PAN & TAN card of the so proposed entity which is being incorporated. The single-window clearance regarding the incorporation of a company was an action taken by the central government of India to increase the feasibility and scope of the incorporation even further.

Certificate of Incorporation

The registration of the memorandum of the association, the article of association and other documents are filed with the registrar. After getting satisfied with the application & documents submitted, the registrar will consider issuing the certificate of incorporation’. A certificate of incorporation is the ultimate proof of the existence of a company.

Effect of the Certificate of Incorporation

1. Certificate of incorporation is the conclusive evidence of the legal existence or presence of the Company as per Section 35 of Companies Act, 1956.
2. Even if there are formal deficiencies in the documents submitted for the incorporation of the company, once the certificate of incorporation is issued, the certificate becomes conclusive evidence regarding the legal existence of the company from the date mentioned in the incorporation certificate.
3. If the certificate of incorporation was received on 24th but the certificate reflects the date 22nd then the company shall be taken to have come into existence from 22nd as reflected by the certificate of incorporation and this will also authenticate the transactions made by such company on 22nd and 23rd in the eyes of law.

Certificate of Commencement of Business

• As soon as a private company gets the certification of incorporation it can start its business. Once the certificate of incorporation is received by the company, a public company issues a prospectus for inviting the public to subscribe to its share capital. It fixes the minimum subscription in the prospectus. Then, it is required to sell the minimum number of shares mentioned in the prospectus.
• After completing the sale of the required number of shares, the certificate is sent to the registrar along with the letter from the bank stating that all the money is received.
• The registrar then scrutinizes the documents. If all the legal formalities are done then the registrar issues a certificate known as ‘certificate of commencement of business’. This is the conclusive evidence for the commencement of business for the public company.

Conclusion

From the above article, we understand that the company’s incorporation period can be understood to be the integration of Pre incorporation period and incorporation period. Pre incorporation period may be understood as the idea phase of the company. The promoter whose name is reflected in the prospectus of the company plays a very important role in collecting the funding for the company. The promoter also conducts a SWOT analysis of the company to understand the potential of such a company in the marketplace and making it a feasible option to invest upon by the investors. The duties and liabilities of the promoter has been discussed in detail showing how the relationship between the promoter and the company is fiduciary in nature. The principle of promoter’s liability relation to the pre-incorporation contract has been dealt in detail coming to a conclusion that the promoter shall be held personally liable for all the pre-incorporation contracts, unless there is novation of the contract or in case of India when the provisions of Specific Relief Act applies wherein the company ratify the contract and send communication to the other party of contract regarding their liability. The role of the government in easing the process of incorporation is very crucial as it determines the potential intention of the investors towards companies in the market. 

The ease of incorporation has been increased by making it online affair, The Ministry of Corporate Affairs provides options to incorporate the company with a unique name by providing the online option of submitting the memorandum of association along with the articles of association online with the declaration digitally signed stating that all the procedures of incorporation of a company under law have been followed by the respective company. The State’s duty as an enabler of business for the growth of the economy finds its presence in this legislation. Certificate of incorporation plays a crucial role to prove that the company has been duly incorporated and the same cannot be taken back unless the winding up is initiated for the registrar of company finds that the company incorporated has played fraud for its incorporation. The certificate of incorporation speaks for itself and receipt date of the same does not affect the date of incorporation i.e. if the incorporation certificate clearly specifies the date of incorporation as 14th February although certificate is received on 20th February all the transactions taken place after 14th February shall be taken to be done in compliance with law.

Reference

1. The Companies Act,2013
2. The Companies (Incorporation) Rules, 2014

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