CENTRAL UNIVERSITY OF SOUTH BIHAR

SCHOOL OF LAW AND GOVERNANCE

PROMOTERS AND PRE INCORPORATION CONTRACTS:A REVIEW

SUBMITTED BY: - SUBMITTED TO: -

GAURAV KUMAR Dr. PRADIP KUMAR DAS

CUSB2113125040 ASSOCIATE PROFESSOR

5th semester DEPARTMENT OF LAW AND GOVERNANCE
B.A.LL.B (Hons.)
Batch- 2021-26
Section: - B

Signature……………………..
pg. 1
 TABLE OF CONTENT
S.No. HEADING PAGE No.
1 Table of cases 3
2 Chapter 1 4-5
• Acknowledgement
• Research methodology
• Research problem
• Research hypothesis
3 Chapter 2 6-8
• Introduction
• Definition
• Relation between promoter and company
4 Chapter 3 9-13
• Function of promoter
• Liability of promoter
• Rights of promoter
• Duties of promoter
5 Chapter 4 14-18
• Pre-incorporation contract
• Legal status
• Is promoter personally liable for the pre
incorporation contract?

pg. 2
TABLE OF CASES

• Kelner v Baxter
• Bosher v. Richmond Land Co. (1892)
• Weaver Mills v. Balkies Ammal (1969)
• Phonogram Ltd v. Lane (1982)
• Seth Sobhag Mal Lodha v. Edward Mill Co. Ltd. (1906)
• Lydney v Wigpool Iron Ore Company
• Twycross v Grant
• Re English & Colonial Produce Company case
• Touche v Metropolitan Railway Warehouse Company
• Cotronic(UK) Ltd. v Lane
• Erlanger v New Sombrero Phosphate Company
• Newborne v Sensolid (Great Britain) Ltd.

pg. 3
 ACKNOWLEDGEMENT
It is a great pleasure to express my deep sense of thanks and gratitude to my course instructor
and guide Dr. Pradip Kumar Das. His dedication and keen interest above all and his
overwhelming attitude to help his students had been solely and mainly responsible for
completing my work. His scholarly and timely advice, meticulous scrutiny, and his logical
approach had helped me to a very great extent to accomplish my project in an excellent manner.

I owe a deep sense of gratitude to Prof. S.P Srivastava, Dean of school of law and governance
(CUSB) for making sure that we are provided with best facilities and surroundings to fetch the
best out of ourselves.

His prompt inspirations, timely suggestions with kindness, enthusiasm and dynamism has also
enabled me to complete my project on time. It is my great privilege to thank my parent for their
constant encouragement throughout my research period.

pg. 4
 RESEARCH METHEDOLOGY
REASEARCH METHEDOLOGY-: This project work is basically based on the Doctrinal
method of research as no field work done on this topic.

AIMS AND OBJECTIVES-: To do a depth analysis on Promoters, its duties, functions, rights
and liabilities along with the Pre Incorporation Contract Analysis.

SOURCES OF DATA-: The whole project report is made with the help of secondary Sources.
The secondary sources of the data used in this project report are as follows-:
a) Books
b) Websites

MODE OF CITATION-: The researcher has followed a uniform mode of citation throughout
the course of this research paper.

TYPE OF STUDY-: For this topic of the project the researcher has opted for the descriptive
and explanatory type of study as in the topic the researcher is providing the description of the
existing facts.

RESEARCH HYPOTHESIS-: The assumption of the whole project topic is to find Importance
of promoter and his/her vital role during Pre Incorporation Contract.

RESEARCH PROBLEM-: The research question in the given project report is to find the
details of the function and liabilities of promoter and role in the Pre Incorporation Contract.

pg. 5
INTRODUCTION

The word “company‟ is derived from the Latin word (Com=with or together; panis =bread),
and it originally referred to an association of persons who took their meals together. In the
leisurely past, merchants took advantage of festive gatherings, to discuss business matters. Now
a days, the business matters have become more complicated and cannot be discussed at length
at festive gatherings. Therefore, the word company has assumed greater importance. It denotes
a joint stock enterprise in which the capital is contributed by a large number of people. Thus,
in popular parlance, a company denotes an association of like-minded persons formed for the
purpose of carrying on some business or undertaking. A company is a corporate body and a
legal person having status and personality distinct and separate from that of the members
constituting it.

Establishing a company is not a one-day task. Before a firm may take its ultimate form, it must
complete many processes. Promoters play an important role right from the start of the process.
The process of forming a corporation is extensive and involves several steps. The ‘promotion’
stage of the formation process is the first step. An individual or a group of people known as
promoters comes up with the concept of starting a business at this stage. Various processes
must be completed to incorporate a firm. The promoters carry out these functions and establish
the firm. The term has been used frequently in Indian company matters. The Indian Companies
Act 1956 used it to fix liability on promoters, but did not define it and accepted their established
position under the common law principle. Subsequently, the Indian Companies Act
2013 defined the term for the first time. It is a common misconception that the promoters’ job
continues until the business has purchased the property, raised initial money, and the board of
directors has taken over control of the company’s activities. However, a review of the different
provisions of the Companies Act of 2013 demonstrates that the promoters’ role cannot be
overlooked even when the board of directors assumes control of the company’s business. This
can be carried over to the period when the firm is operating as a going concern and even to the
time when the company’s affairs are being wound up.1

1
Singh, Prasidh. (2011). Promoter and Pre-Incorporation Contract. SSRN Electronic Journal.
10.2139/ssrn.1938065

pg. 6
A promoter is person who brings the company into existence and holds up food fiduciary
relations towards the corporation. Almost in all cases it is the promoter who enters into a
contract on behalf of a company before its incorporation.

Promoters play a crucial role in establishing A company ride from its inception Stage. An
individual or a group of people who comes up with the concept of starting a business and the
promoter of a company they carry out the required process to establish the firm.

The company’s promoters say the company and thus are moulding blocks of the company
however a promoter is not the owner of the company the promoter helps the established and
run the company but the company shareholder are the actual owner of the company.2

DEFINATION

Promoters are defined under section 2(69)3 Of the Act,:

• A promoted named as a promoter in the prospectus of identified by the company in its

annual return in section 92.
• A person who controls the company affair, indirectly or directly, whether as a director,
shareholder or otherwise.
• A person in accordance with whose directions, advice or instructions the Board of
Director of the company are accustomed to act.

In simple words, promoters perform the preliminary steps, like floating the securities in the
market, making the prospectus of the company, etc., for establishing the company’s business.
However, if a person is doing these things professionally, they will not be considered a promoter.

Lord Justice Lindley in Lidney & Wigpool Iron Ore Company v. Bird 4 , described the
position of promoter, “Although not an agent for the company or a trustee for it before its
formation, the old familiar principles of law of agency and of trusteeship have been extended
and very properly extended to meet such cases. It is perfectly well settled that a promoter of a
company is accountable to it for all monies secretly obtained by him from it just as the
relationship of the principle and agent or the trustee and cestui que between him and company
when the money was obtained.”

2
Prasidh Raj Singh – Student at National Law University, Orissa India, SSRN Electronic Journal, ssrn. id1938065
3
The Companies Act 2013
4
(1885) 31 Ch. D. 328

pg. 7
In the case of Twycross v Grant5 the court defined a promoter as “one who undertakes to form
and set in motion a company with reference to a given project and who takes the necessary step
to achieve their purpose”

RELATIONSHIP BETWEEN THE PROMOTER AND THE COMPANY

Though the case laws and the academic discourse on this issue has been multifaceted and
inconclusive but the Indian Supreme Court has affirmed that the relation between the two as
that of a fiduciary relation. "It rejected the position of the promoter with respect to that of the
unincorporated company as that of agency or trustees." In the case of Weavers Mills v. Balkis
Ammal6, it was held that even without express conveyance of property by the promoter to the
unincorporated company, since the promoter stands in fiduciary duty to the company, all the
benefits of the pre-incorporation contract would pass on to the company.

"Position of the promoter is fiduciary concerning the company which the promoter promotes
his position is quasi legal. A promoter is neither a trustee nor an agent of the company which
he promotes because there is no trust or principal in existence at the time of his efforts. But
certain fiduciary duties, like an agent, have been imposed on him under the Companies Act. As
such he is said to be in a fiduciary position (a position full of trust and confidence) towards the
company and the original allottee of shares." Consequently, a promoter must make full
disclosure of the relevant facts, including any profit made.7

"One position can be that if the company accepts the benefits of the contract, then it must accept
the burden too and hence must compensate the promoter for all his expenses under the said
contract. However, if the company doesn't ratify the contract, then the promoter can't claim for
reimbursement."

As he has a fiduciary relationship with the company so generally there is no issue with regard
to his remuneration. The Chancery Court in the Re English & Colonial Produce Co. case held
that a promoter is not entitled" to claim expenses in his duty unless there is an express provision
to do so but he is entitled to a reasonable remuneration as stated in the Article of Association.

In Touche v Metropolitan Rly Warehousing Co.8 Lord Hatherly highlighted the importance
of remuneration saying that "the help of the promoter is unique which requires great efficiency,

5
(1877) 2 C.P. D. 469
6
(1969) 2 MLJ 509
7
https://www.icsi.edu/media/webmodules/publications/FinalCLStudy.pdf
8
(1871) LR 6, Ch. App. 671

pg. 8
power and which is employed in developing a business plan and making it so to the best benefit
and thus should be given his fees."

FUNCTIONS OF A PROMOTER

A promoter plays many functions in the formation of a company, from conceiving the business
idea to taking all the required steps to make the idea a reality. Below are some of the functions
of a promoter:

• A promoter needs to comprehend/conceive the idea of company formation.

• A promoter looks into the feasibility and viability of the business idea. He/she assesses
whether the company formation will be practicable or profitable.
• Once the idea is conceived, the promoter organises and collects the available resources
to convert the business idea into a reality.
• The promoter decides the company name and settles the contents of the
company’s Memorandum of Association and Articles of Association.
• The promoter decides the location of the company’s head office.
• The promoter nominates associations or people for vital company posts, such as
appointing the auditors, bankers and the company’s first directors.
• The promoter prepares all the necessary documents required to incorporate a company.
• The promoter decides the company’s funding sources and capital requirements.

A promoter cannot be considered a trustee, employee or agent of a company. The role of the
promoter ceases when the company is established and is handled by the board of directors and
the company management.9

LIABILITIES OF A PROMOTER

Liability regarding irregularities in the prospectus

Section 26 describes what should be stated in the prospectus and what reports should be
included. The promoter may be held accountable by the shareholders if this provision is not
followed.

9
https://www.icsi.edu/media/webmodules/publications/FinalCLStudy.pdf

pg. 9
Civil liability

Section 3510 outlines the civil liabilities for any prospectus misstatements. Under this Section,
a person who has subscribed for the company’s shares and debentures on the basis of the
prospectus can hold the promoter accountable for any false statements in the prospectus. The
promoter may be held liable for any loss or damage suffered by any person who subscribes for
shares or debentures as a result of the false statements made in the prospectus. Specific
provisions have also been provided under Section 62 regarding the reasons on which the
promoter can avoid his liability. These remedies are available to anyone who can be held
accountable for a prospectus misstatement.

Criminal liability

Section 3411 deals with the criminal liabilities of drafting a prospectus that contains false claims.
The promoters can be held criminally accountable, in addition to the civil liabilities described
in the previous two examples, if the prospectus they released contains misstatements. The
penalty is either a two-year prison sentence or a fine of up to 5000 rupees, or both. Unless he
can show that the inaccurate statement was inconsequential or that he was justified in believing,
on reasonable grounds, that the statement was truthful at the time of prospectus issuing, the
promoter may be held criminally liable for misstatements.

Public examination of promoters

Section 30012 gives the court the authority to order a public investigation of all promoters found
guilty of fraud in the promotion or establishment of a corporation. If the liquidator’s report
indicates fraud in the promotion or establishment of the company during its winding up, the
promoter, like every other director or officer of the company, can be held liable for public
examination by the court.

Personal liability

Promoters can be held personally liable for pre-incorporation contracts.

10
The Companies Act 2013
11
The Companies Act 2013
12
ibid

pg. 10
 • A promoter has to mention the true facts in the prospectus of the company. If he does
not do so, he may be held liable for it. The promoter will be liable for any untrue
statement which has been made in the prospectus, and on the basis of that untrue
statement any person has subscribed to the securities of the company. The person may
sue the promoter if he has suffered any damage.
• Apart from civil liability, the promoter may be held criminally liable also for
mentioning any untrue statements in the prospectus. A severe penalty will also be
imposed on him if he provides any untrue statement with the view of obtaining capital.
• A promoter can be made liable to a public examination if there are any reports which
allege fraud in the formation of the company or the promotion activities.
• The company can also proceed against the promoter in case there is a breach of duty on
the promoter’s part or he has misappropriated any property of the company or is guilty
of breach of trust.13

RIGHTS OF PROMOTERS14

1. Right of indemnity:-
In case there is more than one promoter working together, one may claim against the
other for the compensation or damages paid by him in course of fulfilment of duty.
Promoters are severally and jointly liable for any untrue or misleading statements and
breach of any other duty.
2. Rights to recover Initial Expenses:-
Promoters have the right to recoup the funds they aim to raise and use to run the
business. The payment of these expenses is contingent on the number of directors.
3. 2. Right to receive a Proportionate amount from Co-promoters:-
When more than one individual acts as the company’s promoter, one promoter might
sue another for the remuneration and damages paid by him. Promoters are jointly and
severally liable for any false statement made in the prospectus as well as any hidden
gains.
4. Remuneration:-

13
https://www.icsi.edu/media/webmodules/publications/FinalCLStudy.pdf
14
Singh, Prasidh. (2011). Promoter and Pre-Incorporation Contract. SSRN Electronic Journal.
10.2139/ssrn.1938065

pg. 11
 The promoters work hard to establish and run enterprises, and as a reward, the
companies pay them. This payment is paid in a variety of ways, including cash or
debentures.

DUTIES OF PROMOTERS

1. Duty of Disclosure:
A promoter is duty-bound to disclose all material facts to the company’s stakeholders.
As mentioned already, there exists a fiduciary relationship between a company and its
promoter so, in case of non-disclosure of any fact or profit made by him shall make him
liable to punishment with a fine of Rs. 50,000 or five times the amount of benefit
received by him for the aforesaid act [as under Section 102(5) of the Act].
In the case of the promoter selling his own property to the company, he may disclose
such interest and act in good faith during the deal.
Such disclosure may be made-
• To the Directors of the Company.
• In the Articles of Association of the Company.
• In the prospectus of the company.
• To the existing and potential shareholders, directly.

2. Duty not to make secret profits:

A promoter is duty-bound to not make any profits directly or indirectly at the expense
of the company as it breaches the fiduciary nature of their relationship and incapacitates
such promoter from its legal definition. In a case where any secret profit made by a
promoter becomes known to the company’s stakeholders then they can compel him to
surrender such profit.

3. Duty as regards Prospectus:

Some certain facts and reports need to be set out in the prospectus of a company. Section
62(1) of the Act provides that a promoter is liable to pay compensation to every person
who subscribes to the faith of the prospectus for any loss or damage sustained by them
due to any untrue statements in the same.
As under Section 63 of the Act, a promoter making any misleading statements in a
prospectus may face imprisonment for a term that may extend to 2 years (in cases of

pg. 12
grave fraud and subsequent offences) or may be penalized with a fine of Rs.5000 per
false statement in the prospectus.

pg. 13
PRE-INCORPORATION CONTRACT

Pre-incorporation contracts are contracts entered into by a company promoter on behalf of the
company being promoted prior to the incorporation of the proposed company. A pre-
incorporation contract is often incomplete in the sense that such a contract will not normally
provide for the effect of the contract where the proposed company fails to incorporate. Even if
the proposed company has been duly incorporated, such a contract may fail to provide for the
parties' rights and obligations where the company chooses not to have (e.g., through ratification)
the contract. It is therefore necessary for the law to provide rules to fill these gaps.15

The relationship between promoter and the company that he has floated must be deemed to be
fiduciary relationship from the day the work of floating the company starts. In Phonogram
Ltd v Lane 16 , the court decided that although a contract made before a company’s
incorporation cannot bind the company, it is not wholly devoid of legal effect even if all the
persons who negotiated the contract are aware that the company has not yet been incorporated.

In Cotronic (UK) Ltd v Dezonie17, the court said that the contract takes effect as a personal
contract with the persons who purport to contract on behalf of the company. But it is still not
clear up to what extent the promoter is personally liable for the pre-incorporation contract. It
is also necessary to know that the promoter stands in a fiduciary position towards the company.

In Erlanger v. New Sombrero Phosphate company18, it was held that the promoter of a
company undoubtedly stands in a fiduciary position. They have in their hands the creation and
molding of the company. They have the power of defining how and when and in what shape
and under whose supervision.

LEGAL STATUS OF PRE-INCORPORATION CONTRACTS

"The legal status of a pre-incorporation contract is not easy to assess. Going by the definition
of the contract, there have to be at least two parties/persons who enter into contract with each
other. "So, the general principle is that if one of the parties to the contract is not in existence at
the time of entering into the contract then no contract will there.

15
Prasidh Raj Singh – Student at National Law University, Orissa India, SSRN Electronic Journal, ssrn. id1938065
16
[1981] EWCA Civ J0310-1
17
[1991] BCC 200
18
(1878) 3 App Cas 1218

pg. 14
Hence, the company can't enter into a contract before it comes into existence, and it comes into
existence only after its registration. Thus, it is said that the pre-incorporation contract is entered
into by the promoters on behalf of the company.

The promoters, while entering into the contract, act as agents of the company. However, when
the principal, that is the company is itself not in existence, how can it appoint an agent to act
for it." So, the promoters, themselves" and not the company, become personally liable for all
contracts entered into by them even though they claim to be acting for the prospective
company.19

But under section 230 of the Indian Contract Act, "an agent cannot personally enforce contracts
entered into by him on behalf of his principal, nor is he personally bound by them if he specifies
clearly, at the time of making the contract, that he is only acting as an agent and he is not
personally liable under the contract. So, if this principle is applied, the contract becomes in
fructuous as neither of the parties is liable under the contract."

Before Specific Relief Act, 1963

"A pre-incorporation contract never binds a company since a person (legal or juristic) cannot
contract before his or its existence and a company before incorporation has no legal existence.
Another reason is that promoters are proverbially profuse in their promises and if the
corporation were to be bound by them, it would be subject to many unknown, unjust and heavy
obligations."

"Even where there is a request purported to enforce such a contract, the company cannot be
found because ratification is not possible as the ostensible principal did not exist at the time the
contract was made. In re English and colonial Produce Company case, a solicitor was
engaged to prepare the necessary documents and obtain the registration of a company. He paid
the registration fee and incurred the certain expenses incidental to registration. It was held in
this case that the company was not liable or bound to pay for his services and expenses."

"The company is also not entitled to sue on a pre-incorporation contract. As it was held in the
case of Natal land and Colonisation Company v. Pauline Colliery Syndicate that the syndicate
was not entitled to its claim as it was not in existence when the contract was made and a
company cannot obtain the benefit of a pre-incorporation contract in the suit of specific

19
http://legalonline.blogspot.com/2011/03/pre-incorporation-contracts-legal.html

pg. 15
performance.

So, fact of this case was that the a 'N' company contracted with 'A', the nominee of the syndicate
company which was not even incorporated, to grant a lease of certain coal mining rights for
three years. After the syndicate was registered, it claimed the contracted lease which the
company 'N' refused."

After Specific Relief Act, 1963

"Until the passing of the Specific Relief Act, 1963, in India the promoters found it very difficult
to carry out the work of incorporation. Since contracts prior to incorporation were void and
also could not be ratified, people hesitated to either supply any goods or services for the cause
of incorporation. However, the Specific Relief Act, 1963 came as a relief to the promoters.

Section 15(h) and 19(e) of the Specific Relief Act provides as" follows:

• The contract should have been entered into by the promoter for the purpose of the
company.
• The terms of incorporation should warrant should warrant such contract.
• The company should accept the contract after incorporation.
• Such acceptance should be communicated to the other party to the contract.

"Section 15(h) of the Specific Relief Act, 1963, the definition, it expressly states that the
contracts incorporated before the incorporation stage are "entered into by the promoters of the
for the very purpose and utility of the company and subject to terms of incorporation of the
company, the company may ask for specific performance from the third party.
However, this condition can only be applied if, after the registration/incorporation, the
company has expressly demonstrated acceptance of those contracts, and communicated such
contracts to the third party concerned." Under identical circumstances the other party to the
contract under Section 19(e) of The Specific Relief Act, 1963 may enforce specific
performance against the company.20

20
http://legalonline.blogspot.com/2011/03/pre-incorporation-contracts-legal.html

pg. 16
IS PROMOTER PERSONALLY HELD LIABLE FOR PRE-
INCORPORATION?

In the case of Kelner v Baxter21, where the promoter on behalf of an indistinct corporation
accepted an offer of Mr. Kelner to sell wine, subsequently, the corporation failed to reimburse
Mr. Kelner, and finally, he brought the action against promoters. Erle CJ found that the
principal-agent relationship cannot be in being before incorporation, and if the corporation was
not in existence, that means the principal of an agent does not come into existence. He further
explains that the corporation cannot take the liability of pre-incorporation contract through
adoption or ratification; as a stranger cannot sanction or adopt the contract and the corporation
was a stranger for the reason that it was not in existence at the time of formation of the contract.
Consequently, he held that the promoters are personally liable for the pre-incorporation contract
for the reason that they are the consenting party to the contract.

In the case of Newborne v Sensolid (Great Britain) Ltd22, the Court of Appeal construed the
verdict of Kelner v Baxter in a diverse mode and developed the principle more. In this case an
unformed corporation come into a contract, the other contracting party declined to perform his
duty. Lord Goddard observed that formerly the incorporation of the company cannot be in
existence, and if it is not into being, then there was no existence of the contract which the
unformed corporation signed. So, the corporation cannot bring an action against the contract
of pre-incorporation, and also the promoter cannot bring the suit for the reason that they were
not the party to the contract.

This case created some amount of muddle that, if the contract was signed by the agent or
promoter, then he will be liable personally and he has the right to sue or to be sued. But then
again if an individual representing him as director of an unformed corporation enters into the
contract, then the contract would be unenforceable. This dissimilarity was found objectionable
by Windeyer J in Black v Smallwood23 and this was also disparaged by Professor Treitel in
the Law of Contract. Far along in the case of Phonogram Limited v Lane24, Lord Denning
established the position, he found that if an unformed corporation enters into the contract, then
it cannot bind the corporation, but the lawful effect of contract does not completely lack. In

21
(1866) 15 LT 213
22
(1953) 1 All ER 708
23
(1966) 117 CLR 52
24
Supra

pg. 17
addition, even in that situation the promoter or representor are personally liable for the pre-
incorporation contract.

In the famous case of Phonogram Limited v Lane25, an individual was attempting to form a
corporation that was going to run a group of pop artists and that individual arranged financial
assistance from a recording company for the group of pop artists. Then this firm not ever came
into existence, and the amount was due. The recording corporation took an action against the
individual who represented the unformed company to them.

These principles were found relevant in the Indian case. In the case of Seth Sobhag Mal Lodha
v Edward Mill Co. Ltd.26, the Rajasthan High Court followed the approach of Common Law
regarding the liability of pre-incorporation contract.

25
ibid
26
[1981] EWCA Civ J0310-1

pg. 18