LEGAL MEMORANDUM: POSITION, DUTIES, AND LIABILITIES OF PROMOTERS UNDER

INDIAN LAW
INTRODUCTION
In the realm of corporate law, promoters play a pivotal role in the formation and
establishment of a company. Under Indian law, particularly the Companies Act, 2013
(hereinafter referred to as “the Act”), promoters are individuals or entities who conceive
the idea of incorporating a company and take necessary steps to bring it into existence.
The concept of a promoter is not merely procedural but carries significant legal
implications, encompassing defined duties and potential liabilities. This memorandum
examines the position, duties, and liabilities of promoters under Indian law, with
reference to statutory provisions, judicial interpretations, and regulatory frameworks
such as those enforced by the Securities and Exchange Board of India (SEBI).

DEFINITION AND POSITION OF PROMOTERS

Definition
Section 2(69) of the Companies Act, 2013, defines a “promoter” as a person who:
• Has been named as such in a prospectus or is identified by the company in the
annual return under Section 92;
• Has control over the affairs of the company, directly or indirectly, whether as a
shareholder, director, or otherwise; or
• In accordance with whose advice, directions, or instructions the Board of
Directors is accustomed to act.

Position in Corporate Structure

Promoters occupy a unique position in the corporate ecosystem, acting as the catalysts
for a company’s formation. Their role typically includes:
• Conceiving the business idea and conducting feasibility studies.
• Arranging initial capital and resources.
• Drafting foundational documents such as the Memorandum of Association
(MoA) and Articles of Association (AoA).
• Appointing initial directors and ensuring compliance with incorporation
requirements under the Act.

In the Indian context, promoters are often entrepreneurs, family business owners, or
corporate entities setting up subsidiaries. Unlike directors, promoters do not have a
statutorily defined tenure, but their influence may persist through shareholding or board
representation. Courts have recognized promoters as fiduciaries, imposing on them a
duty to act in the best interests of the company during its formative stages.

A. Promoter vs. Shareholder vs. Director

A promoter is distinct from a shareholder or director. While a promoter may become a

shareholder or director post-incorporation, their role as a promoter is tied to the pre-
incorporation and early operational phases. The Supreme Court in CIT v. Biju Patnaik
(1986) clarified that a promoter’s role is not synonymous with that of a director or
shareholder, as it is defined by their involvement in the company’s formation and initial
management.

B. SEBI’s Perspective

The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR
Regulations) further refine the definition of a promoter for listed companies. Regulation
2(1)(pp) includes persons who are in control of the issuer or whose names appear in the
offer document as promoters. SEBI’s broader definition ensures that entities or
individuals exercising control, even indirectly, are subject to regulatory scrutiny.

II. DUTIES OF PROMOTERS

Promoters, by virtue of their foundational role, owe several duties to the company, its
shareholders, and other stakeholders. These duties are rooted in common law
principles of fiduciary responsibility, statutory obligations under the Companies Act,
2013, and SEBI regulations. The following are the primary duties of promoters under
Indian law:

A. Fiduciary Duty
Promoters stand in a fiduciary relationship with the company they promote. This
principle was established in the English case Erlanger v. New Sombrero Phosphate Co.
(1878), which has been adopted in Indian jurisprudence. As fiduciaries, promoters are
obligated to:
Act in Good Faith: Promoters must act honestly and in the best interests of the
company, avoiding conflicts of interest.
Disclose Material Facts: Promoters must fully disclose any personal interest in
transactions involving the company, such as property sales or contracts entered into
during incorporation.
Avoid Secret Profits: Any profit made by a promoter from the company’s formation (e.g.,
through sale of assets to the company at an inflated price) must be disclosed and
approved by the company. Failure to disclose may result in the profit being held in trust
for the company.
In Lagunas Nitrate Co. V. Lagunas Syndicate (1899), a promoter was held liable for
failing to disclose a profit made from selling property to the company. Indian courts
have followed this precedent, as seen in Official Liquidator v. Raghava Desikachar
(1974), where the court emphasized the promoter’s duty to act transparently.
Statutory Duties under the Companies Act, 2013
The Act imposes specific obligations on promoters, particularly in relation to the
incorporation process and public offerings:
Compliance with Incorporation Requirements: Under Sections 3 to 12 of the Act,
promoters are responsible for preparing and filing the MoA, AoA, and other documents
with the Registrar of Companies (RoC). They must ensure compliance with procedural
and substantive requirements, such as obtaining a Certificate of Incorporation.
Accuracy in Prospectus: Section 34 and Section 35 of the Act mandate that promoters
ensure the accuracy of statements in the prospectus issued for public subscription.
Misstatements or omissions may attract civil and criminal liabilities.
Pre-Incorporation Contracts: Under Section 19, promoters are personally liable for
contracts entered into on behalf of the company before its incorporation unless the
company adopts such contracts post-incorporation. Promoters must exercise due
diligence to ensure that such contracts are in the company’s interest.

B. Duty to Secure Initial Capital

Promoters are tasked with arranging the initial capital for the company, whether through
private investments or public offerings. In the case of public issues, promoters must
comply with SEBI’s ICDR Regulations, ensuring that disclosures in the offer document
are accurate and that the issue process adheres to regulatory standards.

C. Duty to Appoint Competent Management

Promoters are responsible for appointing the initial board of directors and ensuring that
the management team is capable of steering the company toward its objectives. This
duty is particularly critical in family-run businesses, where promoters may dominate
board appointments.

D. Duty under SEBI Regulations

For listed companies or those planning to go public, SEBI imposes additional duties on
promoters:
Disclosure Requirements: Promoters must disclose their shareholding, related-party
transactions, and any material interest in the company under the SEBI (Listing
Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations).
Lock-in Periods: Under Regulation 16 of the ICDR Regulations, promoters’
shareholdings are subject to lock-in periods to prevent premature exits that could
destabilize the company.
Prohibition on Insider Trading: Promoters, as insiders, are subject to the SEBI
(Prohibition of Insider Trading) Regulations, 2015, which prohibit trading based on
unpublished price-sensitive information.

LIABILITIES OF PROMOTERS

Promoters face a range of liabilities under Indian law, arising from breaches of fiduciary
duties, statutory non-compliance, or fraudulent conduct. These liabilities can be civil,
criminal, or regulatory in nature.

E. Civil Liabilities
Breach of Fiduciary Duty: If a promoter makes a secret profit or fails to disclose material
facts, they may be required to disgorge the profit or compensate the company for
losses. In Gluckstein v. Barnes (1900), a promoter was held liable for undisclosed
profits, a principle followed in India.
Misstatements in Prospectus: Under Section 35 of the Act, promoters are liable to
compensate investors who suffer losses due to untrue or misleading statements in the
prospectus. The liability extends to both intentional and negligent misstatements.
Pre-Incorporation Contracts: As noted earlier, promoters are personally liable for pre-
incorporation contracts unless ratified by the company. In Kelner v. Baxter (1866),
promoters were held liable for such contracts, a principle codified in Section 19 of the
Act.
Criminal Liabilities
Fraudulent Misstatements: Section 34 of the Act imposes criminal liability on promoters
for fraudulent statements in the prospectus, punishable with imprisonment for up to
seven years and a fine.
Fraud under Section 447: If a promoter engages in fraud, as defined under Section 447,
they may face imprisonment ranging from six months to seven years and a fine up to
three times the amount involved in the fraud.
Non-Compliance with Incorporation Requirements: Failure to comply with procedural
requirements under the Act may attract penalties under Section 450, including fines for
the promoter and the company.
Regulatory Liabilities under SEBI
SEBI imposes stringent penalties on promoters for violations of securities laws:
Market Manipulation: Promoters engaging in manipulative practices, such as price
rigging, may face penalties under the SEBI Act, 1992, including fines and bans from the
securities market.
Insider Trading: Violations of insider trading regulations may result in penalties up to ₹25
crore or three times the profit made, whichever is higher, under Section 15G of the SEBI
Act.
Non-Compliance with Disclosure Norms: Failure to comply with LODR or ICDR
disclosure requirements may lead to fines, debarment, or other enforcement actions.
Personal Liability for Company Debts
In exceptional cases, courts may pierce the corporate veil to hold promoters personally
liable for the company’s debts, particularly if the company was used as a façade for
fraudulent activities. In Salomon v. Salomon & Co. Ltd. (1897), the principle of separate
legal personality was established, but Indian courts have lifted the veil in cases of fraud,
as seen in Re: Darshan Oils Ltd. (2011).
Liability for Ultra Vires Acts

If promoters engage in activities beyond the company’s objectives as outlined in the

MoA, they may be personally liable for any resulting losses, as such acts are not binding
on the company.

III. JUDICIAL INTERPRETATIONS AND PRECEDENTS

Indian courts have played a significant role in shaping the legal framework governing
promoters. Key judicial pronouncements include:

Official Liquidator v. Raghava Desikachar (1974): The Supreme Court emphasized the
fiduciary nature of promoters’ duties, holding that any undisclosed profit must be
surrendered to the company.