By Dr. Pratima Narayan

In the world of business and corporate governance, the role of promoters is pivotal. They are the visionaries who conceive the idea of a company and take the necessary steps to bring it into existence. They are actively engaged in the company’s formation, early strategies and often, initial funding. But what exactly is the role and legal position of the promoter in a company and how does it evolve after the company is incorporated and as it grows? This blog will deal with the crucial role of promoter, the legal position and how their responsibilities shift as a company transitions from its inception to a fully operational stage. 

 Section 2(69) of the Companies Act, 2013 defines a promoter as –

(a) who has been named as such in the prospectus or is identified by the company in the annual return;

(b) who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director or any other position in the company;

(c) who advises, directs or instructs the Board of Directors of a company, however, it does not include a person who is acting merely in a professional capacity.

The promoter and promoter group concepts also find a mention in Securities Exchange Board of India’s (SEBI) regulations. According to Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (ICDR) Regulations, 2018, promoter essentially means a person directly or indirectly in control of the listed company. But promoter does not include a person acting in a professional capacity or even banks, financial institutions, venture capitals etc. merely because they hold 20% or more equity share capital in the company, unless they satisfy certain prescribed requirements. The regulations also define ‘promoter group’ as a person who is controlled by or related to the promoter.  Considering the age of startups and tech companies, there has been a recommendation under the ICDR Regulations to allow non-individual investors to contribute 10% to the minimum promoter’s contribution without being identified as promoters. This seems to be a transition from the concept of a “promoter” to that of a “person in control”.  

Role of Promoter

The role of a promoter is analogous to a parent of a natural person. However, a company being an artificial person, the relationship between the promoter and the company cannot remain eternal. There may be a change in ownership of the company after a few years of its incorporation. 

Keeping these in view, the definition of promoter under the Companies Act provides three dimensions to the role of a promoter:

1. Promoter whose name is mentioned in the offer document and annual returns. The status of the promoter is by proclamation. So, the promoters are subject to both civil and criminal liability under Section 34 and 35 if the prospectus contains any statements that are false or misleading. 
2. Promoter having control over the affairs of the company as director, shareholder or otherwise directly or indirectly. ‘Control’ here refers to the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
3. The promoter acting as shadow director, that is, though not officially appointed as a director, exerts significant influence over the Board’s decision. Unless the position of a shadow director is legally recognised, promoters cannot be held accountable/liable for breach of trust. 

In this regard, a promoter performs the following activities –

• Promotion of ideas and incorporation of the company.
• Preparation of constitutional documents such as Memorandum and Articles of Association. 
•  Obtaining the necessary licenses and statutory approvals.
• Entering into pre-incorporation contracts with suppliers, service providers or other parties to ensure smooth operations of the company after its incorporation. 
• Securing the necessary capital to start the company through an initial public offering or private placement or public deposits, as the case may be.
• Verification that the statements made in the prospectus are true and correct.
• Exercise due diligence and compliance with applicable laws and regulations, particularly disclosures through annual and periodic reports to the Registrar of Companies, SEBI and other regulatory bodies. 

Position of Promoter

Since the company is not yet established, a promoter can neither act as agent or trustee of the business. Therefore, his legal position can at best be described as person holding fiduciary duty towards the to-be established company. As a fiduciary, the promoter has a duty to act with the utmost good faith and loyalty towards the company. This includes avoiding conflicts of interest and refraining from making secret profits at the expense of the company. Promoters must fully disclose any personal interests in transactions involving the company. This is crucial to prevent any breach of trust or the appearance of impropriety. If a promoter breaches their fiduciary duties, they can be held liable by the company. This liability may include returning any secret profits made or compensating the company for losses incurred due to the promoter’s actions.

Once the company is up and running, promoters typically hand over control to the board of directors and management team. However, they may retain influence, especially if they hold a significant equity stake or assume a leadership role within the company. Here, their focus shifts towards overseeing the company’s adherence to its vision and long-term goals rather than managing day-to-day operations. In some cases, promoters might plan their exit from the company, especially if they intend to cash out their equity through a sale, merger, or public offering. This requires careful planning to ensure the company’s stability and continued growth post-exit.

Promoters often enter into contracts on behalf of the company before its incorporation. The next question that would arise is would the promoter be liable for any pre-incorporation contract? Promoters are responsible for any pre-incorporation contracts they enter unless the company ratifies these contracts post-incorporation. If they fail to disclose their interest in transactions, they may be compelled to surrender profits or face legal consequences. The legal liabilities associated with these pre-incorporation contracts are a persistent issue, especially when such contracts are not ratified by the company after incorporation. The promoters may find themselves personally liable, which creates legal and financial risks for them.

Conclusion

Throughout the company’s lifecycle, the promoter’s role evolves from being hands-on in formation and early operations to a more strategic and oversight function as the company matures. Their influence and responsibilities gradually shift towards ensuring the company’s long-term success, governance, and possibly planning their eventual exit or transition of leadership. However, with the rise of startups and unicorns and emergence of contemporary and diversified shareholding patterns like private equity and institutional investors, the concentrated ownership structure is slowly changing. With SEBI’s recommendation of reclassification of promoters with threshold of 10% equity towards minimum promoters’ contribution, the proposed change seems to be with the intention to shift the legal framework from ‘promoter’ to ‘person in control’. However, this recommendation has also brought about two major debates – reclassifying promoters can cause confusion about who is in charge of the company and can make it difficult to comply with minimum public shareholding norms.

The Indian corporate trends seem to be moving in the direction of professionally managed companies than promoter led companies. However, with many family-run businesses in India and conventional promoter led business operations, there is a need for a good balance in the regulations to enable both forms of business operations.