Role of a Promoter in Incorporation

Chapter 1:

Introduction The meaning of the expression „promoter‟, exclusively for the purpose of fastening civil liability for misstatements in prospectus, is given in Section 62(6) of the Act, thus: „a promoter who was a party to the preparation of the prospectus or of the portion thereof containing the untrue statement, but does not include any person by reason of his acting in a professional capacity for persons engaged in procuring the formation of the company‟; but, otherwise the term is not defined in the Act, nor precisely in any of the decided cases. Rule 405(a) framed by the Security Exchange Commission in USA has it that a „promoter‟ is “a person who, acting alone or in conjunction with other persons directly or indirectly takes the initiative in founding or organizing a business enterprise”. In Whaley Bridge Calico Printing Co. v. Green & Smith1, Bowen, LJ, stated that the term „promoter‟ connotes to sum up “in a single word a number of business operations, familiar to the commercial world, by which a company is generally brought into existence”. In Twycross v. Grant2 Cockburn, CJ, stated that “a promoter is one who undertakes to form a company with reference to a given project and to set it going, and…….takes the necessary steps to accomplish that purpose”.

In UK until about the 19th Century there used to be professional promoters engaged in raising capital through public issues before the formation of companies, as a business in itself and who used to make them over to the Boards of Directors of the Companies after formation and vanish from the scene having filled their deep pockets, to repeat it, and were quite notorious and hounded in law for it. This advance raising of capital is referred to in connection with both a domestic company and a foreign company dealt in Sections 56 (1)(b) and 605 of our Act, too, but it does not appear to have been put to use. In the present day legal framework in our country, there is no advance raising of capital by public offer permissible for proposed companies, as according the SEBI Guidelines for a maiden offering, track record of the company‟s performance

1 2

(1880) 5 QBD 109 (1877) 2 CPD 469 at 541 (CA)

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is a must before going to the public even through the book-building route, and when it is done, the promoter‟s role is assumed by merchant bankers who handle the public offer in collaboration with the Board of Directors of the company with greater transparency, virtually banishing the erstwhile promoter to history so far as public offers are concerned, as it might appear, but still the promoter is in place besides the Merchant Bankers in IPOs and subsequent public offers.

But, the promoters as understood in law are not those: a priori it is they who get up the company by promoting and forming it with a project on hand and bring it forward to the initial public issue, who are the subject-matter of this discussion. However, even these promoters do not really fit into the structure of the companies they bring forth unless they are present as the subscribers or controllers which as professional promoters they would not prefer to be in general, and they are therefore not amenable to the control of the general body or the Boards of the companies for any misdeeds to be settled as matters of indoor management without public disclosures or failing that with recourse to the Courts, and whatever the nature of the public disclosures made the recourse to Courts rarely happened in our country.

This project is a treatise on the role of promoters in the formation of a Company. The cases cited have been from a secondary source that being a commentary on the Companies Act, 1956.

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Chapter 2:

Registration The stamped copies of the memorandum and articles have to be signed by the subscribers by themselves or their powers-of-attorney agents (DCA Circular No. 128/HCC/64 of 27-7-1964), or it could be as nominees of a single beneficial holder. If any subscriber is illeterate, he shall affix his thumb impression mark with proper description added below it, DCA letter No. 8/15/58/PR of 13-9-1958. Everyone of the subscribers is required to write in his or her own hand his or her name, father‟s/husband‟s name, address, description of occupation, number of shares subscribed it being not less than one share [Section13(4)(b) & (e)] in figures and words and then sign against his or her name with date, Section 15. The signatures are to be witnessed by a person who is a non-subscriber and who should also write his particulars in a similar fashion and sign with date. It may in passing be noticed that the subscription clause seems to be common to Tables A and B, as there is no clause such as is provided at the end of Tables C, D and E (the articles part) provided at the end of Table A, with the result that many Registrars insist on the number of shares taken by each of the subscribers to be specified at the end of the articles corresponding to Table A, which is strange and which it is not there as a requirement in the other Tables providing the model articles given in Schedule I to the Act, much against the requirement of the form and signature of articles specified in Section30.

The Documents required to be filed with Registrar for registration of a company are as follows, together with the Memorandum and Articles of Association thus executed the following documents and papers are required to be presented, accompanied by a demand draft for the required fees to be paid as specified in Schedule X of the Act at current rates (presently the range is from Rs. 4,000 to Rs. 2,00,04,000 at the top on the Memorandum plus the filing fee for each of the other documents including the Articles ranging from Rs.100 to Rs.500 per document, depending upon the authorized share capital), to the Registrar : 1.

Two spare copies of memorandum and articles of association identical with the stamped ones for vetting;

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2.

Declaration in Form No.1 signed by a practicing Chartered Accountant or Company Secretary or an Advocate of the High Court who is engaged in the formation of the company, or a Director named in the Articles, declaring that the requirements of the Act and the rules thereunder have been complied with in respect of registration and the matters precedent and incidental thereto (this needs to be pre-stamped, appropriately);

3.

Registrar‟s letter intimating the availability of name;

4.

Power-of-attorney, if any, pursuant to which any person has signed as agent for any subscribers (these need to be pre-stamped, appropriately);

5.

One power-of-attorney signed by all the subscribers authorizing, any one of themselves or the Chartered Accountant, Company Secretary or Advocate engaged by them in connection with the formation of the company, to carry out the corrections, alterations, additions or omissions suggested by the Registrar in the Memorandum and Articles of Association stamped, executed and presented for registration, under the signature of the person authorized (this needs to be prestamped, appropriately);

6.

Notice of situation of the Registered Office of the Company in Form No. 18, Section146 of the Act;

7.

Any agreement entered into with any person for his or her appointment as the managing or whole-time director or manager of the company (this needs to be pre-stamped, appropriately);

8.

Notice in Form No. 32 giving the names and the particulars of the directors, including the chairman, managing or whole-time director or manager and the secretary, Section303 of the Act;

9.

Consents to act as director obtained from the directors in Form No. 29 under Section264 (1) of the Act, or consent to act as a director and the undertaking to take and pay for qualification shares, if any, under Section266, in the case of public companies unless all the directors are named as such in the Articles (and in all cases, consents duly filed with the company before acting as directors);

10.

Bank‟s certificate for the paid-up capital balance held in deposit;

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11.

Agreement, if any, forming the basis for consideration other than cash, if any, in respect of the shares subscribed to the Memorandum (this needs to be prestamped appropriately); and,

12.

„No objection‟ letter(s) from the promoter(s) named in the application for the availability of name sent to the Registrar and subsequently dropped out, if any.

Documents mentioned at 6, 8 and 9 above may, alternatively, be filed within 30 days of the company‟s registration.

The Notices pursuant to Regulation 11 of Companies Regulations, 1956 are required to be published within a week before or after the submission of the application in one or more local newspapers. In the case of a proposed company, the application should be accompanied by the drafts of the memorandum and articles previously scrutinized by an advocate of the Supreme Court or High Court/attorney/pleader entitled to appear before the High Court or a CA or CS in practice in India engaged in the company‟s formation, together with a declaration from him confirming his scrutiny of the application and the accompanying documents and their conformity with the Act; and submitted to the Registrar under Regulation 10 for his scrutiny and forwarding the same to the Regional Director along with his list of modifications to the draft memorandum and articles and his advice on the grant of the license having regard to the promoters, directors and proposed members of the new company and the existence of other companies with similar objects, within 15 days of the receipt of the same.

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Chapter 3:

Statutory Requirements Name of the Company For a promoter intending to register a new company, choosing the name of the proposed company is the first step, and, in fact, it is not just one name, it is one plus three other alternate names, in the order of priority, to fill up the Form No. 1A of the Companies (Central Government‟s) General Rules & Forms, 1956, to be sent to the Registrar of Companies of the State where the registered office of the proposed company is intended to be situated, giving the main objects and details of the names and addresses of the promoters and/or directors as well as the proposed authorized share capital and the fee of Rs. 500 through a demand draft obtained from any bank or IPOs (Rule 4A). The Department of Company Law Administration through its Circular No. 128/HCC/64 of 27th July, 1964 directed the Registrars to help and advise those who approach them intending to form companies, to the extent possible.

A company‟s name is important and as observed in Osborn v. The Bank of US,3 “the name of a corporation is the symbol of its personal existence”. A company‟s name is linked to its objects to be chosen considering the Departmental instructions to the Registrars as a general norm to be observed in new registrations: if the name reflects a specific class of product like „motors‟, „paper‟, „brewery‟ or „sugar‟ or „cement‟, the main object should constitute only that class of product and business, whereas if the name in addition also includes general words like „industries‟ or „enterprises‟ or it simply consists of the proper name of a person with the addition of „sons‟ or „brothers‟, there will be no restrictions about the number or variety of the main objects to be included in the memorandum. In any case, the main objects included in the memorandum cannot miss out the objects given against column No. 5 in the Form No. IA sent to the Registrar seeking his approval for the availability of the name. The name of a company to be newly registered is always considered in the context of its main objects and the amount of the authorized capital chosen by the promoters: mini-operation with small capital with high sounding 3

9 Wheat (22 US) 738 at 877

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name suggestive of the presence of the company in the business arena in a mega-size will not pass off the Registrar‟s scrutiny.

Emblems and Names, Trade Marks The Emblems and Names (Prevention of Improper Use) Act, 1950, prohibits registration of any company, firm or other association or other body corporate which bears any name, trade mark or design or patent containing any title, emblem or name specified in the Schedule to the Act or any abbreviation or colourable imitation without permission of the Central Government. The Schedule lists 26 kinds of names and emblems including the National Flag, Ashoka Chakra etc. This is the Act pursuant to which promoters of new companies are required to obtain the availability of the name of the proposed new company from the Registrar of Companies, in advance as the first procedural step, by filing the application in Form 1A, quite outside the conditions of Companies Act. Further, under the Trade Marks Act, the name chosen for a new company or as a new name of an existing company should not be a colourable imitation of the trade mark of another.

Drawing up of Memorandum and Articles By the time the Registrar‟s communication regarding the name being available is received, the promoters have to get the drafts of the memorandum as well as the articles of association and the agreement, if any, which it is proposed to enter into with any individual entrepreneur for appointment as the proposed company‟s managing or whole-time director or manager made ready in terms of Section 33 of the Act, if the proposed company is an unlimited company, or a company limited by guarantee and/or share capital, or a private company, or, even if it is a public company limited by shares the application of Table „A‟ in the I Schedule to the Act is desired to be excluded. Otherwise, if it is a public company limited by shares, adopting Table A as its articles, the memorandum of association and the agreement, if any, with an entrepreneur for his appointment as managing director or manager of the company, will do as the minimum documents required to be drawn up for registration.

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Articles of association In framing the articles of association, which is a must for a company unlimited or a company limited by guarantee or a private company limited by shares or guarantee or both, as defined in Section 2(2) of the Act, the provisions contained in Sections 26 to 30, and 3(1)(iii)(a) to (d), and the model sets of articles given in Tables „A‟ to „E‟ in the First Schedule of the Act, as applicable, have to be kept in view. In respect of public companies limited by shares, adoption of Table „A‟ avoids registration of articles separately, but it is optional, though unless its application is specifically excluded in any separate set made the provisions contained in its regulations will be applicable by default to the extent not excluded or modified (Section28 of the Act) and it may hit clarity or cause conflict.

Minimum paid-up capital requirement Minimum capital norms - Consequent to the amendment to Section 3 of the Act by the Companies (Amendment) Act, 2000, effective from the 13th of December, 2000, there is a minimum paid-up capital requirement of Rs. 5 lakhs and Rs. 1 lakh, respectively, for forming a new public or private company, and the Central Government is empowered to raise these limits by such as may be prescribed. No company limited by shares can be registered with a paid-up capital lower than those current limits. It has to be noted that what the Act requires is „paid-up‟ capital, and therefore a mere subscription to the memorandum and articles of association by the minimum number of seven members for a public company and the minimum number of two members for a private company agreeing to take the number of shares specified against their names, respectively, in line with what is given in Table „B‟ in I Schedule to the Act, without payment, will not do, strictly, though the wording of the subscription clause to be incorporated as the last clause in the memorandum remains untouched to reflect the paid-up nature of the capital required in Section3 of the Act as amended.

A new concept - This introduces one more imponderable in the understanding of the meaning of the term „capital‟ in its presentation in our Company Law as „authorised‟, „issued‟ on offer, „subscribed‟, „called up‟, „uncalled‟, and „paid-up‟. That is, a company at its registration may have a higher amount, if the promoters like it to have, as its authorized capital, in the Capital

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clause in the memorandum, or if they choose to go by the statutory minimum capital adequacy norm for the company required they may provide nothing more; and in that case, it is paid-up capital since birth of the company, and if it remains so the rest disappear, as one might suppose, which they do not, and it is all-in-one.

Payment up-front by subscribers - It would, however, appear necessary for the subscribers to deposit the money for the shares intended to be subscribed by them respectively up-front in a dedicated joint banking deposit account and produce the bank‟s confirmatory certificate to the Registrar along with the other documents and papers for registration, in proof of the payment, as otherwise it is difficult to conceive „paid-up‟ capital at the company‟s birth if such capital merely remains subscribed in the memorandum without actual payment fully received, in accordance with the definition of „paid up capital‟ that includes capital credited as paid up given in Section2(32) of the Act.

In the event of the capital falling below the minimum by way of reduction of capital covered by Sections 100-105 of the Act, in the absence of anything provided in the Act, it will be for the Company Court to include a direction in its order whether a public company becomes a private company thereby, and about the consequence of what it could be in the case of a private company.

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Chapter 4:

Position of Promoters Fiduciary Relationship In Erlanger v. New Sombrero Phosphate Co. (1878) 3 App. Cases, 1218 at 1236, HL, Lord Cairns said, the promoters “stand…….undoubtedly in a fiduciary position. They have in their hands the creation and moulding of the company, they have the power of defining how, and when, and in what shape and under what supervision, it shall start into existence and begin to act as a trading corporation……I do not say that the owner of property may not promote and form a joint-stock company and then sell his property to it, but I do say that if he does he is bound to take care that he sells it to the company through the medium of a board of directors who can and do exercise an independent and intelligent judgment on the transaction……”

This verdict is nearly impossible to implement in actuality, and runs counter to the decision in Saloman’s case, which is fundamental to Company Law. “After Saloman’s case I think it is impossible to hold that it is the duty of promoters of a company to provide it with independent board of directors, if the real truth is disclosed to those who are induced by the promoters to join the company” said Lindley MR, in Lagunas Nitrate Co. v. Lagunas Syndicate4. This meant that the fiduciary duty consisted of disclosure of the real truth to the members of the company, and it is open for the promoter to do so either directly to the subscribers or to the independent Board who then walk into his shoes to carry the truth to the subscribers. In this context the pronouncement of Lord Halsbury in Gluckstein v. Barnes5 to the effect that the promoters are liable to account for their profits to not only the existing but also to all prospective shareholders stands included in the disclosure requirements of the prospectus (Section 56 read with Clause 11 of sub-part C in Part II of Schedule II to the Act) or the statement in lieu of prospectus (Part I of Schedules III and IV to the Act) concerning the public companies, and any contracting out to waive its compliance is declared void in Section 56(2) of the Act.

4 5

(1899) 2 Ch, 392 CA at 426 [1900] AC 240 at 247

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Companies Act is silent about private placements But, there is nothing in the Act obligating the promoters to make any disclosures of their profits in respect of private placements of public companies unless it involves 50 persons or more (with the exception of non-banking financial companies or public financial institutions), as well as the private companies. These offers are considered as not being calculated to result directly or indirectly in the shares or debentures becoming available for subscription or purchase by persons other than those receiving the offer or invitation; or otherwise as being a domestic concern of the persons making and receiving the offer or invitation. Section 65(5) of the Act specifically declares so in relation to private companies, leading to the obvious conclusion that promoters are absolutely free to do what they please, and it is not a concern of the Act in that behalf in that sphere of shareholders; but, the case law forming part of Company Law on the subject makes no similar concession and therefore the promoter is bound to use his position in relation to the company, whether it is public or private and whether the placement is private or public, in its interest and in good faith, and to abstain from vitiating the contract for shares or debentures by fraud, misrepresentation or undue influence in respect of his deals vis-a-vis the company, from the moment he becomes a promoter and thus a fiduciary agent, insofar as he intends and actually does draw out the funds subscribed by the shareholders or the debenture-holders towards consideration in his deals, Burland v. Earle6. This duty continues until the profits are fully disclosed, Emma Silver Mining Co. v. Lewis7. It is quite lawful for a promoter to sell his property to the company promoted by him subject to such disclosures, Omnium Electric Palaces Ltd. v. Baines.8

Promoter’s status In Weavers Mills v. Balkis Ammal,9 it was held: “As to the exact legal status of promoters, the statutory provisions, both in England and in this country, are silent in most parts except for a couple of Sections in the Specific Relief Act, both old and new one. It appears that a promoter is neither an agent nor a trustee of the company under incorporation but certain fiduciary duties are 6

[1902] AC 83 (PC) (1879) 4 CPD 396 8 [1914] 1 Ch 332 CA. 7

9

AIR 1969 Mad. 462

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imposed on him under the English Companies Act, 1948 and the Indian Companies Act, 1956. He is not an agent because there is no principal and he is not a trustee as there is no cestui-quetrust. It is on this ground that the doctrine of ratification by the company was regarded as inapplicable to the actual promoter vis-à-vis the company under incorporation.” The reference to Specific Relief Act „both old and new one‟ is to Specific Relief Act, 1963 and the earlier Act of 1877 repealed by it. In that case, the company after incorporation took possession of the properties purchased by the promoters on its behalf and improved them showing that the company adopted the promoters‟ contract, and therefore, it was held that the property was of the company‟s. Where promotion of a company begins and ends are all questions of fact. For being considered as a promoter, a person need not necessarily be the one associated with the initial formation of the company, and the association could be at a much later stage when another person is arranged to be a director, or when the actual capital is raised by way of placement of shares, or the preliminary agreements are negotiated.

From a common sense point of view, in the ordinary way, this area continues to remain as a deficiency in Company Law: the statute is silent on who a „promoter‟ is, except in connection with civil liability for misstatements in a prospectus that arises with respect to public companies; and the Courts have pronounced about their nature, position and duties, not necessarily with respect to public companies, only to go back to them, in the few cases that they do. No doubt, it puts a fear in the minds of the promoters to steer clear of being caught, but the overall picture is far from being clear, generally, it is understood though that those are the persons who promote their own rather than the interests of the companies they help create and remain suspiciously elusive.

Promoter’s Liability In terms of Section 62 of the Act, the promoter, along with the persons who are the directors of the company or the persons who consented to be directors and named in the prospectus and the other persons who authorized the issue of the prospectus which contained any untrue statements or misstatements, is fastened to civil liability to pay compensation to every person who

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subscribed for any shares or debentures on the faith of the prospectus by way of loss or damage sustained thereby subject to a contribution by the others, except in the case of fraudulent misrepresentation. Further, a promoter found guilty is subject to criminal liability of two years imprisonment and a fine of Rs. 50,000, Section 63 of the Act. Apart from this, he is disqualified to be a director of a company for a period of 5 years after the expiry of the sentence if it is for a period not less than six months in terms of Section 274(1)(d) of the Act, unless the Central Government notifies the removal of the disqualification pursuant to sub-section (2) of the said section.

Company’s Remedies The duty of disclosure by a promoter is owed to the company and therefore, primarily, it is the company, that is, the Board of Directors or the General Body, entitled either to accept the promoter‟s deal and claim the profits made in his immediate prior deals as well as the deals made with the company while the company was under promotion and formation, or to reject the deal with the company altogether, in toto, and recover the purchase money drawn out of the company‟s resources (Erlanger‟s case and Gluckstein‟s case, referred to above); and, in the case of sale of promoter‟s own properties to the company promoted by him which were acquired by him before the date of his becoming the company‟s promoter, either to affirm his contract with the company or reject it, but not affirm the contract and at the same time demand to account for profit or to compensate for damages, which amounts to asking the Court to vary the contract terms to achieve lower price, Jacobus Marler Estates Ltd. v. Evatt10

Promoter’s Remuneration There can be no contract with a company before its incorporation, and in Common Law in UK even after incorporation the company cannot make a valid contract for promoter‟s services as these form past consideration; and any provision in the memorandum or articles of the company providing for the remuneration of promoter does not hold because he as promoter per se is a stranger. In our country too, the position is not very much different though past consideration is

10

(1971) AC 793 (PC)

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no bar, because of the non-existence of the company when the promoter renders his services to be a party to the contract which otherwise may be implied.

Often, the services of a promoter do involve great organizing skills in securing the wherewithal to establish a new business, and are valuable requiring to be paid for properly and transparently. But, the legal position being what it is, this aspect remains as one of the questions to which Company Law has no answer as the promoters prefer to keep away from the company that they form. At best, the promoter can get commission paid to him by the vendors for his services, but this route is independent of the company though the payment may be at its cost. Or, if he is prepared to remain with the company, the usual way of his getting the remuneration settled is by way of shares allotted to him for a consideration other than cash by the Board. As to expenses incurred by the promoter, Regulation 67 in Table A of Schedule I to the Act provides that the Board may pay all expenses incurred in getting up and registering the company, and even otherwise it is to be taken that it is always within the general powers vested in the Board to pay up such expenses by way of reimbursement to the promoter, but this cannot cover the remuneration to the promoter himself for his services. Thus, there is no way to make a legally valid claim by a promoter of a company against the company for his services even after it is incorporated. But, promotion, formation and registration of companies can be no gratuitous or free public service, for any promoter to get into, and he gets his due very well settled in various ways, notwithstanding the requirement as to disclosure of the payments made or benefits given to the promoter during the preceding two years in the prospectus or the statement in lieu of prospectus.

SEBI Guidelines Promoter in public offers Under Chapter IV of SEBI (Disclosure & Investor Protection) Guidelines, 2000, in a public issue by unlisted companies or offers for sale or public issues by listed companies (unless the company is listed for 3 years or more with dividend payment record for those years), the promoter shall contribute not less than 20% of the post-issue capital, subject to a lock-in period of 3 years from - 14 -

the date of allotment. In case of infringement, it appears that the promoter is liable to be directed by SEBI to refund any money collected under an issue to the investors with or without requisite interest as the case may be and also being liable to be slapped with a ban to access the capital market for the specified particular period under para 17.1 (a) and (b) of SEBI (Disclosure & Investor Protection) Guidelines, 2000. Besides, the company and its concerned officers in charge at the time the offence is committed shall be deemed to be guilty of the offence attracting imposition of penalty by the Adjudicating Officer (Divisional Chief of SEBI nominated by SEBI) upto Rs. 5 lakhs, if it involves implications of insider trading in terms of Section 15G of SEBI Act, 1992, as well as the award of fine and imprisonment for persons upto one year with or without fine under Section 24 of the Act, on a complaint filed by SEBI in the Court having jurisdiction.

Promoter in takeovers SEBI has provided rather unconventional definitions, two of them, of ‟promoter‟ exclusively in relation to substantial acquisition of shares and take-overs, considering the predatory nature of hostile takeovers required in promotion of competition.

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Chapter 5:

Pre-incorporation Contracts Preliminary contracts may be pre-incorporation contracts or pre-commencement of business certificate contracts better known as provisional contracts. Only the former are important, as the latter are provisional contracts become binding on the company on the issue of certificate of commencement of business, Section 149(4).

Position in English Law Before the formation and registration of the company, it is not a person in the eye of law, and because it is an artificial person even after it comes into being, it cannot act otherwise than through some human agent acting for and on its behalf; and, when it is not in existence in law, it can have no agent to accept on its behalf any proposals for transactions in the nature of agreements brought up by the promoter or others. Therefore, if the promoter accepts any proposals connected with the company under formation though from third parties, it is only the promoter who is bound but not the company even after ratification of the contracts on its registration, and no suit lies against the company on the strength of such agreements, nor can the company enforce such contracts for its benefit.

Some persons, who became directors of the company after its registration, gave instructions to the Solicitors to prepare the memorandum and articles of association and to register that very company, which the Solicitors did paying the registration fee from their pocket. In a suit for the recovery of their costs laid against the company by the Solicitors, it was held that the company was not liable, Re English & Colonial Produce Co. Ltd.11. It is so because, “where a contract is signed by one who professes to be signing „as agent‟, but has no principal existing, at the time, and the contract would be inoperative unless binding on the person who signed it, he is bound thereby; and a stranger cannot by a subsequent ratification relieve him from that responsibility.”

11

(1906) 2 Ch 435 (CA)

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Kelner v. Baxter.12 In that case, three persons signed a contract on behalf of a hotel company under formation for purchase of 900 sterling worth of wine. The company was formed and the wine was delivered to it and consumed, but the company was put to liquidation before the payment. It was held that the three persons who signed the contract were liable and no ratification could release them. “A company cannot by adoption or ratification obtain the benefit of a contract purporting to have been made on its behalf before the company came into existence”.-Natal Land & Colonisation Co. v. Pauline Colliery Syndicate13

When the promoter signed the contract in the name of the unborn company adding his own name to it, it was held “This Company was not in existence and….the signature on that document, and indeed the document itself….is a nullity.”-Newborne v. Sensolid (Great Britain) Ltd14. Simply signing the contract „per pro‟ or „for and on behalf of‟ the proposed company does not make the person signing thus an agent and it depends upon the intendment and purport evident in the contract, Phonogram Ltd. v. Lane.15

Novation- After incorporation, a company may effectuate novation, that is, by entering into a new contract with the same party on the same terms afresh in discharge of the promoters‟ contract, or this may be inferred from the acts and conduct of the parties, and such novation is valid, Howard v. Patent Ivory Mfg. Co16.. Section 36(4) of the 1985 Act as replaced by Section 36C(1) (by the 1989 Act - adopted from Section 9 (2) of the European Communities Act, 1972) provides that: “A contract which purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for a company or as agent for it, and he is personally liable on the contract accordingly.” Novation is covered by the words “subject to any agreement to the contrary” in the section. 12 13 14 15

16

(1866) LR 2 CP 174 at 183 (1904) AC 120. (1954) 1 QB 45 (1982) QB 938 at 945. (1888) 38 (Ch. D) 156

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Adoption of contracts in objects’ clause- For avoiding personal liability of promoter in respect of pre-incorporation contracts, the general practice preferred is to make out the agreement as between the third parties and the company under formation in its name even before incorporation, with a clause about it included in the objects clause of its memorandum, duly signed by the third parties in advance on any date, and the partly signed agreement left to the custody of an escrow or a bank on condition that it should be released against execution and payment in full or in part by or on behalf of the company after its incorporation. Another safeguarded model adopted is to make the pre-incorporation contract straightaway between the third parties and the promoters conditional with a clause to the effect that the contract ceases to be binding on the parties in the event of abandonment of the formation of the company short of incorporation, and become binding on its novation by the company after its incorporation pursuant to a clause inserted in the objects clause of the company‟s memorandum of association. Alternatively, such contracts are expressed as signed only for purposes of identification as between the third parties and the promoters and reduced in writing for clarity with the recital that it is only a memorandum of understanding or a gentlemen‟s agreement.

Pre-incorporation Contracts: Position in India These preliminary contracts are inevitable and invariably arise with almost every new registration and incorporation of a company, and probably in recognition of this, our legal system is pro-active so far as the procedure is concerned. These preliminary contracts are governed, as discussed above, by the provisions of Sections 15(h) and 19(e) of the Specific Relief Act, 1963, and are enforceable by or against the new company, respectively, subject to the fulfillment of the conditions specified in the said Sections. As a general practice, these are novated after the company‟s incorporation, often supported by a clause inserted in the objects clause of the company‟s memorandum of association as providing the linkage beyond doubt. The other general practices referred to above of reducing the operative terms in writing for clarity without entailing any liability on the promoters, are also in vogue, alternatively.

Both the Sections 15(h) and 19(e) of Specific Relief Act, 1963, provide, in identical wording, that when the promoters of a company have, before its incorporation, entered into a contract for

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the purposes of the company, and such contract is warranted by the terms of incorporation, the company may sue or be sued, respectively, for specific performance, provided that the company has accepted the contract and has communicated such acceptance to the other party to the contract. Accordingly, the decision in Natal Land & Colonisation Co. v. Pauline Colliery Syndicate17, to the effect that “A company cannot by adoption or ratification obtain the benefit of a contract purporting to have been made on its behalf before the company came into existence” is inoperative in India, Vali Pattabhirama Rao v. Sri Ramanuja Ginning & Rice Factory (P.) Ltd.18

17 18

Supra n. 13 [1986] 60 Comp Cases 568 (AP)

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Chapter 6:

Case Analysis Case No. 1: Natal Land and Colonization Company, Limited v. Pauline Colliery & Development Syndicate, Limited [1904] A.C. 120

Facts The appellants were an incorporated joint stock company, having their head office in London. Mr. Rycroft was their general manager in Natal under a power of attorney dated October 26, 1888, by the terms of which he was empowered to sell and lease the company's lands in the Colony and to make contracts for these purposes. Rycroft, on behalf of the appellants, made a contract with Mrs. De Carrey respecting the coal mining rights in 3000 odd acres of land belonging to the appellants, and known as the Coal Company's Lots. Mrs. De Carrey sold all her interest in the land to one William Louch, provisional director of an as yet unregistered Company, Pauline Colliery Syndicate. On May 30, 1899, the respondents commenced action against the appellants for specific performance of the agreement.

Contentions of the Appellants The appellants in their plea to the declaration contended that there was no contract between the respondents and themselves, and alleged that the agreement to substitute the syndicate for Mrs. de Carrey was obtained from Rycroft by misrepresentation, the misrepresentation charged being that Mr. Binns and Louch had represented that Mrs. de Carrey had been acting for the syndicate all through the negotiations, whereas the syndicate or Louch had purchased the benefit of the agreement from her for a large sum. The appellants contended that, inasmuch as the respondents were not registered at the date of

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these transactions and not till January 22, 1898, there was no privity of contract between them

Contentions of the Respondents They contended that the contract of December 9 was valid, and its alteration on the 29th and 30th of that month gave Mrs. de Carrey the right to substitute the syndicate or the respondents as parties thereto. By her signature to the respondents' articles of association she did so substitute the respondents. In the alteration there was sufficient evidence of the creation of a new contract between the appellants and the respondents in terms of the old one. It appears that the appellants acquiesced in the exercise by the respondents of the right to extend the option of prospecting contained in the contract, in their prospecting during the whole of the extended term, in their expenditure of money in prospecting and boring operations.

Ratio A company cannot by adoption or ratification obtain the benefit of a contract purporting to have been made on its behalf before the company came into existence. In order to do so a new contract must be made with it after its incorporation on the terms of the old one. As has already been stated, this position does not stand in India and the same has been expressly stated by the Andhra Pradesh High Court in the case Vali Pattabhami Rao. Therefore, this position is not good law anymore.

Case No. 2: Kelner v. Baxter & Ors. (1866), L.R. 2 C.P. 174 Facts The plaintiff and the defendants were promoters of the Gravesend Royal Alexandra Hotel Company, Limited. The plaintiff was to be the manager of the hotel under the new company. Before the company was incorporated the plaintiff offered to sell a stock of wine to the proposed th

company for £900 which was accepted by the defendants on January 27 , 1866 on behalf of the - 21 -

st

Gravesend Royal Alexandra Hotel Company Limited. On February 1 the directors of the Gravesend Royal Alexandra Hotel Company Limited ratified the agreement. However, the promoters did not receive a certificate of incorporation for the Gravesend Royal Alexandra Hotel Company Limited until February 20, 1866. The directors then purported to ratify the agreement again on April 11, 1866 just days before the company made an assignment in bankruptcy.

Ratio The court held that the ratification of February 1, 1866 was not a valid ratification because the company was not in existence at the time. The ratification on April 11 was also held not to be a valid ratification.

Reasoning It was not a valid ratification because of the requirement that ratification can only be done by a principal having capacity to contract at the time the contract was entered into as well as at the time of the ratification. It was also not valid on the basis that the company was not in existence at the time of the promoters purported to act on its behalf. The court nonetheless still felt there was clearly an intended contract and the only way in which there could be a valid contract was if the defendants were the other contracting parties. They thus held that there was a valid contract in which the plaintiff was one party and the defendants were the other parties. Kelner v. Baxter thus confirmed that a company cannot ratify a contract, or purported contract, entered into on its behalf if the company was not in existence at the time a person purported to enter into a contract on its behalf. Kelner v. Baxter also highlighted the potential for promoters to be liable on contracts they purport to enter into on behalf of an as yet unincorporated entity. What was not clear after Kelner v. Baxter was whether promoters were automatically liable in these situations (sometimes referred to as the “rule of law” approach) or whether the promoter‟s liability depended on whether it was intended that the promoter be a party to the contract (sometimes referred to as the “rule of construction” approach).

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Case No. 3: Newborne v .Sensolid (Great Britain) Ltd [1953] 1 All E.R. 708

Facts In Newborne v. Sensolid Ltd. Newborne had entered into a contract with Sensolid Ltd. to supply tinned ham to Sensolid Ltd. The price of tinned ham fell and Sensolid Ltd. refused to take further deliveries of tinned ham from Newborne. The contract had been signed by Leopold Newborne underneath the words Leopold Newborne (London) Ltd. It was not formally signed “on behalf of Leopold Newborne (London) Ltd.” as had been the case in Kelner v. Baxter. Unfortunately, Leopold Newborne (London) Ltd. had not been incorporated. Leopold Newborne (London) Ltd. was later incorporated and it brought an action against Sensolid Ltd. That action was dismissed because Leopold Newborne (London) Ltd. had not been incorporated at the time the contract was entered into. Leopold Newborne then sued Sensolid Ltd. in his own name seeking to enforce the preincorporation contract on the basis that he was a party to the contract himself. The argument was made on the basis of Kelner v. Baxter saying that if the contract was not with Leopold Newborne (London) Ltd. then it must have been with the person who signed on behalf of the company, namely, Leopold Newborne.

Ratio The English Court of Appeal held that the correct approach was a rule of construction approach. The real test was whether the promoter was intended, in the circumstances, to be a party to the contract or not.

Reasoning It was held that given the way in which the contract was signed by Leopold Newborne it was intended to be a contract with the company and only the company. In other words, given the way

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in which it was signed it indicated that it was not intended that Leopold Newborne be a party to the contract himself. Thus Leopold Newborne could not enforce the contract in his own name. The English Court of Appeal made it clear that promoter liability was to be based on a rule of construction approach, i.e. promoters were only liable if it was intended in the circumstances that they were themselves to be parties to the contract.

Case No. 4: Tirupati Finlease Ltd. v. Securities and Exchange Board of India MANU/SB/0008/2000 Facts 1. In January, 1996 the appellant-company issued 23 lakhs equity shares of Rs. 10 each. Out of the said 23 lakhs shares 17.80 lakhs were issued to the public. The remaining 5.20 lakhs shares were reserved for allotment to the promoters, directors, their friends, relatives and associates. 2. Shares were listed on the Ahmedabad Stock Exchange (ASE) on 26-3-1996. 3. It was reported that there was substantial variation in the collection figures of the public issue as per the 3 days report and the final report submitted by the lead manager of the issue. Further, unusual movements, in the share prices and volumes traded in the scrip not based on any economic fundamentals were witnessed at ASE. 4. Trading in the scrip on ASE, attributing to volatility, was suspended on 16-5-1996. the respondent had, in the meantime, decided to "investigate into the affairs relating to dealings in the shares in respect of the public issue of the company by Tirupati Finlease Ltd., and other intermediaries/persons associated with public issue and into the irregularities of price rigging and market manipulations in the said scrip which is violative of the provisions of SEBI (prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 1995," 5. Investigations led to the conclusion that the promoters had indulged in unfair and fraudulent trade practices in dealing in the shares. Based on this finding, invoking

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Regulation 11, the appellant was, debarred from accessing capital market for a period of 5 years.

Contention of Appellants While the respondent was after the appellant, they did little realise the plight of the investors by keeping trading of shares under suspension for such a long period spanning over 4 years. The suspension of trading for such a long period was not an investor protection measure. The inquiry was not conducted in a just and fair manner following the principles of natural justice. Even before suspending trading, no opportunity was given to the appellant and no reason for such suspension was communicated. Out of a total issue of 30 lakh shares comprising the post issue paid-up capital of the appellant only 4.95 lakh shares accounting for just 16 per cent were traded between 26-3-1996 to 16-51996, i.e., between date of listing and date of suspension. As per the scope of Regulation 11, the respondent was not empowered thereunder to issue the impugned order debarring the appellant from accessing the capital market.

Contention of Respondent The impugned order was made in public interest after affording reasonable opportunity to the appellant. Since the charges being grave in nature, with a view to protect the integrity of the capital market the appellant was directed not to access the capital market for a period of 5 years.

Ratio In the absence of clinching evidence to pin down the Company, it cannot not be held that the Company was responsible for the volatility in the market.

Reasoning Incidentally, in the normal course, when the shares are listed, and the allotment is over by issuing share certificates to the applicants and the collection money is received from the separate

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collection account, volatility in the price and trade volume immediately in the aftermath of the public issue may not be of any relevance to the issuer company, as the company had already received the issue price. The loss or gain would normally affect those who deal in these shares. That being the normal case, in the absence of clinching evidence to pin down the appellant, it cannot not be held that the Appellant was responsible for the volatility in the market. An artificial scarcity was created in the market to manipulate the price movement, the charge cannot stick on the appellant, as in the respondent's own version, the so-called situation was created by the promoter of the appellant-company. There is no evidence to show that the shares were withheld by the promoter Managing Director, at the instance or for and on behalf of the appellant. A company cannot be substituted for promoters for the purpose of imposing penalties. It is also seen that the respondent had asked ASE to consider revoking the 4 years old ban on trading in the appellant's scrips, but at the same time by the impugned order the appellant has been debarred from accessing the market for the next five years! Hence, the impugned order was quashed by the Securities Appellate Tribunal, Mumbai

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Chapter 7:

Conclusion The nomenclature of promoters and preferential allotments of shares to them is very much in vogue in our country even decades after the company‟s formation and successful working to such an extent as to give the impression that whoever are the present controllers and managers of the company holding the shares that gave them the edge are the promoters as successors not just by transmission or gift of the very shares of the original archtypes but even when control changed hands by takeover for valuable consideration, passing on the privilege as if it were annexed by law to the chunk of shares held by the first acquirers of control over the company even if they had nothing to do with the formation of the company, a super-class distinction of equity shares which the Act has not conceded and not prohibited either to stop the subtle operation of grabbing the shares pursuant to Section 81 (1A) of the Act whether by a special resolution or an ordinary resolution coupled with the Central Government‟s approval (and in the case of unlisted public companies, the procedure being in conformance with the Unlisted Public Companies (Preferential Allotment) Rules, 2003, while it is in conformance with the SEBI Guidelines, 2000, Ch. XIII for the listed companies) at a coveted price and terms, thus, in a frenzy that happened till the year 2000 independent of any public issue, and what the SEBI has since officially conceded subject to parity and „lock-in‟ in its Guidelines, 2000 with effect from 4.8.2000, rendering the preferential allotment almost lustreless in itself otherwise than as strengthening the controlling interest. The point is that the promoter-factor has come to be recognized as pervasively present in connection with public offers long after the company was promoted and formed to run with the company as a going concern, and since the person owns it up and present there should be no hide and seek. That way or otherwise, company world is not free from promoters whether original or rotated; and if it were to be, perhaps big companies that matter and become admirable would not come into being, for it is the promoter who in their creativity and flamboyance in risk-taking bring them into being as in the past for corporate growth. Therefore, the role of promoters is becoming all the more important in the present age and the question of their remuneration and compensation must be settled once and for all. - 27 -

BIBLIOGRAPHY STATUE: 1. The Companies Act, 1956 2. The Emblems and Names (Prevention of Improper Use) Act, 1950 3. The Companies (Amendment) Act, 2000 4. SEBI (Disclosure & Investor Protection) Guidelines, 2000 5. The Specific Relief Act, 1963

BOOKS: 

D.S.R. Krishnamurti, Taxmann's Company Law, (Taxmann Allied Serives, New Delhi, edn. 1, 2006)



AK Majumdar and Dr. GK Kapoor, Taxmann’s Company Law and Practice (Taxmann Publications (P.) Ltd., New Delhi, 11th edn., 2005)

ARTICLES: 

Mark Gillen, Notes on Business Associations

WEBSITES: 

www.legalserviceindia.com/company%20law/com_1.htm



http://www.calfirstholdings.com/Part4.html



http://www.stamfordonline.com.my/courses/dca/dca212/DCA%20212%20Chapter%206. pdf



http://www.sebi.gov.in/guide/dipamendguide.pdf



http://law.uvic.ca/mgillen /315/documents/Ch15-Pre-IncContracts.pdf

CASES REFERRED TO: 1. Bridge Calico Printing Co. v. Green & Smith 2. Twycross v. Grant 3. Osborn v. The Bank of US

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4. Erlanger v. New Sombrero Phosphate Co. 5. Saloman v Saloman 6. Lagunas Nitrate Co. v. Lagunas Syndicate 7. Gluckstein v. Barnes 8. Burland v. Earle 9. Weavers Mills v. Balkis Ammal 10. Omnium Electric Palaces Ltd. v. Baines 11. Emma Silver Mining Co. v. Lewis 12. Jacobus Marler Estates Ltd. v. Evatt 13. Re English & Colonial Produce Co. Ltd 14. Kelner v. Baxter 15. Howard v. Patent Ivory Mfg. Co 16. Vali Pattabhirama Rao v. Sri Ramanuja Ginning & Rice Factory (P.) Ltd 17. Natal Land & Colonisation Co. v. Pauline Colliery Syndicate

CASES ANALYSED: 1. Natal Land and Colonization Company, Limited v. Pauline Colliery & Development Syndicate, Limited 2. Kelner v. Baxter & Ors. 3. Newborne v .Sensolid (Great Britain) Ltd 4. Tirupati Finlease Ltd. v. Securities and Exchange Board of India

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