Formation of Company – Promotion and Incorporation

1. Functions of Promoter
2. Legal Position of Promoter
3. Duties of Promoter
4. Liabilities of Promoter
5. Remuneration to Promoter
6. Preliminary or Pre-incorporation Contracts
7. Adoption of Preliminary Contract
8. Incorporation of a Company

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Promoter is a person who conceives the idea of starting a business, plans the formation of a company and actually brings it into existence. He may be said to be

“the father of the company who sees the prospects of gain in a business which he wishes to set up, and believes that he can persuade others too to think as he does.”

A promoter is one who undertakes to form a company with reference to a given object and who takes the necessary steps to accomplish that purpose.¹ Palmer has defined company promoter as “a person who originates a scheme for the formation of the company, has the Memorandum and the Articles prepared, executed and registered, and finds the first directors, settles the terms of preliminary contracts and prospects (if any) and makes arrangements for advertising and circulating the prospectus and placing the capital.” Thus, a promoter discovers, formulates and assembles a business proposition and brings about a company into existence for its development.

Sec. 2(69) of the Companies Act, 2013 defines the term promoter as a person:

(a) Who has been named as such in a prospectus or is identified by the company in the annual return referred to in section 92; or

(b) Who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or

(c) In accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act. This shall, however not apply to a person who is acting merely in a professional capacity.

A promoter may be an individual, a family, a firm, an association of persons, a company or even the government. It may cover any individual or company that obtains a director, places shares or negotiates preliminary contracts. A promoter need not necessarily be associated with the initial formation of the company; one who subsequently helps to arrange the ‘floating off of its capital’ will equally be regarded as a promoter. Persons doing acts of purely ministerial nature or in a professional capacity for remuneration or fees are not promoters e.g., solicitors, valuers, etc. Promoter does not include any person by reason of his acting in a professional capacity or persons engaged in procuring the formation of the company. A person who only advances money to promoters for meeting out preliminary expenses is not a promoter. But a professional who brings financiers to the company would be considered as promoter.

A person cannot be held as a promoter merely because he has signed at the foot of the Memorandum or that he has provided money for the payment of formation expenses.² A signatory to the Memorandum, who has not performed the functions of the promoter of a company, may not be liable as a promoter.

1. Functions of Promoter

The main functions of a promoter are as follow:

• To conceive an idea of starting a business and explore its possibilities.
• To undertake detailed technical, economic and commercial feasibility of the business propositions. Help of experts may be taken for that.
• To conduct negotiations for the purchase of a business in case it is intended to purchase an existing business.
• To collect the requisite number of persons i.e. 2 in the case of a private company and 7 in the case of a public company, who can sign the memorandum and articles of the company and also agree to act as the first directors of the company.
• To decide the following:

1. 1. the nature of the company
      
   2. the location of its registered office
   3. the amount and form of its capital
   4. the underwriters or brokers for capital issue, if necessary
   5. the bankers
   6. the auditors
   7. the legal advisers.

• To get the memorandum of association and articles of association drafted and printed.
• To enter into preliminary contracts with vendors, under-writers etc.
• To arrange for the preparation of prospectus, its filing, advertisement and issue of capital.
• To pay preliminary expenses.
• To arrange funds required by the company.

2. Legal Position of Promoter

A promoter can neither be termed as an agent nor a trustee of a company which has not come into existence. The reason is that there was no principal or trust in existence for whom or for whose benefit the promoter has acted. Thus, the legal position of the promoter cannot be precisely established. However, Lindley, L. J. described his position in Lydney & Wigpool Iron Ore Co. v. Bird (1866) which may be termed as that of ‘quasi-trustee’.

“Although not an agent for the company, nor 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 is accountable to it for all monies secretly obtained by him from it, just as the relationship of the principal and agent or the trustee and the trust had really existed between him and the company when the money was obtained”.

Promoters have wide powers relating to the formation of the company. Law has put the relationship of the promoters with the company they bring into existence as well as with those whom they induce to become shareholders in it, as that of a fiduciary nature. This fiduciary relationship is based on utmost faith and confidence.

“Those who accept and use such extensive powers are not entitled to disregard the interests of the corporation altogether. They must make a reasonable use of the powers which they accept from the legislature; and consequently they do stand, with regard to the corporation, when formed, in what is commonly called a fiduciary relation to some extent.”³

3. Duties of Promoter

The promoter stands in a fiduciary relationship with the company. Though the fiduciary relationship really arises when the company is formed, the fiduciary obligation of a promoter begins as soon as he sets out to act as promoter of the company.⁴ This fiduciary relationship imposes the following obligations on the promoters:

1. Not to make Secret Profit: Promoters should not make any secret profits at the cost of the company without its knowledge and consent. Secret profits or undisclosed benefits of any type received by the promoters can be recovered from them by the company.⁵ Company can proceed against the promoters for any damage caused to it on account of their fraud or breach of duty. The estate of the promoter shall remain liable in an action by a company for deceit or breach of trust if any benefit has accrued to the estate.
2. Disclosure of Material Facts: It is the duty of the promoters to disclose fully all material facts relating to the formation of the company. The disclosure of all material facts, regarding contracts made and the profits earned by them from the formation of the company, should be made to an independent and competent Board of Directors. If the promoters fail to disclose complete facts, company may set aside the transaction and recover the benefit earned by them.

4. Liabilities of Promoter

• Non-disclosure of Secret Profit: In case a promoter fails to make full disclosure of his dealings and profits made in promoting the company, he can be compelled by the company to hand over such secret profit. The company can also sue for the rescission of the contract of sale by the promoter where the promoter has not disclosed his interest therein.
• Non-adoption of Preliminary Contract: If a promoter enters into contracts on behalf of the company before the company was actually incorporated, he may be held personally liable for non-adoption of those contracts by the company provided he has purported to act as an agent and the non-existence of the company was known to both the parties.
• Fraud in the Promotion of the Company:

1. 1. If a promoter furnishes any false or incorrect particulars of any information or suppresses any material information, of which he is aware in any of the documents filed with the Registrar in relation to the registration of a company, he shall be liable for action under section 447.
   2. Where it is found that any fraud has been committed in promoting or forming a company, the Tribunal may order investigation against the promoters any other director or officer of the company involved in such fraudulent activities (Section 282).
   3. A company may proceed against a promoter where the promoter has wrongfully obtains possession of any property, including cash of the company or wrongfully withholds it or knowingly applies it for the purposes other than those expressed or directed in the articles and authorised by the Act (Section 452).

• Omission in the Prospectus: Prospectus issued by a company must have the contents as laid down by Section 26 of the Companies Act. In case of omission of facts, promoters may be held liable under section 35 to compensate the investors for the losses suffered by them.
• Misrepresentation in the Prospectus: A promoter is liable for any untrue statement in the prospectus to a person who has subscribed for any shares or debentures on the faith of the prospectus. Such a person may sue the promoter for compensation for any loss or damage sustained by him (Section 35).

5. Remuneration to Promoter

The promoter has to incur the initial expenses in the process of formation of a company besides undergoing a good deal of arduous task. The promoter has, therefore, a legitimate right to claim for both the expenses incurred by him as well as remuneration for the work done by him. The claim for expenses should be supported by vouchers and should be placed before the directors of the company when formed. However, there is no contractual obligation on the part of the company to pay him for these expenses unless the company has expressly agreed to pay after its formation for the services rendered by him. The same is true about his remuneration.

The promoter may be remunerated in any of the following ways:

• Promoter may sell his own asset to the company at profit for cash or shares in the company.
• He may be given commission on the purchase price of the business taken over by the company.
• He may be granted a lump sum as remuneration either in cash or in shares or debentures.

The amount of remuneration payable or paid to the promoters is required to be disclosed in the prospectus issued by the company.

6. Preliminary or Pre-incorporation Contracts

6.1 Meaning

Preliminary contracts are contracts entered into by the promoters on behalf of the company before its incorporation with third parties.

6.2 Validity

It is usual for the promoters to enter into these contracts of purchases of assets on behalf of the company about to be formed but before it is actually formed. They generally enter into these contracts as agents or trustees of the company, which has not yet come into existence. Such contracts are legally not binding upon the company even after it comes into existence. The company can neither ratify those contracts nor sue the vendors on them after its incorporation because ratification requires existence of the principal at the time when the contract was entered into.

A company cannot adopt contracts entered into before its incorporation even by passing a special resolution or with the unanimous consent of its members. Thus, preliminary contracts will either have to be left as mere “gentlemen’s agreements” or the promoters will have to undertake personal liability; which of these courses will be adopted depends largely on demands of the other party.⁶ ‘Since the pre-incorporation contracts purported to be made by a company which does not exist is a nullity, neither the company when formed nor the promoter whose signature is added can sue or be sued on contract.’⁷

6.3 Liability of the Promoter

The nature of the liability of the promoter on preliminary contracts depends on the tenor of such contracts. He can be held personally liable if he has purported to act as an agent and the non-existence of the company was known to both the parties. This is because where a contract is made on behalf of a principal known to both the parties to be non-existent, the contract is deemed to have been entered into personally by the actual maker. Case of provides an illustration:

But, if the contract is purported to be made by the company itself, the person so acting i.e., the promoter, cannot be held personally liable, for he shall be taken to have simply authenticated the contract and the company shall be taken to have entered into the contract and the company being non-existent the contract shall become nullity. Case of Newborne (London) Ltd. v. Sensolid (GB) Ltd. (1954) may be cited:

In case of personal liability, the promoters will continue to be liable until the company adopts the contracts. In order to avoid their liability, the promoters usually insert a clause in the original contract to the effect that if the contract is not adopted by the company after its incorporation within a limited time, both the promoters and the third party will be exonerated from liability. Some of the promoters simply agree to the draft contract to be entered into by the vendor and the company after incorporation.

7. Adoption of Preliminary Contract

A company may adopt preliminary contracts by either of the two ways:

1. The company may adopt these contracts by entering into new contracts with the third parties on the same terms as were embodied in the original contract. Such a new agreement of adoption may not be expressly made but may be implied by the acts of the company.
2. The company may adopt these contracts under the Specific Relief Act, 1963. Sections 15(h) and 19(e) of the Act provide that a contract entered into by the promoters on behalf of the company before its incorporation can be enforced by or against the company, if the following two conditions are satisfied:

• • The contract is entered into, for the purposes of the company and such contract is warranted by the terms of incorporation. The term “for the purposes of the company” implies that the contract should be for the working purpose of the company.
  • The company accepts the contract after its incorporation and communicates such acceptance to the other party to the contract.

8. Incorporation of a Company

Incorporation brings a company into existence as a separate corporate entity.

As per Sec. 3(1) a company may be formed for any lawful purpose by:

1. seven or more persons, where the company to be formed is to be a public company;
2. two or more persons, where the company to be formed is to be a private company; or
3. one person, where the company to be formed is to be One Person Company that is to say, a private company, by subscribing their names or his name to a memorandum and complying with the requirements of this Act in respect of registration.

8.1 Preliminary Steps

The promoters have to go through the following preliminary steps before applying for incorporation of the proposed company:

1. As per Sec. 4(2) a company cannot be registered with a name which is considered to be undesirable in the opinion of the Central Government. The name should not be identical with or resemble too nearly to the name of an existing company or registered under this Act or any previous company law. Therefore the promoters are advised to make an application in the Form 1 A to ascertain the availability of maximum six names in the order of their preference.
2. A fee of Rs. 500 has to be paid alongside and the digital signature of the applicant proposing the company has to be attached in the form. If proposed name is not available, the user has to apply for a fresh name on the same application.
3. The name approved will be reserved by the Registrar for a period of 20 days from name approval. Within this period, the applicant can apply for registration of the new company by filing the required forms (i.e. Forms 1, 18 and 32).
4. Before promoters begin the incorporation of a company, they have to appoint chartered accountants, lawyers etc., to help them in preparing various documents.
5. Arrange for the drafting of the memorandum and articles of association by solicitors, vetting of the same by Registrar of Companies and printing of the same.

The Memorandum and Articles must be signed by at least 7 subscribers (2 in case of private company) along with address, description, occupation, if any, in the presence of at least of one witness. The subscribers should also clearly mention the number and nature of shares subscribed by them.

8.2 Applying to the Registrar of Companies

After having done the preliminary work, the promoters are required to make an application to the Registrar of the State in which company’s registered office will be situated, accompanied by the following documents and information for registration [Sec. 7(1)]:

1. the memorandum and articles of the company duly signed by all the subscribers to the memorandum in such manner as may be prescribed;
2. a declaration in the prescribed form by an advocate, a chartered accountant, cost accountant or company secretary in practice, who is engaged in the formation of the company, and by a person named in the articles as a director, manager or secretary of the company, that all the requirements of this Act and the rules made thereunder in respect of registration and matters precedent or incidental thereto have been complied with;
3. a declaration from each of the subscribers to the memorandum and from persons named as the first directors, if any, in the articles that he is not convicted of any offence in connection with the promotion, formation or management of any company, or that he has not been found guilty of any fraud or misfeasance or of any breach of duty to any company under this Act or any previous company law during the preceding five years and that all the documents filed with the Registrar for registration of the company contain information that is correct and complete and true to the best of his knowledge and belief;
4. the address for correspondence till its registered office is established;
5. the particulars of name, including surname or family name, residential address, nationality and such other particulars of every subscriber to the memorandum along with proof of identity, as may be prescribed, and in the case of a subscriber being a body corporate, such particulars as may be prescribed;
6. the particulars of the persons mentioned in the articles as the first directors of the company, their names, including surnames or family names, the Director Identification Number, residential address, nationality and such other particulars including proof of identity as may be prescribed; and
7. the particulars of the interests of the persons mentioned in the articles as the first directors of the company in other firms or bodies corporate along with their consent to act as directors of the company in such form and manner as may be prescribed.

The Registrar on the basis of the required documents and information filed shall register all the documents and information in the register and issue a certificate of incorporation in the prescribed form to the effect that the proposed company is incorporated under this Act.

On and from the date mentioned in the certificate of incorporation, the Registrar shall allot to the company a corporate identity number, which shall be a distinct identity for the company and which shall also be included in the certificate.

If any person furnishes any false or incorrect particulars of any information or suppresses any material information, of which he is aware in any of the documents filed with the Registrar in relation to the registration of a company, he shall be liable for action under section 447 of the Companies Act.

8.3 Online Registration of a New Company

The Ministry of Corporate Affairs enables online registration of a company on the portal of the MCA. The steps for online registration of a company are as follows:

Step 1: Acquire Director Identification Number (DIN)

Each proposed director of the company to be formed are required to obtain DIN by filing an e-form DIN-1.

Step 2: Acquire/Register Digital Signature Certificate (DSC)

All filings done by the companies under MCA 21 e-Governance programme are required to be filed with the use of Digital Signatures by the person authorised to sign the documents.

Acquire DSC — A licensed Certifying Authority (CA) issues the digital signature.
Register DSC — After acquiring the DSC it is important to do the Role check to verify whether the Digital Signature affected on the e-form are of the Director, Manager, or Secretary and whether the Digital Signature is registered on the MCA Portal.

Step 3: New User Registration

To file an e-Form or to avail any paid service on MCA portal, it is first required to be registered as a user in the relevant user category, such as registered and business user.

Step 4: Incorporate a Company

• Select, in order of preference, at least one suitable name up to a maximum of six names, indicative of the main objects of the company.
• Ensure that the name does not resemble the name of any other already registered company and also does not violate the provisions of Emblems and Names (Prevention of Improper Use) Act, 1950 by availing the services of checking name availability on the portal.
• Apply to the concerned ROC to ascertain the availability of name by filing Form INC-1 for the same in to the portal. A fee of Rs. 500 has to be paid alongside and the digital signature of the applicant proposing the company has to be attached in the form. If proposed name is not available, the user has to apply for a fresh name on the same application.
• After the name approval, the applicant can apply for registration of the new company by filing the required forms Form INC-7 or Form INC: Form INC-7 for Application for incorporation of a company (Other than OPC) or Form INC-2 for Application for Incorporation of OPC within 60 days of name approval.
• Arrange for stamping of the Memorandum and Articles with the appropriate stamp duty. It can be paid electronically on the MCA portal.
• Get the Memorandum and the Articles signed by at least two subscribers (7 in case of public company) in his/her own hand, his/her father’s name, occupation, address and the number of shares subscribed for and witnessed by at least one person.
• Ensure that the Memorandum and Article is dated on a date after the date of stamping.
• Login to the portal and fill the following forms and attach the mandatory documents listed in the e-Form:

• • 1. Form INC-22: Notice of situation or change of situation of registered office based on the option chosen in Form INC-7.
    2. Form DIR-12: Particulars of appointment of directors and the key managerial personnel and the changes among them.
    3. Declaration of compliance
• After processing of the Form is complete and Corporate Identity is generated, obtain Certificate of Incorporation from RoC.

8.4 Documents Required for Company Registration

The following are the documents required to be while applying for registration with the Registrar of Companies on the MCA website:

1. PAN card and Aadhaar card of each of the proposed directors.
2. Address proof of the proposed directors like Aadhaar cards, utility bills, Voter-ID cards, ration cards, driver’s licenses, passports.
3. Contact details of the proposed directors along with their Email IDs.
4. Passport-sized photographs of each of the proposed directors.
5. Proof of ownership of the office space, for the proposed company. If the office space is on rented premises, then the lease deed/rent agreement of the office space along with ‘No Objection Certificate’ from the landlord.
6. Address proof of the office space, like utility bills.
7. Email ID of the proposed company.
8. Draft Memorandum of Association (MOA), and draft Articles of Association (AOA) of the proposed company.
9. Document showing the proposed activities of the company, expected income of the company and the expenditure for the next three years with the source of income and the purpose of the spending.
10. Declaration under Form INC-9 stating that the shareholders and the directors have committed no offence or malfeasance.
11. The articles of association and the memorandum of association signed by the subscribers as provided under the Companies (Incorporation) Rules, 2014.

8.5 Forms to be filed for Incorporating a Company

The MCA website facilitates the online registration of companies by filing applications and uploading requisite documents on the website. Following are some of the important forms which are required to be filed for incorporation:

SPICe+ Form: This Form is segregated into two parts. SPICe+ Form Part-A is filed to reserve a unique name for the company. The applicants must provide alternative names in the Form for the registrar to choose the names in order of preference. The applicants may use the RUN or Reserve Unique Name feature available on the MCA website to check for the existence of similar or identical names.

SPICe + Form Part B is used to apply for incorporation of the company, Details pertaining to the capital structure of the company, and director details. Add details of subscribers, address of the office space, and information as to the jurisdiction for obtaining the TAN and PAN for the company.

Steps to register a Company in India

• Digital Signature Certificate
• Director Identification Number
• Registration on MCA portal
• Uploading of Documents
• Payment of Fees
• Certificate of Incorporation

8.6 Certificate of Incorporation

Certificate of incorporation is a legal document relating to formation of a company which confirms the name by which the company is registered under the Companies Act and date of incorporation. The Registrar of Companies issues certificate of incorporation in the prescribed form on the basis of submission of the required documents and information laid down by the Companies Act.

From the date of incorporation mentioned in the certificate of incorporation, such subscribers to the memorandum and all other persons, as may, from time to time, become members of the company, shall be a body corporate by the name contained in the memorandum, capable of exercising all the functions of an incorporated company under this Act and having perpetual succession and a common seal with power to acquire, hold and dispose of property, both movable and immovable, tangible and intangible, to contract and to sue and be sued, by the said name.

Thus, the consequences of certificate of incorporation are:

1. The certificate of incorporation brings the company into existence from the date mentioned in the certificate.
2. It grants legal personality, corporate existence and perpetual succession to the company.
3. The subscribers to the Memorandum together with such other persons, as may from time to time become members of the company, become a body corporate with a distinct entity from such members having a perpetual succession with a common seal and with the liability of the members limited to the amount for the time being unpaid on the shares held by them.
4. The Memorandum and Articles of Association become binding upon the members and the company as if they have been signed by the company and by each member.

8.7 Validity of Certificate of Incorporation

Certificate of incorporation is a legal evidence with regard to the registration and formation of a company. Section 7(6) of the Companies Act, 2013 provides that where at any time after the incorporation of a company, it is proved that the company has been got incorporated by furnishing any false or incorrect information or representation or by suppressing any material fact or information in any of the documents or declaration filed or made for incorporating such company, or by any fraudulent action, the promoters, the persons named as the first directors of the company and the persons making declaration shall each be liable for action under section 447 of the Companies Act.

Section 7(7) of the Act provides that where a company has been got incorporated by furnishing any false or incorrect information or representation or by suppressing any material fact or information in any of the documents or declaration filed or made for incorporating such company or by any fraudulent action, the Tribunal may—

1. pass such orders, as it may think fit, for regulation of the management of the company including changes, if any, in its memorandum and articles, in public interest or in the interest of the company and its members and creditors; or
2. direct that liability of the members shall be unlimited; or
3. direct removal of the name of the company from the register of companies; or
4. pass an order for the winding up of the company; or
5. pass such other orders as it may deem fit.

8.8 Commencement of Business [Section 10A]

A company incorporated after the commencement of Companies (Amendment) Act, 2019 and having a share capital shall have to fulfil the following procedural requirement before commencing any business or exercising any borrowing powers:

• Filing of declaration to the Registrar of Companies: A declaration by a director within 180 days of incorporation of the company in the prescribed form to the Registrar of Companies must be filed stating that every subscriber to the memorandum has paid the value of shares agreed upon by them at the time of making such declaration; and
• Verification of the registered office: The company is required to file with the Registrar of Companies a verification of its registered office as per section 12(2) of the Companies Act.

8.9 Default

In case of default by a company in complying with the requirement of this provision on commencement of business, the company shall be liable to a penalty of Rs. 50,000 and every officer in default with a penalty of Rs. 1000 for each day during which such default continues which may go up to Rs. 1 lakh.

Further, the Registrar of Companies may initiate action for the removal of the name of the company from the register of companies when the Registrar has reasonable cause to believe that the company is not carrying on any business.

8.10 Provisional Contract

Provisional contracts are the contract entered into by a company having share capital between the date of incorporation and the date on which the company has fulfilled the requirement of section 10A on commencement of business. These are valid contracts if company meets the requirements and would be non-operative in case the company fails to do so.

8.11 Important Case

• Lydney & Wigpool Iron Ore Co. v. Bird – Liability of Promoters
• Enlarger v. New Sombrero Phosphate Co. – Liability of Promoters
• Kelner v. Baxter – Liability of Promoters
• Natal Land and Colonisation Co. Ltd. v. Pauline Colliery & Development Syndicate Ltd. – Preliminary Contracts
• Imperial Ice Mfg. Co. v. Manchershaw – Preliminary Contracts
• Newborne (London) Ltd. v. Sensolid (GB) Ltd. – Preliminary Contracts
• Peel’s Case – Certificate of Incorporation
• Moosa Goolam Arif v. Ebrahim Goolam Ariff. – Certificate of Incorporation
• Jubilee Cotton Mills Ltd. v. Lewis – Certificate of Incorporation

1. Twy Cross v. Grant (1877)
2. G. Tiruvengadachariar v. Velu Mudaliar (1938)
3. Lagunus Nitrate Co. v. Lagunus Nitrate Syndicate (1899).
4. S.M. Shah, “Lectures on Company Law”
5. Cavendish Bentick v. Fenn (1887)
6. Gower L.C.B., “The Principles of Modern Company Law”, Third Ed., p. 280.
7. New Borne v. Sensolid (GB) Ltd. (1954).