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-Dewesh Kumar Vinod†
Introduction
Recently, the Burman family, who has been buying into Everready since 2019, clarified that they intend to become the promoters of the Everready Industries. With Khaitan group, the current promoters stepping down, they would become the sole promoters of the said industries. While in this case, the Burmans had made their intention to act as promoters explicit, sometimes identifying promoters may become a challenging task in light of the vague control-based definitions of ‘promoters’ in Indian statutes. The Companies Act, 2013, , as well as Security Exchange Board of India’s (‘SEBI’) Issues of Capital and Disclosure Regulations (‘ICDR’), have define ‘promoters’ and ‘promoter groups’. They define a promoter, inter alia, as an individual “who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise”.
Recently, the ICDR regulations witnessed a huge structural change which might lead to a revision of a number of laws concerning companies and their management. By virtue of these changes, SEBI has in-principle agreed to move from the concept of a ‘promoter’ to ‘person/s in control’. Their rationale for the same, is that this control-based approach might prevent individuals with no controlling rights from being recognised as promoters. Under the current definition, private equity and institutional investors may be considered promoters where they hold the largest shares. Therefore, the goal behind this transition is to develop a better mechanism for identification of promoters.
In this paper, I argue that the current definition of promoters is too narrow in its approach, and fails to account for the ‘other’ type of promoters—the ones that do not hold any controlling shares. At the same time, the proposed solution of substituting it with the concept of person/s in control remains an incomplete concept as well since it fails to account for person/s who were in control, especially during the constitution of a company. In my opinion, the most prominent challenge in identifying promoters is this very conflation of promoters and persons in control. Instead, I argue that both concepts (promoter and person in control) should be retained for the identification of promoters and promoter groups, and the test for identifying promoters should be modified to an Animus-Factum Test. I have also substantiated this argument from the perspective of the inalienability principle, as conceptualized by Calabresi and Melamed.
The shortcomings of the current definition of promoters under the Companies Act, 2013
As mentioned earlier, the terms ‘promoter’ and ‘promoter groups’ have been defined in the Companies Act, 2013 and ICDR Regulations, and both of these definitions hinge upon ‘control’ of the business. They define a promoter as an individual “who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise”. The question that naturally follows such a definition is — what is control? Section 2(27) of the Companies Act of India, 2013, defines contro. However, it is an inclusive definition, and I daresay, hardly a definition at all. It is a circular arrangement of words, which ends up defining control as control itself—defining control as “controlling the management”.
The current definitions of a promoter assume that the promoter would like to be involved with the management of the company. However, they do not account for situations where a promoter creates a company, promotes it by soliciting a large initial share subscription, and then moves on to another company, while holding a minor or no share in the former. For instance, Larsen & Toubro have no individual/group of shareholders that can be classified as promoters. Instead, they are controlled by the Board of Directors. The initial promoters have transferred their shares to those who do not define themselves as promoters. The same is true for a few other examples such as ITC and ICICI.
Should legal liabilities not be traced back to their promoters simply because they are minor shareholders/absent now? The current definition would lead to this conclusion. However, since it was these promoter/promoter groups that lead the current shareholders to invest and subscribe to the shares of this company, it should be them to whom a legal liability should accrue for their acts, and not to the current ‘person/s in control’. The current ‘person/s in control’ are representatives of the company, and should be responsible only for the legal liabilities of the company. The then-promoters/promoter groups might have committed acts where they ought to be held personally responsible—for instance, inducing parties into subscribing to a companies’ shares on the basis of forged documents, or on the concrete promise of high yielding returns. If the concept of ‘person/s in control’ is allowed to engulf the concept of promoters, it might lead to situations where promoters who were earlier in control, will be able to evade their legal responsibility, simply by giving up controlling shares.
The issue with the idea of person/s in control
As mentioned earlier, SEBI has agreed to an in-principle shift to the concept of person/s in control. However, they too have not provided a concrete definition of person/s in control. Since the only other model which resembles this model is the ‘person with significant control’ (‘PSC’) model, as it is in the United Kingdom and therefore, SEBI may rely on the PSC model to materialise the concept in India. PSC is defined as “someone who owns or controls a company”.
However, this definition presents similar challenges as the definition of the control-based definition of a promoter under the Companies Act 2013. It simply recognizes the person in power currently. As a result, individuals can escape the consequence of their crimes by simply giving up control. These crimes include inducing parties into subscribing to a companies’ shares on the basis of forged documents, or on the concrete promise of high yielding returns.
As I have demonstrated, both the concepts are incomplete in isolation—the concept of a promoter is not able to impose any legal liability in situations in which the promoter gives up controlling shareholding. On the other hand, the concept of a person/s in control does not take into account the actions of the initial solicitors of the company’s shares, and therefore, is not able to trace the legal liability beyond the people currently responsible. Therefore, my solution is to amalgamate both the ideas together, after changing the test of identification of promoters to an animus factum test.
Animus-Factum Test- The way ahead?
In old English law, the term ‘promoter’ lacked a statutory definition, and the tests for identifying promoters were laid down by the judiciary. These tests revolved around whether the defendant had the intention to act as a promoter, and whether he did any act in furtherance of that intention.[1] For instance, being the author of the articles of association and the memorandum, founding directors, paying for printing and advertising, soliciting initial share subscriptions, etc., were acts that according to the court, an individual with the intention of being a promoter of a company would carry out.[2] This test is known as the Animus-Factum test (a parallel with the terminologies of actus reus and mens rea in criminal law would not be out of place). I argue that this test is the most suitable test for identifying promoters in my opinion, since it adequately ensures accountability of promoters. The Animus-Factum test holds a person accountable if they intend to act as promoters.
Critics may argue that the test is subjective as it depends on the facts and circumstances of the case, and how a judge might interpret the same. However, subjectivity in itself is not detrimental. A strict test might be free from individual proclivities and interpretations, but it also imposes a textual limit on the meaning of a concept. Restraining judges to understand ‘promoters’ only within a textually defined limit, and not allowing them to expand the scope of the same in the interest of investors, is directly in contradiction with the intent of regulatory bodies worldwide. Instead, a ‘standard’ based skeletal test must be used which provides the judiciary the requisite broad tools to protect investors.
This requirement of retaining both, the promoters as well as persons in control, is necessitated by the inalienability rule principle as well presented by Calabresi and Melamed. The inalienability rule principle suggests that some rules may be inalienable, which means that the state might intervene to regulate or limit the grant of an entitlement—(in a sense, a right) altogether, when a transaction would result in significant externalities to third parties. In the current case, if the concepts of a promoter and a person in control were allowed to be conflated, it would result in a loss to the shareholders as shown above, who would not be able to hold the original promoters liable in case those promoters do not hold significant shares/rights anymore. In the light of the issues with the current definition of promoters, as well as substituting the concept of persons in control in place of promoters, the most efficient solution would be for the state to intervene to prevent such a conflation from actualizing.
†Dewesh Kumar Vinod is a fourth year student at National Law School of India University, Bangalore.