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PROSPECTUS[1]

Table of Contents

QUESTION BANK

Q.1 What is the prospectus? What are the liabilities of the Directors for wrong statements in the Prospectus?

Q.2. Discuss the remedies for misrepresentation in a prospectus.

Q.3. Define prospectus and Promoters. Discuss the legal requirements of prospectus and explain the role of promoter in the formation of a company?

Q.4. Write an exhaustive note on Formalities for issue of Prospectus and liability for misstatement.

SHORT NOTES

Q.1 Prospectus.

I] DEFINITION AND MEANING OF PROSPECTUS:-

1) According to S. 2 (70) of the Companies Act 2013, ‘Prospectus’ means

(i) any document described or issued as a prospectus, and

(ii) includes a red herring prospectus referred to in S. 32 or shelf prospectus referred to in S. 31 or any notice, circular, advertisement or another document

(iii) inviting deposits from the public or inviting offers from the public

(iv) for the subscription or purchase of any shares in, or debentures of, a corporate body.

2) According to Lord Kindersley, “Prospectus is one of the means by which the

the investor is informed about the soundness of the company’s business”.

The prospectus is an offer to the general public to invest in a company by purchase of shares, debentures or deposits. Through the prospectus, the public is (i) informed as to the soundness of the company’s business and (ii) invited to invest in the company by purchasing its shares or debentures.

II] WHAT AMOUNTS TO THE PROSPECTUS?

From the above definitions, we may say the following amounts to a prospectus-

1) Document Described as a Prospectus[2]:-

As per the definition, any document described or issued as a prospectus by the company is a prospectus. It is a proper prospectus issued by the company for the purpose of inviting the public to invest in the company by purchasing its shares or debentures.

2) Deemed Prospectus (S. 25):-

Where a company allots or agrees to allot any securities of the company with a view to all or any of those securities being offered for sale to the public, any document by which an offer for sale to the public is made shall, for all purposes be deemed to be a prospectus issued by the company.

‘Deemed prospectus’ is not properly called a ‘prospectus’. However, from the very nature of its publication, it is deemed or assumed to be a prospectus or treated by the Court as a prospectus.

It is any notice, circular, advertisement, or other document that, though not described as a prospectus by the company, is issued to invite deposits from the public or offers for the subscription or purchase of any shares in or debentures of the company.

Though not specifically mentioned, it is deemed a prospectus and carries the same effect and liabilities as a prospectus (S. 24 (2)).

In Promodha Natha Sayal V/s Kali Kumar Dutta

Facts- Advertisement issued in the newspaper stating that few shares are available and can be bought by application.

Issue- Whether the advertisement is a prospectus?

Held- A newspaper advertisement is a prospectus.

3) Red Herring Prospectus[3] (S. 32):-

‘Red herring’ means a “prospectus which does not include complete particulars of the quantum or price of the securities included therein”.

The red-herring prospectus is issued by the company, which is planning to raise money from the public. It provides detailed information as to its business operations, financial position, information as to its promoters, reasons for raising money, use of raised money, the risk involved in investment, etc. However, it does not provide information as to the price and quantum (quantity) of offerings or shares. A red herring prospectus is issued to ascertain the price at which securities will be sold in the market. Such a prospectus invites demand for securities and the price at which the public is willing to buy those securities. This process is called the ‘book building process’. In other words, the process is used to ascertain the price at which shares will be offered to the public.

Red herring prospectus must be filed with the Registrar of Companies at least three days before the opening of the subscription list and the public offer. A red herring prospectus carries the same obligations as those applicable to a prospectus. Any variation between the red herring prospectus and a prospectus shall be highlighted.

4) Shelf Prospectus[4] (S. 31):-

“Shelf prospectus” means “a prospectus in respect of which securities or classes of securities included therein are issued for subscription in one or more issues, over a certain period, without the issue of a further prospectus”.

Any company class may file a shelf prospectus with the Register of the Companies at the stage of the first offer of securities.

The Shelf Prospectus shall indicate the validity period of such a prospectus, which does not exceed one year. Once a Shelf Prospectus is issued, there is no requirement for any further prospectus for any subsequent offer of the securities during this validity period. In other words, the advantage of filing a shelf prospectus is that it does not have to file a prospectus every time it issues securities within the period of one year. It also saves time and money for such financial companies to issue prospectus at every issue.

For subsequent issues, the company shall file an ‘information memorandum’.

Information Memorandum[5]:-

A shelf prospectus has to be filed at the first issue of the prospectus; however, at the time of subsequent issues, an ‘Information Memorandum’ has to be filed informing subsequent changes, charges created, securities provided, etc.

‘Shelf prospectus’ and ‘Information memorandum’ constitutes prospectus. Information memorandum shall be circulated to the public along with the shelf prospectus filed at the time of the first offering of the securities and every time the offer is made. In other words, the shelf prospectus remains the same for one year but shall accompany an ‘information memorandum’ at every subsequent issue.

A public company issuing securities may circulate an information memorandum to the public before filing a prospectus.

A company inviting a subscription through an information memorandum is bound to file a prospectus at least three days before the opening of the subscription list and the offer as a red-herring prospectus.

The information memorandum and red-herring prospectus shall carry the same obligation as applicable in a conventional prospectus.

The issuing company has to highlight any variations between the information memorandum and the red-herring prospectus.

The ‘Information Memorandum’ shall contain all material facts relating to

(i) new changes created, and

changes in the financial position of the company from the first or previous offer, and
such other changes as may be prescribed (S. 31 (2)).

These documents are to be filed with the Registrar within the prescribed time before the issue of a second or subsequent offer of securities under the shelf prospectus.

When an offer of securities is made on a shelf prospectus, the information memorandum and the shelf prospectus are deemed to be one prospectus.

III] CONTENTS OF PROSPECTUS (S. 26):-

1) The Prospectus shall contain the following Information:-

(i) Names and Addresses:-

Names and addresses of the registered office of the company, company secretary, Chief Financial Officer, auditors, legal advisers, bankers, trustees, if any, underwriters and such other persons as may be prescribed;

(ii) Dates:-

Dates of the opening and closing of the issue and declaration about the issue of allotment letters and refunds within the prescribed time;

(iii) Statement of Board of Directors:-

A statement by the Board of Directors about the separate bank account where all monies received out of the issue are to be transferred and disclosure of details of all monies, including utilised and unutilised, out of the previous issue in the prescribed manner;

(iv) Details about the underwriting of the issue;

(v) Consents:-

Consent of the directors, auditors, and bankers to the issue, expert’s opinion, if any, and of such other persons as may be prescribed;

(vi) Details as to issue– the authority for the issue and the details of the resolution passed, therefore;

(vii) Procedure and time schedule for allotment and issue of securities;

(viii) Capital structure of the company in the prescribed manner;

(ix) Main objects of the public offer, terms of the present issue and such other particulars as may be prescribed;

(x) Main objects and present business of the company and its location, schedule of implementation of the project;

(xi) Particulars relating to:-

(a) management perception of risk factors specific to the project;

(b) the gestation period of the project;

(d) deadlines for completion of the project and

(e) any litigation or legal action pending or taken by a Government Department or

a statutory body during the last five years immediately preceding the year of

the issue of a prospectus against the promoter of the company;

(xii) Minimum subscription, amount payable by way of premium, issue of shares otherwise than on cash;

(xiii) Details of directors, including their appointments and remuneration, and such particulars of the nature and extent of their interests in the company as may be prescribed; and

(xiv) Disclosure as to Promoter’s sources of contribution-

Disclosures in such manner as may be prescribed about sources of promoter’s contribution;

2) Reports for the purposes of financial information, namely:-

(i) Reports by the auditors of the company with respect to its profits and losses and

assets and liabilities and such other matters as may be prescribed;

(ii) Reports relating to profits and losses for each of the five financial years immediately preceding the financial year of the issue of prospectus, including such reports of its subsidiaries and in such manner as may be prescribed:

However, in the case of a company where the period of five years has not elapsed from the date of its incorporation, the reports of each financial year shall be set out in the prospectus.

(iii) Reports about the business or transaction to which the proceeds of the securities are to be applied directly or indirectly;

3) Make a declaration about the compliance of the provisions of this Act and a statement to the effect that nothing in the prospectus is contrary to the provisions of this Act, the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and the Securities and Exchange Board of India Act, 1992 (15 of 1992) and the rules and regulations made thereunder;

4) State such other matters and set out such other reports as may be prescribed.

However, the provisions abovementioned do not apply to the issue of shares to the company’s existing members or debenture holders. Moreover, the provisions do not apply to an issue that is in all respects uniform with shares or debentures previously issued and for the time being dealt in or quoted on a recognised stock exchange.

IV] ISSUE OF SECURITIES:-

The Companies Act 2013 has adopted the definition of ‘Securities’ mentioned in S. 2 (h) of the Securities Contracts (Regulation) Act. 1956. The definition of “Securities” includes “shares, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or another body corporate”. Thus, the definition of securities is wide, incorporating many things along with shares.

Public offer and private placement (S. 23):-

A ‘Public Company’ may issue securities-

to the public through a prospectus (herein referred to as “public offer”),
through private placement,
through a rights issue[6] or a bonus issue.

Thus, a Public Company can raise its funds in the above-mentioned three ways, whereas a ‘Private Company may raise its funds through the following two ways.

A ‘Private Company’ may issue securities-

by way of rights issues or bonus issues,
through private placement.

“Public Offer’ or “Public Issue” means an offer to the general public through the prospectus. Whereas ‘Private placement’ is an offer made to a specific class or group of persons. In private placement, the company cannot issue a prospectus or make an advertisement inviting investment.

V] LIABILITY FOR MISSTATEMENT:-

There shall be full, frank and honest disclosure of all material facts related to the company. It should disclose truth and truth only. The company is liable for misstatement in the prospectus. A false, misleading, ambiguous or fraudulent statement as to material facts or suppressing marital facts amounts to a ‘misleading statement’ in the prospectus.

Misstatement in prospectus attracts criminal as well as civil liability. Directors, proposed directors, holding out directors, promoters, the person responsible for the issue of prospectus and experts allowing or making misstatements are liable for it.

A) Civil Remedies for Misrepresentation:-

Following are the civil remedies available for misrepresentation.

1) Recession of Contract[7]:-

According to S. 19 of the Indian Contract Act, when a party’s consent is obtained by misrepresentation, that party has the right to avoid the contract. Thus, the shareholder avoiding a contract is entitled to get back the money he paid. Moreover, he may also claim compensation for the damage he has sustained due to the non-fulfillment of the contract (S. 75 of the Contact Act).

In Karbarg’s case[8]

Facts– The prospectus stated that two businessmen of good reputation had agreed to become directors of the company. In fact, the businessmen had only expressed their views to help and advise the company.

Held– That the prospectus contains a misrepresentation of fact, and, therefore, the plaintiff can rescind the contract.

However, the right of the recession of contract is not available to the shareholder if-

(i) he does not bring an action within a reasonable time.

(ii) winding up of a company has already commenced.

(iii) he waives his right of recession.

2) Claim for damages and compensation:-

a) Damages for Deceit (i.e., fraud)[9]:-

Deceit (i.e., fraud) is a tort that attracts damages liability. When the prospectus contains statements that are fraudulent, the shareholder misled by those statements may bring an action for the tort of deceit and claim damages from the company.

However, the misstatement in the prospectus should have been made dishonestly, with an intention to deceive. Thus, if it is found that the statement is not made with an intention to deceive, no liability under tort attracts; this is held in very famous English cases, i.e. Derry V/s Peek[10]

Facts—Tramway Company issued a prospectus containing a statement that the company had been authorised to run tramways with steam power. In those days, tramways were run by horses. However, the Board of Directors refused the sanction subsequently, but the Board of Directors believed that getting such permission would be a matter of time. The directors, therefore, made such a statement under bonafide belief.

Issue– whether the statement was a misstatement to attract liability for fraud.

Held-No; the statement was bonafide. Therefore, directors were not liable for deceit.

However, the decision exposed the inadequacy of the ‘action for deceit’; therefore, in India, a more comprehensive provision is made in S. 62 of the Indian Companies Act.

The section states that the investor is entitled to bring a suit for compensation for any loss he sustained due to any untrue statement in the prospectus. A statement is deemed untrue if it is false in the form and context in which it is made.

Such compensation can be recovered from the directors, promoters or the persons who have authorised the issue of the prospectus.

However, the director or promoter may defend the suit by showing that he has withdrawn his consent to be a director, and then a prospectus is issued without his knowledge or consent, and he has immediately published notice for the same.

b) Compensation under S. 75 of the Contract Act:-

According to S. 75, a person who rightfully rescinds the contract is entitled to compensation for any damage which he has sustained through the non-fulfilment of the contract.

c) Compensation under S. 35 of the Companies Act:-

If a prospectus, which invites persons to subscribe for shares or debentures, contains untrue statements that cause damage to those who have subscribed on the faith of those statements, every Director, promoter or person authorising the issue of the prospectus is liable to pay compensation. Their responsibility are joint as well as several.

However, in the following exceptional circumstance person cannot be held liable to pay compensation- (1) if the director proves that he had withdrawn consent to be a director before the issue of the prospectus and the prospectus was issued without his authority and consent. (2) that the prospectus was issued without his knowledge or consent and that on becoming aware of its issue, he forthwith gave a reasonable public notice that it was issued without his knowledge or consent. (3) correct and fair representation of the statement made by an expert.

B) Criminal Liability:-

As per S. 34, if a prospectus issued, circulated or distributed includes any statement which is untrue or misleading in the form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, every person who authorises the issue of such prospectus shall be liable for punishment provided under S. 447 of the Companies Act.

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[1] माहीती पत्रक [विवरण-पुस्तिका]

[2] महीतीपत्रक म्हणुन वर्णन केलेले कागदपत्र [विवरणिका के रूपमें वर्णित दस्तावेज़|

[3]विवरणिका जिसमें उसमें शामिल प्रतिभूति यों की मात्रा या की मत का पूरा विवरण शामिल नहीं होता है| [माहीतीपत्र ज्यामध्ये किती भाग/रोखे इ. आहेत अथवा त्याची किंम्मत किती आहे हे नमुद केलेले नसते.]

[4]एकविवरणि का के जरये और शेअस या प्रतिभूतियों कि बिक्री [एकाच माहीती पत्रकात पुढील काही भाग/रोखे यांची विक्री

[5] माहीतीस्मरणीका [सूचनाज्ञापन]

[6] When shares are offered to existing shareholders it is called as “Rights Issue”.

[7] करार रद्द करणे [करार को रद्द करना]

[8] Re Metropolitian Coal Consumers’ Association (1892) 3 Ch 1.

[9] फसवणुकीबद्दल नुकसाणभरपाई [धोखे के लिए नुकसान]

[10] (1889) 14 AC 337