This article has been written by Pankhuri Anand. The article seeks to provide a brief analysis of the concept of prospectus under the Companies Act, 2013. An attempt has been made to identify the kinds of prospectus under the Companies Act and the procedure followed for filing a prospectus.

Introduction

One of the major reasons why businesses choose the company form of business is because it allows greater accessibility to funds. A public company that has been incorporated under the Companies Act, 2013 is allowed to raise investments from the general public through different modes. Since a company raises funds from the public, it also becomes necessary that such a company be accountable to the public. Accordingly, to secure the interests of the investors in the company, the Companies Act, 2013 mandates the filing of a prospectus with the Registrar prior to raising funds. 

A prospectus is a document issued by a company to invite deposits or subscriptions from the public by way of issuing securities of the company. It can be understood as a document or a booklet containing crucial information about the company and its securities for potential investors. Section 2(70) of the Companies Act, 2013 defines a prospectus as “prospectus means any document described or issued as a prospectus and includes a red herring prospectus referred to in section 32 or shelf prospectus referred to in section 31 or any notice, circular, advertisement or other document inviting offers from the public for the subscription or purchase of any securities of body corporate”

Meaning and purpose of a prospectus under Company Law

From the perspective of the issuer

A prospectus is a document that provides all the essential information about the company at the time of raising an investment from the public. It can be understood as an invitation to offer the securities of the company. The public intending to invest in the company can make an offer above the offered price but within the price band. It is upon the company to allot shares to the public in the manner it deems fit. Every time a company has to raise an investment from the public, it is the duty of the company to inform the public about its financial position and the purpose of the investment. A prospectus is the first document through which a company publicises or discloses its financial and other relevant information.

Section 28(2) of the Companies Act, 2013 provides that any document through which an offer for sale is made to the public shall be deemed a prospectus. It is pertinent to note that the document has to be issued to the public and not a particular set of persons. Even if an advertisement is made in a newspaper regarding certain shares left for purchase by the company, it shall constitute a prospectus, as has been held by the Hon’ble Calcutta High Court in Pramatha Nath Sanyal v. Kali Kumar Dutt (1924). From the perspective of the Investor

In order to be able to make an informed decision regarding an investment, an investor must have access to all the information about a company before investing in it. Institutional investors might receive such information without much trouble. However, it is the retail investors whose interest might be compromised if such information is not provided in due course. Thus, a prospectus becomes the most crucial document for any investor intending to invest in a company. This is also the reason why the company law mandates the filing of a prospectus every time before raising a public investment. It can also be safe to infer here that issuing a prospectus is one of the means of ensuring good corporate governance practices in a company as it encourages transparency, accountability and responsibility.

Golden Rule by VC Kinderseley

The ‘Golden Rule’ of the prospectus was propounded by Judge VC Kinderseley in the landmark judgement of The New Brunswick Railway Company v. Muggeridge (1859). In this case, it was held that “Prospectus is one of the means by which the investor is informed about the soundness of the company’s venture.” The essence of the rule is that it is mandatory on part of the company to issue a prospectus; it is not only required to accurately put forth all the relevant facts and information but also ensure that it does not hide any information which might affect the decision of an investor. The rule is also known as the ‘Golden Legacy’ as has been described by Judge Pagewood in Henderson v. Lacon (1865).

This aforementioned rule has been reflected under various provisions of the Companies Act, 2013 which seeks to protect the interests of investors by providing comprehensive and elaborative guidelines and requiring relevant disclosure of material facts to ascertain the financial soundness of a company.

Essentials for a document to be called as a prospectus

The essential conditions required to be fulfilled for a document to be considered as a prospectus under the Indian company law are as follows:

1. Invitation to the Public – One of the most important points that one must remember is that a prospectus is an invitation to offer rather than an offer itself. This means that a company makes an open declaration to the public at large that some of its securities are available for subscription. A document shall be deemed to be an invitation to the public only if it is open for any person to subscribe, though there may be a possibility that ultimately the securities may not be issued to him owing to oversubscription or any other disqualification.
2. Invitation by the company – The prospectus must be issued by the company itself that wishes to raise the funds. Even if all the requisite disclosures are made available by the public by some other authority, that would not satisfy the criteria for making the invitation. However, an entity, on behalf of the company or on the authorisation of the company, may follow the stipulated process in order to make an invitation to offer to the public. Hence, an invitation to offer must be made by the company itself or on behalf of the company by some other authority authorised by the company.
3. Nature of document and particulars therein – A prospectus shall be in the nature of an invitation to offer, allowing subscription to the securities of the company. Any document merely disclosing the details of the securities shall not be considered a prospectus. It must fulfil all the required stipulations that have been provided under the Companies Act, which have been discussed in the later section of the article.
4. Information regarding securities of the company – A prospectus is required to contain all the details regarding the securities. The prospectus must specify the nature of securities, whether equity-based or debt-based. It must also specify the category as to whether it is an equity or preference share, debenture, bond, warrant, etc. It must specify the number of securities available for subscription. It must also provide for other particulars, such as redemption, rate of interest, etc., as may be applicable to the category of securities.

Advertisement for a prospectus under Company Law

Section 30 of the Act provides for certain particulars to be mentioned whenever a prospectus is being advertised in any manner for call for subscription to securities. These particulars include specifying the contents of the memorandum regarding the primary object for raising funds, liability of the members, amount of total share capital, names of the signatories and the number of shares subscribed by each of them, and the capital structure of the company.

Types of prospectus under Company Law

The definition of prospectus under Section 2(70) is an inclusive definition. It provides that a prospectus shall include a Shelf Prospectus (as mentioned under Section 31), a Red Herring Prospectus (as mentioned under Section 32), or any other document inviting applications for subscription/purchase of securities of the company. The various categories of prospectus under the Companies Act, 2013 have been discussed hereafter.

Shelf prospectus

Drafting a prospectus is a cumbersome process as it requires a number of disclosures and information to be passed on to the investor. It may also be possible that a company makes multiple public offers in one financial year itself. In such a case, it will become nearly impossible for the company to draft an entirely new prospectus every time. Yet, it is also crucial to note that significant changes may take place in the financial status of the company. To balance the interests of the company as well as that of investors, the law provides for the concept of shelf prospectus.

Explanation to Section 31 of the Companies Act, 2013 provides that “the expression “shelf prospectus” means a prospectus in respect of which the securities or class of securities included therein are issued for subscription in one or more issues over a certain period without the issue of a further prospectus.” A company issues a shelf prospectus when it has to offer for subscription by the public, more than one round of issue. Shelf prospectus is a single prospectus that can hold good for multiple public offers.

The Securities Exchange Board of India (SEBI) shall have the power to prescribe the class or classes of listed companies that may be allowed to file a shelf prospectus. The validity of a shelf prospectus shall not exceed one year from the date of the first offer. The provision also provides a more stringent rule for disclosures by the company issuing a shelf prospectus.

An information memorandum has to be filed by the company while filing a shelf prospectus, containing the following material facts:

• new charges created;
• all the changes in the financial position that have occurred after the first offer of securities or the previous offer of securities and before the succeeding offer of securities; and
• such other changes as may be prescribed.

Such an information memorandum must be filed with the Registrar within the prescribed time period (three months) prior to the issue of the second or subsequent offer made under the shelf prospectus.

Further, it is also the obligation of the company to inform an investor about the changes if they have been allotted the securities in advance before the adjustments. Further, based on such information, an investor has also given the right to withdraw their application and they will be refunded their money within fifteen days thereof.

Red Herring prospectus

Though most of us imagine big companies when talking about investments and funding, mid-size and small companies also require investments and they also make public offers. To safeguard their rights and enable them to have better access to finance, the law provides for red herring prospectus. Explanation to Section 32 of the Companies Act, 2013 provides the definition of a red herring prospectus as “the expression “red herring prospectus” means a prospectus which does not include complete particulars of the quantum or price of the securities included therein.” A red herring prospectus is a prospectus wherein information regarding either the quantity of securities or the price of securities is not disclosed by the company. Rather, the company only provides a price band. This enables a company to gauge the worth of its securities and enables them to achieve the requisite minimum subscription, which may not otherwise be possible had they already supplied the entire information . 

A red herring prospectus is subjected to same regulations as a prospectus. It has to be filed before the Registrar of Companies at least three days before the issue has to be made public. Further, the company must file the complete details of the issue with the Registrar and the SEBI after the securities has been duly subscribed to.

Abridged prospectus

A prospectus could run into hundreds of pages in a single issue, which may prove to be a hectic task for retail investors. Retail investors, having limited access to financial knowledge as well as resources, might not be competent enough to understand the intricate details mentioned in the prospectus. A solution to this problem is an abridged prospectus. 

Section 2(1) of the Companies Act, 2013 defines an abridged prospectus as a memorandum containing the salient features of an issue. The features to be included in an abridged prospectus are to be provided by  SEBI. Further, Section 33 of the Act mandates for annexing an abridged prospectus along with form for application of purchase of securities. However, the proviso to sub-section (1) provides that this requirement may be dispensed with where the form of application was issued for:

• “in connection with a bona fide invitation to a person to enter into an underwriting agreement with respect to such securities; or
• in relation to securities which were not offered to the public.”

Section 33(3) of the Act provides that if the company fails to comply with the provisions of abridged prospectus as discussed above, it shall be subjected to a penalty of up to Rs.50,000 for every default.

Deemed Prospectus

When a company wishes to issue its securities through an intermediary, the document containing the details of such securities is considered a deemed prospectus. Section 25(1) of the Companies Act, 2013 governs the deemed prospectus. The document shall be a deemed prospectus for the company whose securities are being offered to the public. 

Process for filing and issuing a prospectus under Company Law

Contents

For filing and issuing the prospectus of a public company, it must be signed and dated and contain all the necessary information as stated under Section 26 of the Companies Act, 2013:

1. Name and other crucial information, such as the registered address of the office, its secretary, auditor, etc.;
2. The dates of issue, including the opening date and the closing date;
3. Undertakings of the Board of Directors regarding separate bank accounts for the purpose of keeping receipts of the issue;
4. Undertakings of the Board of Directors regarding the details of utilisation and non-utilisation of receipts of previous issues;
5. Consent of the directors, auditors, and bankers to the issue, and expert opinions;
6. The details of the resolution passed for the issue;
7. Procedure and time scheduled for the allotment of securities;
8. The capital structure of the company;
9. The objective of the issue;
10. The objective of the business and its location;
11. Particulars related to risk factors of the specific project, gestation period of the project, any pending legal action and other important details related to the project;
12. The amount is payable on the premium;
13. Details of directors, their remuneration and the extent of their interest in the company;
14. Reports for financial information such as auditor’s report, report of profit and loss of the five financial years, business and transaction reports, statement of compliance with the provisions of the Act and any other report.

As per Section 26(4) of the Companies Act, 2013, the company issuing the prospectus has to deliver a copy of the prospectus, signed by every person whose name has been mentioned in the prospectus as a director of the company or the attorney of the director, to the Registrar on or before the date of publication. 

Delivery of a copy of the prospectus to the registrar

As per Section 26(6) of the Companies Act 2013, the prospectus shall duly state that a copy of the prospectus has been served to the registrar. It should also mention the documents submitted to the registrar along with the prospectus.

Registration of a prospectus

Section 26(7) states when the registrar can register a prospectus when:

1. It fulfils the requirements of the provision; and
2. It contains the written consent of all the persons named in the prospectus. 

The invalidity of a prospectus

The prospectus is considered invalid if it is not issued within 90 days from the date of delivery to the Registrar.

Contravention of Section 26

The punishment for contravention of the mandatory provisions is provided under Section 26(9) of the Act, which includes a fine of not less than Rs. 50,000 extending up to Rs. 3,00,000.

Any person knowingly participating in the issue of prospectus even after knowing that it is in contravention of the provisions shall be punished with imprisonment up to a term of 3 years, or a fine of more than Rs. 50,000 not exceeding Rs. 3,00,000.

Liability for misstatements in a prospectus under Company Law

A prospectus is used by potential investors to gather information about the company. Thus, it is the duty of the company and its authorised persons to make true and correct statements in the prospectus. Generally, when false or incorrect information is added to the prospectus, it becomes a misstatement. Even an omission of important information amounts to a misstatement in a prospectus. Making a false or misleading statement thus entails certain liabilities. Under the Companies Act, 2013, there are two types of liability for misstatements in the prospectus.

Civil Liability

Civil liability under the Companies Act, 2013 is provided under Section 35. It provides that where a person has subscribed to the securities of the company acting on any misstatement included in the prospectus and has consequently suffered any loss, the company and the persons authorising the issue of such prospectus are liable for such loss, provided that certain conditions are fulfilled. These conditions include:

1. Subscription to the securities acting upon the misstatement
2. Loss or damages due to such misstatement
3. Knowledge of the Defendant must be proved by the Plaintiff
4. Such misstatement must be material to the facts

If the above conditions are met, the Plaintiff can claim remedies against the company as well as against the authorised personnel. The remedies include rescission of the contract, damages, and damages for the non-disclosure of material facts.

Criminal Liability

Apart from the civil liability in case of misstatements, Section 34 of the Act also provides the liability of the authorised personnel for the misstatements in the prospectus. Criminal liability has been provided under Section 447 of the Act. In case of fraud on the Plaintiff (investor of the company), a criminal suit can be filed against the following persons:

1. All the directors authorising the issue of the prospectus
2. All the proposed directors of the company
3. Each promoter
4. Any expert involved in the issue

Section 447 of the Act prescribes a minimum imprisonment of six months but not more than ten years, along with a fine which shall not be less than the amount of damages suffered but not more than three times of such amount. The proviso to the provision provides that in case the issue involves a public interest, the minimum term of imprisonment of the aforesaid persons shall be three years. 

Important judicial pronouncements

Kiran Mehta v. Universal Luggage Manufacturing Co. Ltd. (1988)

In this case, the Plaintiff filed a PIL against a company alleging that the company had issued a prospectus containing false statements. It was stated that the Plaintiff himself did not have any interest in the matter but filed the case as the statements were likely to confuse or mislead the general public. The Hon’ble Bombay High Court dismissed the case stating that a locus standi of the Plaintiff was required to file such a case. 

Vijay Kumar Gupta v. Eagle Paint & Pigment Industries Ltd. (1997)

In this case, the question before the Company Law Board (now replaced by the National Company Law Tribunal) was whether a private company could issue advertisements for inviting deposits from the public. It was held by the Board that a private company cannot do so as per the provisions of the Act. Moreover, when the company accepts deposits from its members or directors, it has to obtain a declaration stating that the deposits are not a debt to the company.

Mohandas Shenoy Adige v. Securities and Exchange Board of India (2021)

In this case, the question raised by the complainant was whether the non-compliance with the statements made in the prospectus amounted to misstatement in the prospectus. The allegations included that the company raised public funds only to syphon funds to the group of companies. The Securities Appellate Board held that no case of misstatement was found as the complainant was unable to establish that the funds were actually being syphoned. In case of no fact-based finding, the non-adherence with the statements in the prospectus cannot be held to be misstatements. It was further held that “If a statement made in the prospectus is not adhered to by the Company it does not become a misstatement. At best it can be a case of the Company violating the terms and conditions of the prospectus”. 

Conclusion

A prospectus is an official document containing crucial information about the company and the investment round for the perusal by the public at large so that they can invest in the securities of the company. Every company that wants to raise investments from the public has to file a prospectus with the Registrar of Companies and circulate it for the information of the potential investors. Under the Companies Act, 2013, there are various kinds of prospectus. Each of these types serves a distinct purpose, as has been elaborated in the article. However, each of them has to fulfil the basic criteria of a prospectus. The conditions for a valid prospectus are to be complied with irrespective of the kind of prospectus being issued by the company.

Based on the kind of investment round that the company wishes to raise, it can adopt the type of prospectus that has to be issued. The regulation of each kind of prospectus is provided under the provisions of the Companies Act, 2013 as well as various Regulations issued by the Securities Exchange Board of India (SEBI). Compliance with all the regulations is mandatory for raising investment from the public. Moreover, such information provided under the prospectus shall be carefully added as the provisions of the Companies Act provide punishment in the form of a fine for misrepresentation by the company under the prospectus.

Frequently Asked Questions (FAQs)

Whether a document circulated in an envelope marked “confidential” for the sale of securities of a company be deemed as a prospectus?

When a document is circulated to a selected audience in an envelope marked as “confidential”, it is not for the purpose of an advertisement to the public. In such a case, it cannot be said that the company intends to raise public funds through the issue of securities. Even if the contents of the document include an offer for the sale of securities of the company, such a document cannot be said to be a prospectus.

Upon whom would the criminal liability fall for misstatements made in a prospectus?

Under the Company law, the ‘Golden Rule’ of issuing a prospectus is followed. The same has been adopted under the Companies Act, 2013 as well. Under Section 34 of the Act, every person who authorised the issue of the prospectus shall be liable for any misstatements shall be punished under Section 447 of the Act. Section 447 of the Act prescribes a punishment of not less than six months which may extend up to ten years, and also be liable for fine which may extend up to three times of the amount of fraud. 

What is the ‘Golden Rule’ of issuing a prospectus?

The ‘Golden Rule’ of issuing a prospectus provides that if a company is making any voluntary statements regarding the financial health of the business, it must include true and verified information. A prospectus is issued for the benefit of the potential investors, which are from the general public. In case there are any misstatements, it would amount to fraud with the public. Thus, the company issuing a prospectus must include only true and correct information for the perusal of the public.

References

• Avtar Singh, Company Law (EBC Reader 2021)
• Dr. G.K. Kapoor, Company Law and Practice (Taxmann 2021)
• A Ramaiya, Guide to the Companies Act (Lexis Nexis 2020)
• Companies Act, 2013
• Companies (Incorporation) Rules, 2014
• Companies (Prospectus and Allotment of Securities) Rules, 2014
• Company Law Ready Reckoner (Taxmann 2021)

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