This article is written by Mehar Verma, currently pursuing BBA.LLB from Jindal Global Law School (3rd year). The author in this article talks about the meaning and importance of prospectus and promoters under the Companies Act, 2013.

Introduction

Whether you are starting a new company, raising money through issuing of shares or buying shares of any company, you are required to have the necessary knowledge about the prospectus and promoters of a company. To get a better understanding of the role of the prospectus, let’s assume there is a company ABC Ltd. which is issuing its share in the market. Before issuing the shares to the public, the company will be required to file a registration statement, disclosing all the material information about the company. Part of such registration statement is a prospectus. It is based on the prospectus of a company that an investor decides whether or not to become a shareholder of that company.

As a prospectus decides the fate of the company and shareholders, concealment of any material facts or untrue statement would attract civil or criminal liability towards the company. Considering the same example, if ABC in its prospectus states that it received a profit of INR 5,00,000 in the last financial year, which in turn induced Mr. X to invest. However at a later stage, Mr. X found out that the statement was untrue and in reality, ABC ltd had incurred a profit of only INR 4,00,000 only, then ABC ltd will be liable.

Promoters also play a crucial role in the working and incorporation of a company. They select the managing body of the corporation, prepare all the necessary legal and formal documents, find first directors and advertise the prospectus.

What is a prospectus under Company Law

A prospectus is a formal document given out by a company, when such a company wants to sell its securities or bonds to the public, containing all the necessary details about the sale, including the company’s financial position, the number of shares offered, types of securities being offered, etc. Section 2(70) of the Companies Act, 2013 defines prospectus as any document described or issued as prospectus and includes RHP or shelf hearing 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 a body corporate.

A prospectus shall be issued by or on behalf of a company only when it has been delivered to the registrar for registration. A prospectus is to be issued to the public within 90 days from the date of delivery to the registrar and no shall prospectus shall be valid if it is issued after the expiration of such period.

Section 23 of the Companies Act, 2013 provides that a public company may issue securities to the public through a prospectus.

Application forms

Section 33 of the Companies Act, 2013 states that no application for the purchase of any securities can be issued unless such form is accompanied by a suitable prospectus. 

This rule has two exceptions:

1. When an application is issued to invite a person to enter into an underwriting agreement concerning such securities
2. When an application is issued about securities that are not offered to the public.

Public issue

Any public company can issue securities to the public by complying with the provisions mentioned in Part I of Chapter III of the Companies Act, 2013. A public issue can be either in the form of the initial public offer (IPO) or follow on public offering (FPO). With an IPO, an unlisted public company can either make a fresh issue of securities or offer its existing securities for sale for the first time to the public while an FPO allows an already listed company to make a fresh issue of securities to the public. Both IPO and FPO are governed by SEBI, and the corresponding laws and regulations.

Contents of prospectus

As per Section 26 of the Companies Act, 2013, and Rule 3 of Companies (prospectus and allotment of securities) Rules, 2014 a prospectus must be signed and dated and have the following details:

1. Name and address of the registered office of the company, company secretary, Chief Financial Officer, auditors, legal advisers, bankers, trustees, if any, underwriters and such other person as may be prescribed,
2. Dates of the opening and closing of the issue,
3. A statement by the Board of Directors of separate bank account,
4. Details about underwriting of the issue,
5. Consent of the directors, auditors, banker to the issue, expert’s opinion, if any, and of any other person as may be prescribed,
6. The authority of the issue and the details of the resolution passed thereafter,
7. Procedure and time schedule for allotment and issue of securities,
8. Capital structure of the company in the prescribed manner,
9. Main objects of the public offer, terms of the present issue and such other particulars as may be prescribed,
10. Main objects and present business of the company and its location, schedule of implementation of the project,
11. Particulars relating to:

• Management perception of risk factors specific to the projects,
• Gestation period of the project,
• Extent of progress made in the project,
• Deadlines for completion of the project and,
• Any litigation or legal action pending or taken by a Government Department of a statutory body during the last past five years immediately preceding the year of the issue of prospectus against the promoter of the company,

1. Minimum subscription, amount payable by way of premium, issues of shares otherwise than on cash,
2. 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
3. Disclosures in such manner as may be prescribed about sources of promoter’s contribution.

If any prospectus is issued without the mention of any of the above-mentioned content, then the company and every person who is a party to the issue of prospectus shall be punishable with imprisonment for a term which may extend to 3 years or with a fine not less than INR 50,000 which may extend to INR 3 lakhs, or with both.

Procedure for changing the terms of the prospectus

Any change or variation in the terms and objects of the prospectus shall be done only passing of a special resolution through postal ballot and the notice of such resolution should have the following details:

1. Particulars of the terms of the contract to be varied,
2. Particulars of the proposed variation,
3. Reasons or justification for such variation,
4. Effect of the proposed variation in the financial statement or position of the company,
5. Major risk factors pertaining to the new objects.

Secondly, an advertisement of the notice for getting the resolution passed for varying the terms shall be published in PAS-1 form simultaneously with dispatch of postal ballot notices to shareholders.

Deemed prospectus

When a company offers any security to the public for sale, including shares and debentures, then any document through which such sale is made shall be deemed to be a prospectus under Section 25 of the Company Act, 2013.

A deemed prospectus shall be subject to the same liabilities and obligation as a prospectus defined under Section 2(70) of the Act. In Iridium India Telecom ltd vs Motorola Incorporated & ors, it was held that as the nature of the document was that of a deemed prospectus while issuing it, the promoter was required to make a true and full disclosure of all the relevant facts.

Shelf prospectus

According to Section 31 of the Companies Act, 2013 a shelf prospectus is a document issued by the securities and exchange board of India specified companies that issue securities more than once over a period of time without issuing further prospectus. Financial institutions like banks, insurance companies tend to engage in fundraising activities at a very frequent rate, to reduce the process of registering the prospectus again and again the concept of shelf prospectus was introduced, thus when a self prospectus is issued then the issuer is not required to issue a separate prospectus of any kind for each offering. The shelf prospectus must include the validity period of the prospectus which shall not exceed one year. This period commences from the opening date of the first offer.

If in between from the time when the shelf prospectus was issued and when the fundraising was required, the company experiences any significant or any material change, which is required to be informed to the investor, then the same should be done through information memorandum.

Information memorandum

As per Section 31(2) of the Company Act, 2013 a company filing a shelf prospectus shall be required to file an information memorandum. Information memorandum contains all the relevant changes that have taken place in the company, including the financial changes, from the time of the first offer of a security or previous offer of securities. Before issuing the subsequent offer of securities under the shelf prospectus, the information memorandum is to be filed with the registrar within 3 months as given under Rule 4CCA of section 60A(3) of the Companies (Central Government’s) General Rules and Forms, 1956.

Where a company or any other person receives application along with advance payments for the subscription of security before the changes were made in the information memorandum, then such changes must be communicated to the applicant. If the applicant thereafter, wishes to withdraw their application, the company shall return all the money received within 15 days.

Remedies for misrepresentation in a prospectus

An investor determines the financial position, liabilities and the current market position of a company through its prospectus, thus to ensure the interest of the investor, no material facts should be misrepresented or concealed. However reasonable puffing up of prospectus does not attract any liability. For instance, an advertisement claiming that their product will make your teeth whiter than white, then it would not amount to misrepresentation, as no reasonable person would believe such an advertisement. A statement is said to be misrepresented if it satisfies the following:

1. Untrue statement,
2. Intends to produce the wrong statement,
3. Conceals material facts,
4. Omits material facts.

An investor, investing based on the misrepresented prospectus has a right to claim damages or rescind the contract.

Damages for deceit

A victim of a misleading statement is entitled to receive damages if they have suffered monetary loss as a direct consequence of the misleading prospectus. Section 447 of the Companies Act provides that any person or company that is found to be guilty of fraud or deceit shall be liable to fine. The amount of fine shall not be less than the amount involved in fraud but may exceed till three times the fraud amount involved. If it is a case of contributory negligence or if the victim contributed towards its loss in any manner, then the court can reduce the damages to be awarded accordingly.

Rescission for misrepresentation

If there is a misrepresentation of a material fact or an omission of such fact in the prospectus, the contract can be rescinded or cancelled by the aggrieved party. While rescinding the contract, the parties can not rescind a part of the contract, the whole of the agreement is to be rescinded. However, the right to rescind is lost in the following circumstances:

By affirmation

The shareholder loses his right to rescind if he had the full knowledge of the misrepresentation made in the prospectus and yet upheld the contract. When the shareholder does any of the following, knowingly that the prospectus was misrepresented, he loses his right to rescind:

1. Attempts to sell his shares,
2. Executes a transfer,
3. Pays call money,
4. Receives dividend,
5. Attends and votes at the general meeting.

By unreasonable delay

Unreasonable delay or lapse of time can be another reason for bar to rescission. A shareholder, if he wants to cancel his contract, must do it within a reasonable time, he does not have unlimited time to rescind the contract. If a prompt decision is not taken up by the shareholder, he cannot be relieved from his obligation to pay for his shares. 

By commencement of winding up

Once the company has started the process of winding up, the shareholders can’t claim damages or rescindment of contract on the ground of misrepresentation in the prospectus. In Shiromani Sugar Mills Ltd v Debi Prasad, the court held that the right of rescission is lost on commencement of the winding up of the company and as the shareholder had not taken any active steps to avoid the contract during the working of the company neither they gave any indication of their intention to avoid the contract at any time, he has no right to rescind. But where a shareholder has started active proceedings to be relieved of his shares, the passage of winding up during pendency would not prevent his relief.

When statement deemed to be untrue

Any prospectus issued in contravention of Section 26 of the Companies Act is deemed to be untrue. The company would be punishable with a fine ranging between INR 50,000 and INR 3,00,00 and all the people who are a party to the issue of such prospectus may be liable to imprisonment for a term not exceeding three years.

Criminal liability

Section 34 of the Companies Act, 2013 imposes criminal liability on every person authorised to issue a prospectus for excluding or including any material facts which are likely to mislead the shareholders or investors. In DLF ltd v SEBI, the court declared that the defendants were to be held liable as there was concealment of material facts in their prospectus. As this was done to mislead and induce the investors to buy the shares of DLF, it is to be considered fraud. A person shall not be held liable if he proves the omission was immaterial or that he had reasonable grounds to believe that the statement issued was true. In Derry vs Peek, the court did not find the defendants liable as the statement made by them in the prospectus was made by them in the honest belief that it was true.

Acceptance of deposits under Company law 

Deposits include the money received against subscription to any securities including the share application money. Section 73 of the Company Act, 2013 provides that after the commencement of this Act no deposit shall be invited, accepted or renewed from the public in contravention to the provisions provided in this Act.

Who is a promoter under Company law?

Section 2(69) of the Companies Act, 2013 provides that promoter means a person who has been named as such in the prospectus or is identified by the company, has control over the affairs of the company, directly or indirectly and in accordance with whose advice, directions or instructions the Board of Director of the company is accustomed to act. Thus a promoter is a person who discovers the business opportunity and takes the required steps in the formation of a company. He is the one who undertakes the task of reaching the stage of incorporating the company. The status of the promoter is generally terminated when the board of directors has been formed and they start governing the company. They handover the control of the company to its directors, essentially post incorporation of the company, it is post this step that the promoter’s fiduciary and common law duties cease, and he is subject to more extensive duties in dealing with the company.

Duties and liabilities of a promoter

A promoter gives the practical shape to the idea of a company and renders a very useful service in the formation of a company. A promoter may be an individual, firm or company that originates the scheme, prepares executes and registers memorandum of association and articles of association. He finds the first directors of the company and enters into preliminary contracts. In Kelner v Baxter, the court held that contracts entered by promoters on behalf of the company cannot be ratified after the formation of the company, as the company was not in existence when the contracts were executed.

The promoters are in a fiduciary relationship with the company and they should not be making in any secret profit at the expense of the company. For instance, buying property at a lower price and then selling it to the company at a higher rate after incorporation of the company.

Normally promoters become directors of the company after incorporation of the company. However, whether or not a promoter becomes director, he is still fiduciary liable to the company with respect to the pre-incorporation contracts entered into and profits incurred.

In Erlanger v New Somrero Phosphate Co, the court laid down that if a promoter does not disclose his interest in the contract with the company, it is a breach of duty of the promoter and the contract can be rescinded by the company and the amount to be repaid to the company with interest. In Leeds and Hanley theatres of Varieties ltd damages were awarded for breach of promoter’s duty whereas in Cape Brenton co. it was held that if a promoter had acquired property before he became a promoter and if the company has affirmed the contract then no remedy is available for breach of promoters’ fiduciary duties.

Conclusion

Every public company issuing shares either through an IPO or FPO has to file a prospectus which a formal document containing all the material statements about a company required by the investors before acquiring shares in the company. All prospectus, including shelf prospectus and deemed prospectus, must be true to the knowledge of the company and all those responsible for issuing of the prospectus, as any omission or concealment of material facts, attract liability. In circumstances of fraud and misrepresentation, the aggravated party has the right to damages, compensation and to rescind the contract.

As the promoter plays a significant role in the incorporation of the company and other legal formalities, he has a fiduciary relationship with the company and can be held liable for breach of his duties.

References

1. 1. The Companies Act, 2013
   2. Iridium India Telecom ltd vs Motorola Incorporated & ors, 2004 (1) BOM 479

• Shiromani Sugar Mills Ltd v Debi Prasad, AIR 1950 All 508

• DLF ltd v SEBI, (SAT Order in Appeal No. 331 of 2014)

• Derry v Peek, (1889) LR 14 AC 337

• Erlanger v New Somrero Phosphate Co, (1878) 3 App Cas 1218
• Leeds and Hanley theatres of Varieties ltd, (1902) 2 ch 809 

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