This article is written by Tarini Kalra, a student of BBA LL.B. from Fairfield Institute of Management and Technology, GGSIPU. The present article provides exhaustive information about prospectuses and their types.
It has been published by Rachit Garg.
Table of Contents
Introduction
Capital in a company is vital because it indicates a company’s available finance and is used by businesses to pay for the ongoing production of goods and services in order to produce a profit. More the capital, the more the expansion of the company. Companies can raise funds through debt or equity financing. In such cases, a prospectus becomes an essential tool. A prospectus is a detailed document containing information on the securities issued by a company to invite the potential public and investors to subscribe to the securities.
Prospectus under the Companies Act, 2013
Section 2(70) of the Companies Act, 2013 (hereinafter referred to as CA, 2013) defines a prospectus as “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 a body corporate.”
In other words, a prospectus is any advertisement, circular, or document that invites public deposits or offers to subscribe or purchase any shares or debentures of a corporate body. The company’s operations and objectives, along with the purpose of the securities being offered are disclosed in a prospectus. A prospectus may only be issued by a public company to offer its shares and debentures. A private company cannot issue a prospectus because private companies are relatively small in size, thus, they issue fewer shares, and share transferability is limited, resulting in low liquidity of the private company’s stocks. A prospectus is released by or on behalf of a public company with regard to the company’s formation or on behalf of any individual who is, has been, or has expressed interest in the creation of a public business. The individual is known as the ‘promoter’ of the company. A promoter is defined under Section 2(69) as a person who is acting solely in a professional capacity and who is:
- A person that the company has recognised in the annual return under Section 92; or
- A person with the authority over the company’s operations directly or indirectly, acting as a shareholder, director or in another capacity; or
- A person under whose advice, directions, or instructions the company’s board of directors ordinarily acts.
Section 2(71) of the CA, 2013 defines a public company, whereas Section 2(68) of the CA, 2013 defines a private company.
A company that prohibits the transfer of its shares to the public is a private company. It forbids public requests for an invitation to subscribe to any of the company’s securities. The number of members in a one-person company is restricted to two hundred. When two or more persons own one or more shares of a company together, they are recognised as a single member in the situations mentioned below:
- Persons who are employed in the company;
- The number of members will not include those who were members of the company at the time of employment and remained members after their employment terminated.
Contents of a prospectus
A prospectus must enlist the following details:
- Name of the company,
- The registered address of the company,
- Objectives and purpose of the company,
- Purpose of the issue of prospectus,
- Nature and capital structure of the business,
- Name, location, and the number of shares that signatories have subscribed,
- Qualification shares of the directors,
- Details on redeemable preference shares and debentures,
- Remuneration of directors and promoters,
- Minimum subscription for allotment,
- Date of opening and closing of the issue,
- Information on underwriting commission and brokerage,
- Name and address of the company’s auditor, secretary, banker, and trustee,
- Particulars of material documents,
- Forecasted rate of dividend and voting rights.
Requirements for the issuance of a company’s prospectus
Section 26 deals with the legal requirements for the issuance of a prospectus. The requirements are as follows:
- Every prospectus must be issued by or on behalf of a public company or behalf of a person involved in or interested in the establishment of the company. The prospectus has to be duly dated and signed. It must provide the information and set out the financial information reports required by the Securities and Exchange Board of India (hereinafter referred to as SEBI) under the Securities and Exchange Board of India Act, 1992 (hereinafter referred to as SEBI Act, 1992) in consultation with the Central Government.
- A company is required to certify that the provisions, rules, and regulations under the CA, 2013, as well as a statement that nothing in the prospectus is in violation of the Securities Contracts (Regulation) Act, 1956 and the SEBI Act, 1992.
- The issue of a prospectus or application form for shares or debentures to existing members or debenture holders of a company is exempt under Section 26(1) even if an applicant has a right to surrender the shares in favour of any other person or not under Section 62(1)(a)(ii). The issuance of prospectus or application forms for securities that are similar to securities that have previously been issued, traded or listed on recognised stock exchanges will also be exempt from its applicability.
- The date stated in the prospectus will be regarded to be the date of its issuance of a prospectus or a form of application regardless of whether it was released prior to, in compliance with, or after the foundation of a company.
- It must be ensured that on or before the date of its publication, a copy duly signed by every person who is named as a director or proposed director of the company or by his duly authorised attorney must be delivered to the Registrar for filing otherwise a prospectus cannot be issued by or on behalf of a company.
- A statement claiming to be made by an expert may not be included in a prospectus issued under Section 26(1) unless the expert is a person who is not, and has not been, involved in any form of management or operations of the company. Written consent to the issue of the prospectus must be given, and must not withdraw his consent prior to delivery of a copy of the prospectus to the Registrar for filing. A statement to that effect must also be included in the prospectus.
- Every prospectus issued must mention that a copy has been supplied to the Registrar for filing and must specify any documents that must be attached to the copy supplied. It may also refer to statements within the prospectus that list the requisite documents as per the provision of Section 26(1).
- If a prospectus is issued more than 90 days after a copy is delivered to the Registrar, it is deemed to be invalid.
- If a prospectus is issued in violation of provisions mentioned under Section 26, the company will be penalised with a fine not less than fifty rupees and not exceeding three lakh rupees. Any individual who voluntarily participated in the issuance of the prospectus would be penalised to a fine of not less than fifty thousand rupees and cannot exceed three lakh rupees.
Types of prospectus
According to the CA, 2013, there are four types of prospectus: Red Herring, Shelf, Abridged, and Deemed;
Red Herring
A red herring prospectus is defined under Section 32 of the CA, 2013. A red herring prospectus does not provide detailed information about the quantum, or quantity, and price of the securities offered. It is used for the book-building process. The process through which an issuer seeks to identify the price at which an initial public offering (IPO) will be offered is known as book building. An issuer often creates a book for institutional investors to make offers for the quantity of shares and the estimated amount of money they will pay. The issuer examines the data and estimates the final price for the security using an average value.
A company that intends to offer securities to the public can issue a red herring prospectus before issuing the original prospectus. It must be filed with the Registrar at least three days prior to the opening of the subscription list and offers.
A red herring prospectus is subject to the same obligations as a prospectus, and any difference between the red herring prospectus and the prospectus must be identified as ‘deviations in the prospectus’. Following the close of the offer of securities, the prospectus must state the total capital raised, whether by debt or share capital, and the closing price of the securities, as well as any other details not included in the red herring prospectus, and must be filed with the Registrar and the SEBI.
Shelf
The shelf prospectus is outlined under Section 31 of the CA, 2013. A shelf prospectus offers securities for subscription in one or more issues over a specific period of time without the need for a fresh prospectus to be issued. This is done especially in projects where the issue size is substantial, and large sums of money are required to be raised in order to save on the expense of filing a new prospectus every time.
Any company may file a shelf prospectus with the Registrar at the stage of the first offer of securities, and the validity period of such prospectus shall not exceed one year, which shall begin from the date of opening of the first offer of securities under the prospectus and in respect to subsequent offers of securities issued during the period of validity of that prospectus in accordance with the guidelines issued by SEBI. A fresh prospectus is not required to be issued for the offer of securities.
A company filing a shelf prospectus must file an information memorandum under Form PAS.2 with the Registrar within one month under Rule 10 of the Companies (Prospectus and Allotment of Securities) Rules, 2014, prior to the issue of a second or subsequent offer of securities, containing all updated charges in the facts, the company’s financial position that changed between the previous offer of securities and the succeeding offer of securities, or any other changes. Prior to applying any changes, a company or any other person shall inform applicants of the changes, and if they express willingness to withdraw their application, the company or other person shall reimburse money received as a subscription within fifteen days.
When an information memorandum is submitted with the shelf prospectus at the time of the offer for securities, it is considered a prospectus.
As per the SEBI (Issue and Listing of Debt Securities) (Amendment) Regulations, 2014, the entities listed below may submit a shelf prospectus for the public issuance of their debt securities:
- Public financial institutions defined under Section 2(72) of the CA, 2013, and scheduled banks defined under Section 2(e) of the Reserve Bank of India Act, 1934; or
- Issuers authorised by the notification of the Central Board of Direct Taxes to make a public issue of tax-free secured bonds, with respect to such tax-free bond issuances; or
- Infrastructure debt funds and non-banking financial companies regulated by the Reserve Bank of India; or
- Non-Banking Financial Companies (NBFCs) registered with the Reserve Bank of India and Housing Finance Companies (HFCs) registered with the National Housing Bank that meet the following criteria:
- Having an audited net worth of at least Rs.500 crore balance sheet from the previous fiscal year;
- Has a track record of sustained distributable profit over the previous three years;
- Securities issued under the shelf prospectus have been assigned a rating of not less than the “AA-” category or equivalent by a credit rating agency registered with the Board;
- There are no pending regulatory actions against the firm or its promoter or directors before the Board, Reserve Bank of India or the National Housing Bank;
- The issuer has not defaulted on any payments on deposits or interest due, redeemed debentures or preferred stock, paid dividends to shareholders, or repaid term loans or interest due to any public financial institution or banking company in the prior three fiscal years.
- The listed entities complying with the following requirements:
- Whose public issued equity shares or debt securities are listed on a recognised stock exchange for a period of minimum three years immediately preceding the issue and have been in compliance with the listing agreement entered into between the issuer and the recognised stock exchanges where the issuer’s securities are listed;
- According to the previous fiscal year’s audited financial statement, with a net value of at least Rs.500 crore;
- Having a three-year track record of consistent distributable profit;
- Securities issued under the shelf prospectus have received a credit rating of minimum “AA-” or an equivalent credit rating from a credit rating agency registered with the Board;
- There are no pending regulatory actions against the firm or its promoter or directors before the Board, Reserve Bank of India or the National Housing Bank;
- The issuer has not defaulted on any payments on deposits or interest due, redeemed debentures or preferred stock, paid dividends to shareholders, or repaid term loans or interest due to any public financial institution or banking company in the prior three fiscal years.
- The issuer who files a shelf prospectus must immediately submit a copy of the information memorandum with the recognised stock exchanges and the Board after filing it with the Registrar.
- The disclosures must be included in the information memorandum required by the CA, 1956 or the CA, 2013, as applicable, and the rules promulgated thereunder, including disclosures regarding the summary term sheet, material updates, including rating revisions, if applicable along with the rating rationale, and financial ratios specified in Schedule I, specifying the pre and post issue change.
- A single shelf prospectus shall not be used for more than four issuances.
Abridged
Section 2(1) of the CA, 2013 outlines an abridged prospectus. It means a memorandum containing the salient features of a prospectus as per the regulations specified by the Securities and Exchange Board. Section 33 mandates the issuance of application forms for securities along with an abridged prospectus.
Section 33 shall not be applicable to the application form issued for:
- A valid invitation to a person to engage in an underwriting agreement with regard to such securities; or
- Securities that were not offered to the public.
A copy of the prospectus shall be sent to any individual who requests it prior to the close of the subscription list and the offer. If a corporation fails to comply with the provisions of Section 33, it would be liable for a penalty of fifty thousand rupees for each default.
SEBI released regulations governing disclosures in the abridged prospectus and front cover page of the offer document via circular number SEBI/HO/CFD/SSEP/CIR/P/2022/14 dated 4th February 2022.
Deemed
Section 25 of the CA, 2013 discusses deemed prospectuses. A deemed prospectus is a document that is assumed to represent a company’s prospectus. A deemed prospectus is a document that contains an offer for sale made by the intermediary or issuing house on behalf of a company that allots or agrees to allot its shares or securities through an intermediary, such as a merchant bank, another business, or an issuing house. A company usually opts for a deemed prospectus to avoid complying with regulations issued by the SEBI.
A deemed prospectus is considered a document of offer for sale if it meets any of the following criterias:
- The intermediary made an offer to sell shares to the public within six months of the allotment of shares; or
- The company which allotted its shares to the intermediary has not received payment in exchange for the shares the offer for sale was made by the intermediary.
Liability for misstatement in a prospectus
The SEBI Complaints Redressal System (SCORES), introduced by SEBI, requires all listed businesses to address shareholder complaints. The SEBI’s centralised online grievance redress system allows investors to file complaints, follow up on them, and see the progress of their resolution from any location. The SEBI Act, 1992, imposes penalties on the corporation for non-compliance. The liabilities for misstatement in a prospectus can be classified into civil liability under Section 35 and criminal liability under Section 34 of the CA, 2013.
Civil liability under Section 35
A person who subscribed to the securities must prove that the prospectus was issued by the company and the statements were untrue. A person who has subscribed to the securities of a company can claim compensation for misstatements in the prospectus against:
- The company,
- The director of the company,
- A person who has authorised to be named as a director of the company or has consented to become a director, either immediately or after a period of time,
- A promoter of the company,
- A person who has authorised the issue of the prospectus, or
- An expert under Section 26(5).
shall be liable to pay compensation to every subscriber of securities of the company who has incurred loss or damage.
The following are the exceptions to civil liability:
- The person withdrew his permission or consent prior to the prospectus’s release, and it was issued without his authority or consent, or
- The prospectus was released without his knowledge or consent, and upon discovery of its release, a reasonable public notice is released stating that the prospectus was released without his knowledge or consent,
- The individual had reasonable grounds to believe that the expert was competent to make the assertion and that the document is an accurate copy, or a right and appropriate extraction of the report or valuation.
Criminal liability under Section 34
If any statement in a prospectus is untrue, false, deceptive, or likely to mislead in any form, context, or omission in which it is offered, and the person who approves the distribution of such a prospectus is accountable under Section 447.
It exempts any person who proves that the statement or omission was irrelevant or the person had reasonable grounds to believe the statement was accurate, or that the omission was significant at the time the prospectus was issued
Conclusion
A prospectus contains information about the company, its management, financial stability, and other essential information, and it is distributed to the general public and investors to encourage them to subscribe to the securities of the company. A prospectus can be classified into four types: Red Herring, Shelf, Abridged, and Deemed. Each prospectus performs differently, which may help a company make a reasonable investment decision. Identifying the appropriate type of prospectus for issuing securities helps the company to make an informed investment strategy. As a result, a prospectus is essential for every public company, and it must be issued in accordance with the terms of the Companies Act, 2013.
Frequently Asked Questions (FAQs)
Why is a prospectus issued?
A prospectus is issued to invite the potential public and investors to subscribe to the securities.
How may investors benefit from a prospectus?
The prospectus includes details about the company, its management, financial stability, and other relevant information pertinent to potential investors.
References
- https://tavaga.com/tavagapedia/prospectus/#:~:text=The%20prospectus%20is%20a%20legal,herring%20prospectus%2C%20and%20shelf%20prospectus.
- https://www.dynamictutorialsandservices.org/2014/05/prospectus-and-its-contents.html
- https://lawcorner.in/all-about-prospectus-of-company/#:~:text=According%20to%20the%20provision%20of%20Section%2034%20of%20the%20Companies,be%20punishable%20under%20Section%20447.
- https://www.indiafilings.com/learn/prospectus-of-a-company/
- https://www.angelone.in/knowledge-center/ipo/what-is-a-deemed-prospectus#:~:text=As%20the%20name%20suggests%2C%20a,deemed%20to%20be%20a%20prospectus.
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