Prospectus and its kinds under Company Law

Section 2(70) defines a ‘Prospectus’ to mean ‘any document described or issued as a prospectus and includes a Red Herring Prospectus referred to in Section 32 of the 2013 Act or shelf prospectus referred to in Section 31 of the 2013 Act 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.

On the basis of aforesaid definition, it may be said that a document should have following ingredients to constitute a prospectus:

1. There must be an invitation to the public
2. The invitation must be made “by or on behalf of the company or in relation to an intended company”
3. The invitation must be “subscribe or purchase”
4. The invitation must relate to any securities for the company

INVITATION TO THE PUBLIC: In essence, it means that a prospectus is an invitation issued to the public to offer for purchase/subscribe any securities of the company. A document is deemed to be issued to the public, if the invitation to subscribe for share capital is such as to be open to anyone who brings his money and applies in prescribed form, whether the prospectus was addressed to him or not. The test is not who receives the document, but who can apply for the securities in response to the invitation contained in it.

LEADING CASE LAW:

In the case of Govt. Stock and Other Securities Investment Co. Ltd. v. Christopher, (1956) I.W.L.R. 237 it was held that a circular issued by a company to the shareholders of other companies to acquire their shares held in those companies and issue its own shares in exchange of those shares did not amount to be a prospectus, as there is no public issue. It was pointed out that the circular did not involve an offer for the purchase of any shares.

In another case of Nash v. Lynde (1929) Nash applied for certain shares in a company on the basis of a document sent to him by Lynde, the managing director of the company. The document was marked “strictly private and confidential.”

The document did not contain all the material facts required by the Act to be disclosed. Nash filed a suit for compensation for loss suffered by him by reason of the omissions.

The suit was dismissed. The court observed, “The public is of course a general word. No particular numbers are prescribed. Anything from two to infinity may serve. The point is that the offer as such is to be open to anyone who brings his money and applies in due form, whether the prospectus was addressed to him on behalf of the company or not. A private communication is not thus open and does not construe to be a prospectus”.

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: 

1. A person that the company has recognised in the annual return under Section 92; or
2. A person with the authority over the company’s operations directly or indirectly, acting as a shareholder, director or in another capacity; or
3. 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:

1. Persons who are employed in the company; 
2. 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 Prospectus/ Prospectus is a silent Salesman:Section 26

Section 26(1) states that every prospectus issued by or on behalf of a public company either with reference to its formation or subsequently, or by or on behalf of any person who is or has been engaged or interested in the formation of a public company, shall be dated and signed and shall state the information, stated as per law.

Disclosure requirements in the prospectus as per Provisions of Section 26(1):

1. 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;
2. Dates of the opening and closing of the issue, and declaration about the issue of allotment letters and refunds within the prescribed time;
3. Statements of the Board of Directors about separate bank accounts where receipts of issues are to be kept.
4. Statement of the Board of Directors about the details of utilization and non-utilisation of receipts of previous issues.
5.      Consent of the directors, auditors, bankers to the issue, expert opinions.
6.       Authority for the issue and details of the resolution passed for it.
7. Procedure and time scheduled for the allotment and issue of securities.
8. The capital structure of the in the manner which may be prescribed.
9.       The objective of a public offer.
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.

• Minimum subscription and what amount is payable on the premium.
• Details of directors, their remuneration and extent of their interest in the   

      company.

Reports:

Reports for the purpose of 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.

Requirements or Formalities  for the issuance of a company’s prospectus

Section 26 (4) deals with the legal requirements for the issuance of a prospectus. The requirements are as follows: 

Filing of copy with Registrar -Sub-section (4) provides that no prospectus is to be issued by or on behalf of or in relation to an intended company unless on or before the date of its publication a copy has been delivered to the Registrar for registration. The copy should be signed by every person who is named in the prospectus as a director or proposed director or by his duly authorised attorney.

Statement of independent expert-A prospectus is not to include a statement purporting to be made by an expert unless the expert is a person who is not and has not been engaged in the formation, promotion or management of the company and has given his consent to the issue of prospectus and has not withdrawn his consent before delivery of a copy to the Registrar. A statement to that effect has to be included in the prospectus.

_{The term “expert” has been defined in S. 2(38) as including an engineer, valuer, chartered accountant, company secretary, cost accountant, and any other person who has the power or authority to issue a certificate in pursuance of any law for the time being in}

_force.

Delivery of copy to Registrar S. 26(6)– The prospectus has to state on the face of it that

1. A copy has been delivered for registration to the Registrar as required under subsection (4); and
2. Specify any documents required by this section to be attached to the copy so delivered or refer to statements included in the prospectus which specify these documents.

Registration of prospectus by Registrar S. 26(7)– The Registrar is not to register a prospectus unless the requirements of section with respect to registration have been complied with and it is accompanied by consent in writing of all the persons named in the prospectus.

Date of issue after registration [S. 26(8)].- If a prospectus is issued more than 90 days after a copy is delivered to the Registrar, it is deemed to be invalid.

Penalty for contravention [S. 26(9)]. – If a prospectus is issued in contravention of the provisions of the section, the company becomes punishable with fine of not less than Rs 50,000 but extending up to Rs 3,00,000. Every person who is knowingly a party to such a prospectus is punishable with imprisonment for a term which may extend to three years or with fine of not less than Rs 50,000 but extending up to Rs 3,00,000 or both.

Offer of sale of shares of certain members [S. 28]

Where certain members of a company, in consultation with the Board of directors, and in accordance with applicable law, propose to offer the whole or a part of their holding of shares to the public, they may do so in accordance with the prescribed procedure. [Sub-section (1)]

Sub-section (2) provides that any document by which the offer of sale of shares to the public is made is to be deemed a prospectus issued by the company and, therefore, all requirements as to contents of prospectus and liability for misstatements and omissions become applicable.

Advertisement of Prospectus: Section 30 provides that where an advertisement of any prospectus of a company is published in any manner, it shall be necessary to specify therein the contents of its memorandum as regards the objects, the liability of members and the amount of share capital of the company, and the names of the signatories to the memorandum and the number of shares subscribed for by them, and its capital structure.

Kinds of Prospectus :

1.     Shelf Prospectus:

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 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.

• Red Herring Prospectus :

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.

As per Section 32 –

1. Red herring prospectus has to be filed with the registrar at least three days before the opening of the subscription list and the offer. [32(2)]
2. A red herring prospectus carries the same obligations as are applicable to a prospectus. [32(3)]
3. Upon closing of the offer of securities, the prospectus has to state the total capital raised, whether by way of debt or share capital and the closing price of securities and any other details which are not included in the Red Herring Prospectus has to be filed with the registrar and the SEBI. [32(4)]

Liability for misstatement in a prospectus :

Liability of Director for false/ Inaccurate/ Misstatement/ untrue statement in Prospectus/ Liability of the Director

When he contends that the false statement in the prospectus was prepared by promoters and he had relied on them as such: The Golden Rule or Golden Legacy:

It is the duty of those who issue the prospectus to be truthful in all respects.

LEADING CASE LAW:

In RV. Kylsant (1932), all statements in the prospectus were literally true but it failed to disclose that the dividends stated in it as paid, were not paid out of trading profits, but out of realized capital profits (secret reserves). The statement that the company had paid dividends for a number of years was true.

But the company has incurred losses for all those years (1921-27) and no disclosure was made of this fact. The prospectus was held to be false in material particulars and the managing director and chairman, who knew that it was false, were held guilty of fraud.

Liability for Untrue Statement in Prospectus: It is now clear from the above illustrative case  that a prospectus must be complete and perfect in all details or in other words nothing should be omitted and nothing must be untrue in a prospectus.

Where an untrue statement occurs in a prospectus, there may arise

1. Civil liability
2. Criminal liability.
3. 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:

1. The company,
2. The director of the company, 
3. 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, 
4. A promoter of the company,
5. A person who has authorised the issue of the prospectus, or
6. 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:

1. Withdrawal of Consent : The person withdrew his permission or consent prior to the prospectus’s release, and it was issued without his authority or consent, or 
2. Issue without Knowledge: 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,
3. Reasonable Ground for Belief: 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.

A director will also be protected if he can show that he had reasonable ground to believe, and did up to the time of allotment believe the statements to be true”. It may be recalled that under the rule in Derry v Peek, a director having honest belief in the truth of his statement is protected. But under this section it is not enough for him to say that he was honest. He must go further and show that his honest belief was based upon reasonable grounds. And so in Adams v Thrift 1915 :

An action was brought by the plaintiff to recover compensation from a director of a company in respect of false statements in a prospectus.

The director contended that the statements were prepared by the promoters and before issuing he enquired from one of them, ‘Is everything perfectly alright and he said ‘of course, it is’. It was held that although the director did honestly believe the statement to be true, he had no reasonable ground to do so. ‘The promoter is the very last person whose uncorroborated statement ought to be relied upon by an intending director as justification for saying that he had reasonable ground for belief. If they had taken the opinion or obtained a report of competent people as to material facts in the prospectus that might have afforded a reasonable ground for belief.

• 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

Remedies available to a person who has been induced to invest money on a company by misstatement in the prospectus:

Remedies for Misrepresentation in Prospectus:

A company is responsible for a statement in prospectus only if it is shown that the prospectus was issued by the company or by someone with the authority of the company, e.g., the Board of directors. The company is also liable for misstatement in prospectus even though the prospectus is issued by the promoters & the Board ratifies and adopts the issue of prospectus. Following are the remedies :

Rescind the Contract :- The first remedy against the company is to rescind the contract. A person who takes securities on the faith of a prospectus containing false statements, may apply to the Court for setting contract aside, and striking off his name from the register of members. He may also claim his money back.

Damages for Deceit : The second remedy against the company is to sue for damages for deceit. This suit is founded on the tort of deceit, and is not a case of fraud on the part of directors or promoters. The allottee may recover damages from the company for any loss he may have suffered if the invitation to take securities is emanating from the company and the persons making it on behalf of the company have fraudulently misrepresented material facts. The allottee cannot both retain the securities and get damages against the company.

Remedies against Directors or Promoters: A person who subscribed for shares on the faith of a false prospectus may claim from directors or promoters:

• Damages for fraudulent misrepresentation,
• Compensation under Section 35 of the Act,
• Damages for non-compliance with the requirements of Section 26 of the Act.

Damages for fraudulent misrepresentation: An allottee may sue the director for     
damages for deceit, if there are fraudulent misrepresentations in the prospectus. But the directors will not be liable for damages for mis-statement if they believed them to be true,

LEADING CASE LAW: [Derry v. Peek, (1889) 14 AC 337]

Derry v Peek, the prospectus of a company stated that the company had been authorised to use steam power in moving its trams. The authority was in fact subject to the approval of the Board of Trade, which refused its approval. Yet the directors were held to be not guilty of fraud, because they were honest, whereas fraud requires a statement which the maker knows to be false, or does not believe it to be true or is too reckless as to its truth. The company may also be sued for damages provided that the fraudulent statement was made by its officers within the scope of their authority.

Compensation for untrue Statement: An allottee is also entitled to claim compensation from directors, promoters and any other persons who authorised the issue of the false prospectus, for damages sustained by reason of any untrue statement in it,

Conclusion

As per the Companies Act 2013 in India, companies have to follow specific guidelines and requirements when preparing and filing prospectuses for public offers of securities. The different types of prospectus, including red herring prospectus, shelf prospectus, abridged prospectus, and deemed prospectus, each have their own distinct features, usage, and regulatory provisions. 

It is crucial for companies to understand the requirements and comply with the relevant provisions while preparing and filing prospectuses to ensure compliance with the law and provide accurate information to potential investors.