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What is a Prospectus and Statement in Lieu of Prospectus? Discuss the Consequences of Mis-statement in Prospectus

Definition of Prospectus

According to Section 2(70) of the Companies Act, 2013, a prospectus means “any document described or issued as prospectus and includes any notice, circular, advertisement or other document inviting offers from the public for the subscription or purchase of any shares in, or debentures of a body corporate.” In essence, any advertisement offering shares or debentures of the company to the public is known as a prospectus.

Essential Elements of a Prospectus

For a document to qualify as a prospectus, the following elements must be present:

There must be an invitation offering to the public
The invitation must be made by or on behalf of the company or in relation to an intended company
The invitation must be to subscribe or purchase securities
The invitation may relate to shares or debentures

Prospectus Must Be Issued to the Public

A document qualifies as a prospectus only if it is “issued to the public,” and the provisions of the Act are not attracted unless the prospectus is issued to the public. The case of Nash v. Lynde (1929) clarifies this point. In this case, several copies of a document marked “strictly confidential” and containing particulars of a proposed issue of shares were sent by the managing director of the company to a co-director, who sent a copy to a solicitor, who in turn gave it to a client who passed it on to a relation. Thus, the document was passed privately through a small group of friends of the director. The House of Lords held that there had been no issue to the public, and therefore, no action for compensation of loss caused to the allottees would be sustained.

Registration of Prospectus [Section 26]

Sub-section (1) of Section 26 provides that no prospectus shall be issued by or on behalf of a company or in relation to an intended company unless, on or before the date of publication, there has been delivered to the Registrar for registration a copy thereof signed by every person who is named therein as a director or proposed director of the company or by his agent authorised in writing.

Documents to Accompany the Prospectus

The prospectus must be accompanied by the following documents:

The consent of the expert, if his report is to be published in the prospectus
A copy of every contract relating to the appointment or remuneration of managerial personnel
A copy of every material contract not being a contract entered into in the ordinary course of business of the company entered into within two years of the date of issue of prospectus
A written statement relating to the adjustments, if any, in respect of figures of any profits or losses, and assets and liabilities
The consent in writing of the person, if any, named in the prospectus as auditor, legal adviser, attorney, solicitor, issue house, banker or broker of the company to act in that capacity
The consent of directors in respect of new directors, if any, named therein
A copy of the underwriting agreement, if any, should also be filed along with the prospectus

Contents of Prospectus

The prospectus must contain a statement that a copy has been delivered for registration, indicating the requisite documents delivered therewith. It must be issued within ninety days of its registration, either by newspaper advertisement or otherwise.

Section 26 of the Act requires that if the prospectus includes a statement purporting to be made by an expert, his consent in writing should be obtained and this fact be stated in the prospectus. It should also state that the consent has not been withdrawn. The term ‘expert’ has been defined in Section 2(38) of the Companies Act, 2013 and includes “an engineer, a valuer, an accountant and any other person whose profession gives authority to a statement made by him.” The expert should not be one who is himself engaged or interested in the formation, promotion or management of the company. In other words, he should be unconnected with the formation or management of the company.

Section 26 further casts a statutory duty upon the company to disclose matters specified in Schedule III of the Act. ‘Private placement’ means any offer of securities or invitation to subscribe securities to a select group of persons by a company (other than by way of public offer) through issue of a private placement offer letter and which satisfies the conditions specified in Section 42.

Matters to Be Stated in the Prospectus

Main objects of the company including the details about the signatories to the memorandum of association of the company. This is, however, not necessary when the prospectus is issued merely as a newspaper advertisement.
Number and classes of shares and the interest of the shareholders in the property and profits of the company. In case of redeemable preference shares, the date of redemption or the notice period for redemption and the proposed method of redemption.
Names, addresses, descriptions and occupations of the directors. The qualification shares, if any, held by the directors and the terms of their appointment, remuneration and compensation for loss of office etc.
Minimum subscription amount which, in the opinion of the directors or signatories of the memorandum, must be raised by the issue of shares offered to the public for subscription to provide for the purchase price of any property acquired or to be acquired, preliminary expenses, underwriting commission, repayment of loans etc.
Time of the opening of the subscription list.
Amount payable on application and allotment on each share and if any prospectus was issued within two years, the details of the shares subscribed for and allotted.
Particulars of any options to subscribe for shares or debentures, including the time for exercise of option, the price to be paid and the consideration given for the option, and the persons entitled to the option.
Particulars of shares and debentures issued as fully or partly paid up in the preceding two years otherwise than in cash, and the consideration for such issue, and of any shares issued or to be issued at premium.
Names of the underwriters, if any, and the opinion of the directors that the resources of the underwriters are sufficient to discharge their obligations.
Particulars about vendors from whom any property has been or is to be acquired by the company and the price whereof is to be paid out of the proceeds of the issue.
Amount or rate of underwriting commission.
Amount or estimate of preliminary expenses and the expenses of the issue, by whom paid or payable.
Amount paid or benefit given within two preceding years to the promoters of the company.
Particulars of every contract appointing or fixing the remuneration of a managing director or manager whenever entered into, and every other material contract, unless made in ordinary course of business or more than two previous years.
Names and addresses of the auditors of the company, if any.
Particulars as to interest of every director or promoter in the promotion or property of the company within two years of date of prospectus.
Rights attached to different classes of shares, where the shares are of more than one class—the rights of voting and the rights as to capital and dividend attached to the several classes of shares.
Restrictions, if any, imposed by the articles upon the members in respect of their right to participate at company meetings and to transfer shares or upon the directors in respect of their powers of management.
Length of time during which the company has been carrying on its business; and if the company proposes to acquire a business which has been carried on for less than three years, the length of time during which such business has been carried on.
Particulars of capitalisation if any reserves or profits of the company or any of its subsidiaries have been capitalised, and surplus arising from revaluation of the assets of the company.
Time and place for inspection of accounts—a reasonable time and place at which copies of all accounts on which the report of the auditors is based may be inspected.

Reports to Be Set Out in the Prospectus

In addition to the matters stated above, the following reports must also be set out in the prospectus:

Auditors’ report relating to profits and losses and assets and liabilities of the company for each of the five financial years before the issue of the prospectus. The report must refer to the rates of dividends, if any, paid by the company in respect of each class of shares for each of the said years. The report of the auditors must also state separately the profits and losses of the company’s subsidiaries and also combined profits and losses.
Report on business to be acquired—if the company proposes to acquire any business, a report should be made by a chartered accountant, whose name should be disclosed, upon the profits and losses of the business for each of the five years before the date of the prospectus and assets and liabilities of the business.
Reports about the business and transactions to which the proceeds of the securities are to be applied directly or indirectly.

Voluntary Statements in Prospectus

In addition to the compulsory particulars stated above, any other information is usually considered voluntary. Such information may relate to the terms of the issue of share application to deal with shares of the company on the Stock Exchange. The prospective buyer is entitled to all true disclosures in the prospectus.

The ‘Golden Rule’ of Framing a Prospectus

A prospectus must therefore tell the whole truth and nothing should be concealed which ought to be disclosed. Thus the prospectus must reflect the company’s real position and the nature of its venture. This is known as the ‘Golden Rule’ as to the framing of prospectus and described as ‘golden legacy’ by Kindersley VC in Henderson v. Lacon. The essence of the rule is that it is obligatory on the part of those responsible for the issue of prospectus not only to state accurately all the relevant facts but also not to omit any fact which may be relevant to the prospective investor to know about the company.

Issuing Houses and Deemed Prospectus [Section 25]

It would be seen that the provisions relating to issue of prospectus are most stringent and extremely onerous. In order to evade these onerous requirements, companies usually allot the whole of their capital to an intermediary known as an ‘Issuing House’ which offers the shares to public by means of an advertisement of its own, which is obviously not a prospectus in form. However, under Section 25, every such advertisement sponsored by an ‘Issuing House’ is known as an ‘Offer for sale of securities’ and is deemed to be a prospectus issued by the company. Therefore, the responsibility of the company, its directors and promoters remains the same. In addition, the Issuing House incurs its own additional liability in respect of mis-statements contained in the document or otherwise in respect thereof.

Presumption of Intent

The intention of the company in making the allotment may be proved in any manner. But Section 25(2) provides that it will be presumed, unless the contrary is proved, that an allotment of or agreement to allot shares or debentures was made with a view to the shares or debentures being offered for sale to the public if it is shown:

That an offer for sale was made within six months of allotment or agreement for allotment to the Issuing House; or
That at the date of the offer for sale, the company had not received the whole consideration for the shares or debentures.

Additional Information in Deemed Prospectus

The prospectus issued by the Issuing House which is known as ‘offer for sale’ shall also set out the following additional information:

The net amount of consideration to be received by the company in respect of those shares or debentures to which the offer relates.
Since the offer for sale is a ‘Deemed Prospectus’, it must be registered under Section 26 of the Act. The copy sent for registration is to be signed by the persons making the offer as if they were named as directors of the company. If the offer for sale is made by a company or a firm, at least two directors or half the number of partners, as the case may be, must sign the prospectus.
The place and time at which relevant contracts may be inspected must also be stated in the deemed prospectus.

Restriction on Variation of Terms in Prospectus [Section 27]

A company shall not, at any time, vary the terms of a contract referred to in the prospectus or statement in lieu of prospectus except with the approval of the general meeting by way of special resolution.

Provided that the company shall not use any amount raised by it through prospectus for buying, trading or otherwise dealing in equity shares of any other listed company.

The dissenting shareholders who have not agreed to the proposal to vary the terms of contracts or objects referred to in the prospectus shall be given an exit offer by promoters or controlling shareholders at such price, and in such manner and conditions, as may be specified by SEBI by making regulations in this behalf.

Liability for Omission or Fraudulent Mis-statements in Prospectus

Omissions

Any omission from a prospectus of those matters which are required to be stated as per Section 26 shall render the director or any other person responsible for the issue of prospectus liable to a fine of not less than fifty thousand rupees, which may extend to three lakh rupees. In addition to this, the director or the official concerned may also incur civil or criminal liability for non-disclosure.

However, in the event of omission to disclose the nature and extent of a director’s or promoter’s interest in the promotion of or property acquired or to be acquired by the company, no director or other person shall incur liability unless it is proved that he had knowledge of the matters not disclosed.

The liability for violation of provisions of Section 26 of the Companies Act, 2013, will also be covered by Sections 34 and 35 of the 2013 Act, which deal with civil and criminal liability for mis-statements in prospectus.

Civil Liability for Mis-statements [Section 35]

Under Section 35, where a prospectus issued, circulated or distributed includes any statement which is untrue or misleading in 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 all damages sustained by any person who subscribes to securities on the basis of such prospectus.

Persons liable include:

Every director of the company at the time of issue
Every person who has authorised himself to be named and is named in the prospectus as a director or as having agreed to become a director
Every promoter of the company
Every person who has authorised the issue of the prospectus

Defence available: A person shall not be liable if he proves:

That the statement or omission was immaterial; or
That he had reasonable ground to believe and did believe that the statement was true or the inclusion or omission was necessary; or
That he withdrew his consent and gave reasonable public notice of withdrawal; or
That the prospectus was issued without his knowledge or consent and he gave reasonable public notice thereof; or
That as regards any expert’s statement, he had reasonable ground to believe and did believe that the expert was competent and had consented.

Criminal Liability for Mis-statements [Section 34]

Section 34 provides for criminal liability where a prospectus includes any statement which is untrue or misleading, or where any inclusion or omission is fraudulent. Any person who authorises the issue of such a prospectus shall be liable for fraud under Section 447 of the Companies Act, 2013.

Punishment under Section 447:

Imprisonment for a term which shall not be less than six months but which may extend to ten years
Fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud

Defence: No person shall be liable if he proves that the statement was immaterial or that he had reasonable grounds to believe and did believe up to the time of issue of the prospectus that the statement was true.

Conclusion

The provisions relating to prospectus are designed to ensure full disclosure of material facts to prospective investors. The law imposes stringent requirements on companies, directors, promoters and other persons responsible for issuing prospectus. Both omissions and mis-statements attract serious civil and criminal consequences, including substantial fines, imprisonment, and liability to compensate investors for losses sustained. The ‘Golden Rule’ requires that a prospectus must tell the whole truth—stating all relevant facts accurately and not omitting any material information that prospective investors need to make informed decisions.