Prospectus

Meaning of Prospectus (Section 2(70))

A prospectus is the primary legal document used by a company to invite the public to subscribe to its securities (shares or debentures). It is the window through which a potential investor gets a glimpse into the affairs of the company. The purpose of a prospectus is to provide all the necessary information to an investor so they can make an informed decision about whether to invest in the company or not. It serves as a formal invitation and a comprehensive disclosure document.

Any Document Described or Issued as a Prospectus

The legal definition of a prospectus under Section 2(70) of the Companies Act, 2013, is very broad. It states that a prospectus is:

"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."

The key elements of this definition are:

Form is Immaterial: The name given to the document does not matter. Any document, whether it is a notice, circular, advertisement, or even a detailed newspaper advertisement, will be considered a prospectus if it serves the purpose of inviting offers from the public for its securities.
Invitation to the Public: The document must be an invitation to the public. An offer made to a select group of people privately (e.g., to existing members or friends) is not considered an invitation to the public and hence does not require a prospectus. An offer is considered to be made to the public if it is made to 50 or more persons.
For Subscription or Purchase of Securities: The invitation must be to subscribe to (in case of a new issue) or purchase (in case of an offer for sale) any securities of the company.

This wide definition ensures that a company cannot evade its disclosure obligations by cleverly naming an invitation document as something other than a "prospectus".

Contents of Prospectus (Section 26)

The guiding principle for drafting a prospectus is often called the "golden rule" of disclosure: every fact that could realistically affect an investor's decision-making process must be disclosed fully, frankly, and accurately. The prospectus must not only state the truth but the whole truth, without any concealment or misleading ambiguity.

Full Disclosure of Material Facts

Section 26 of the Companies Act, 2013, along with rules prescribed by the Securities and Exchange Board of India (SEBI) for listed companies, mandates that a prospectus must contain a vast amount of information. The objective is to provide a complete picture of the company's financial health, management, and future prospects. Key contents include:

Company Information: Name, registered office address, details of the main objects, and history of the company.
Director's Details: Names, addresses, and details of the directors, their remuneration, and their interest in the company's promotion.
Issue Details: The purpose of the issue (e.g., for expansion, to repay debt), the amount being raised, the price of the securities, and the opening and closing dates of the issue.
Capital Structure: Details of the authorized, issued, and paid-up capital of the company.
Financial Information: Audited financial statements (Profit & Loss Account, Balance Sheet, Cash Flow Statement) for the previous years as specified by the Act.
Material Contracts and Risks: Details of any material contracts, litigation involving the company, and a clear statement of risk factors associated with the investment.
Statutory Declarations: A declaration that all provisions of the Companies Act have been complied with and that the prospectus does not contain any matter which is misleading.

The prospectus must be dated and signed by every person who is named therein as a director or proposed director.

Consequences of Mis-statement or Omission

A mis-statement in a prospectus is any statement that is untrue or misleading in the form and context in which it is included. An omission refers to leaving out a material fact that would have influenced an investor's decision.

Landmark Case: Rex v. Kylsant (1932)

Answer:

This case established the principle that a prospectus can be misleading not just by what it says, but by what it doesn't say. A company issued a prospectus stating it had paid dividends for several years, which was technically true. However, it failed to disclose that in recent years, these dividends were not paid out of trading profits but out of hidden reserves accumulated during the war. The impression given was of a consistently profitable company, which was false.

The court held that the prospectus was misleading because the omission of this crucial fact created a false impression. Lord Kylsant, the chairman, was convicted of issuing a false prospectus. This highlights that a statement can be "literally true but practically false".

The consequences of such mis-statements or omissions are severe and can lead to:

The shareholder rescinding (cancelling) the contract to buy shares.
The company and its responsible officers facing civil and criminal liability.

Liability for Mis-statement in Prospectus (Sections 34, 35, 36)

The law imposes stringent liabilities on those responsible for the contents of the prospectus to ensure they perform their duties with diligence and honesty. The liabilities are both civil (to compensate the investors) and criminal (to punish the wrongdoers).

Civil Liability (Section 35)

This section provides a remedy to investors who have subscribed to securities based on a misleading prospectus and have suffered a loss as a result.

Who is Liable?

The following persons can be held liable to pay compensation:

The company itself.
Every person who was a director of the company at the time of the issue of the prospectus.
Every person who has authorized himself to be named as a director in the prospectus.
Every promoter of the company.
Every person who has authorised the issue of the prospectus.
An expert (like a chartered accountant, valuer, or engineer) who has prepared or certified any report or statement included in the prospectus.

Defenses Available

A person can escape civil liability if they can prove any of the following:

Withdrawal of Consent: They withdrew their consent to act as a director before the prospectus was issued, and it was issued without their authority or consent.
Issue without Knowledge: The prospectus was issued without their knowledge or consent, and on becoming aware of its issue, they gave reasonable public notice of that fact.
Belief in Truthfulness: They had reasonable grounds to believe, and did believe up to the time of allotment, that the statement was true. For an expert's statement, they had reasonable ground to believe that the expert was competent and had given their consent.

Criminal Liability (Section 34)

This section deals with the criminal consequences of issuing a prospectus with untrue statements. It states that where a prospectus includes any statement which is untrue or misleading in form or context, or where any inclusion or omission is likely to mislead, every person who authorises the issue of such prospectus shall be liable for fraud.

The punishment is prescribed under Section 447 of the Act, which deals with fraud. The punishment for fraud is:

Imprisonment: For a term which shall not be less than six months but which may extend to ten years.
Fine: An amount 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.

This section makes the issuance of a false prospectus a very serious criminal offence.

Punishment for Fraudulently Inducing Persons to Invest Money (Section 36)

This is a broader provision that covers all fraudulent inducements, not just those in a prospectus. It makes it an offence for any person to knowingly or recklessly make any statement, promise, or forecast which is false, deceptive, or misleading with the intention of inducing another person to enter into an agreement for acquiring or disposing of securities.

Any person who engages in such activity is also punishable for fraud under Section 447, with the same severe penalties of imprisonment and fine as mentioned above.

Allotment of Shares

Rules regarding Allotment (Section 39)

The allotment of shares is the formal process by which a company assigns a specific number of its newly created shares to applicants. This process is strictly regulated by Section 39 of the Companies Act, 2013, to protect the interests of the investing public. These rules ensure that the company has sufficient funds to carry out its stated objectives before it binds the applicants into a contract.

Minimum Subscription

Minimum Subscription is the minimum amount of capital that the company must receive from its public offering before it can proceed with the allotment of shares. This concept acts as a safety net for investors. It ensures that the company does not commence its business with inadequate funds, which could jeopardize the project for which the money was raised.

Purpose: The amount of minimum subscription is specified in the prospectus and is calculated to be sufficient to cover preliminary expenses, the purchase price of any property, working capital requirements, and other necessary expenditures.
SEBI Mandate: For public issues, the Securities and Exchange Board of India (SEBI) has stipulated that the minimum subscription to be received shall be 90% of the entire issue size. If the subscription is less than 90%, the issue is considered to have failed.

Allotment not to be made unless Minimum Subscription is Received

Section 39(1) of the Act places a clear prohibition on allotment without meeting the minimum subscription threshold. It states that no allotment of any securities offered to the public shall be made unless:

The amount stated in the prospectus as the minimum subscription has been subscribed; and
The sums payable on application for this amount have been paid to and received by the company.

Consequences of Non-Receipt: If the company does not receive the minimum subscription within the specified time, it cannot proceed with the allotment. In such a scenario, the company is legally obligated to refund all the application money received from the applicants without interest. However, if the refund is delayed beyond the prescribed period, the company and its defaulting officers become liable to repay the money with interest.

Time limit for Allotment

The law prescribes specific timelines for the entire process to ensure that investors' money is not locked up indefinitely.

Time to Receive Minimum Subscription: The company must receive the minimum subscription amount within thirty days from the date of the issue of the prospectus (or a shorter period as may be specified by SEBI).
Time to Refund Application Money: If the minimum subscription is not received within this 30-day period, the company must refund all application money within the next 15 days from the closure of the issue.
Penalty for Delayed Refund: If the company fails to refund the money within this 15-day period, the company and its officers in default shall be jointly and severally liable to repay that money with interest at the rate of 15% per annum for the period of delay.

Allotment through Electronic Mode

In the modern era, the allotment of shares, especially in public issues, is conducted almost exclusively through electronic mode. This system, known as dematerialization, involves holding and transferring securities in an electronic (digital) form instead of physical share certificates.

The key components of this system are:

Depositories: Organizations like the National Securities Depository Limited (NSDL) and the Central Depository Services (India) Limited (CDSL) hold securities in dematerialized form on behalf of investors.
Depository Participants (DPs): These are agents of the depositories (e.g., banks, stockbrokers) through which investors open and maintain their demat accounts.
Demat Account: An electronic account held by an investor to hold securities. Upon successful allotment, the shares are directly credited to the allottee's demat account.

Application Supported by Blocked Amount (ASBA)

A crucial mechanism for electronic allotment is ASBA. Under this process:

When an investor applies for shares, they authorize the bank to block the application money in their own bank account.
The money is not debited from the account but remains blocked. The investor continues to earn interest on this blocked amount.
Upon the finalization of the allotment, the bank debits the account only for the value of the shares allotted. The remaining amount, if any (in case of partial or no allotment), is simply unblocked.

This process has made allotments highly efficient, transparent, and has eliminated the delays and risks associated with refunding application money via cheques.

Allotment with Dual First Allottee

This refers to the concept of joint shareholding, where shares are allotted and registered in the names of two or more persons. The individuals holding the shares jointly are considered a single member for most legal purposes, but their rights and liabilities have specific nuances.

Joint and Several Liability: The liability of joint holders for any unpaid amount on the shares (calls) is joint and several. This means the company can demand the full amount from any one of the joint holders or from all of them collectively.
First Named Holder: The person whose name appears first in the Register of Members is known as the "first named holder" or "first allottee".
Communication: All official communications from the company, such as notices of meetings, annual reports, and dividend warrants, are sent to the registered address of the first-named holder.
Voting: At a meeting, the vote of the first-named holder who tenders a vote (whether in person or by proxy) is accepted to the exclusion of the votes of the other joint holders.
Transfer: A valid transfer of jointly held shares requires the signature of all the joint holders.

The Articles of Association of the company typically contain detailed provisions regarding the rights and procedures related to joint shareholding.

Consequences of Irregular Allotment

An irregular allotment is one that is made by a company in contravention of the statutory provisions laid down in Section 39 of the Companies Act, 2013. The most common grounds for an allotment being irregular are:

Allotting shares before receiving the minimum subscription.
Failing to refund the application money within the prescribed time when the minimum subscription is not received.
Failing to file a copy of the prospectus with the Registrar of Companies (RoC) before the issue.

Such an allotment is not void from the beginning but is voidable at the option of the allottee. This means the allottee has the right to either accept the shares or cancel the allotment.

Rights of the Allottee

An allottee in an irregular allotment has the right to rescind the contract. The conditions for this are:

The option to avoid the allotment must be exercised within two months after the holding of the statutory meeting of the company.
If the company is not required to hold a statutory meeting, the option must be exercised within two months of the date of allotment.
The allottee can avoid the allotment even if the company is in the process of being wound up.

Liability of Directors

Any director of the company who knowingly contravenes or permits the contravention of the provisions of Section 39 with respect to allotment shall be liable to compensate both the company and the allottee for any loss, damages, or costs they may have sustained. The legal action to recover such compensation must be initiated within two years from the date of the allotment.