COMPANY LAW UNIT - 3 LESSON 1 PROSPECTUS

 

UNIVERSITY OF DELHI / SCHOOL OF OPEN LEARNING 

B. Com. (Program) / B. Com. (Hons.)

COMPANY  LAW 

N.O.T.E.S 

UNIT - 3

LESSON 1
PROSPECTUS

INTRODUCTION

Public Company:

1. Required to raise capital after obtaining the Certificate of Incorporation.

2. Can raise funds through public issues, private placement, or rights/bonus issues.

3. If raising funds from the general public, a prospectus must be issued.

4. If confident of raising capital privately from friends or relatives, a statement instead of a prospectus is filed with the Registrar.

Private Company:

1. Restricted from raising funds from the general public.

2. Can arrange funds through private placement (friends and relatives) or rights/bonus issues.

3. Prohibited from issuing a prospectus.

4. Not required to file a statement instead of a prospectus.

DEFINITION OF PROSPECTUS

- A prospectus is an invitation to the public to subscribe to a company's securities.

- It includes any document that invites deposits from the public.

- Conditions for a document to be called a prospectus: issued on behalf of a public company and invites deposits or subscriptions from the public.

Purpose of Prospectus:

- Informs the public and investors about the company's available securities (stocks, bonds, mutual funds, etc.).

- Accompanied by financial information and relevant facts to inform about the company's prospects and capital requirements.

- Aims to arouse investor interest and encourage subscriptions to the company's shares and debentures.

What Constitutes an Offer to the Public:

- Sending a prospectus marked "not for publication" to friends, relatives, or customers is not considered an offer to the public.

- The provisions of the Act regarding prospectus are not applicable unless it is issued to the public.

- An invitation to subscribe to the public refers to any selected section of the public, not the public at large.

- Private communication of the prospectus to friends and relatives does not constitute an offer to the public.

Case Examples:

- Nash vs. Lynde (1929) A.C. 158: Document circulated within a small circle of friends and relatives, not treated as a prospectus.

- Re South of England Natural Gas and Petroleum Co. Ltd. (1911): Distribution of prospectus among certain gas company members considered an offer to the public because it could be accepted by persons beyond the recipients.

OBJECTS OF A PROSPECTUS

1. Invitation: Acts as an invitation to the general public to subscribe to a company's shares, debentures, or deposits.

2. Advertisement: This serves as a medium of advertisement by providing information about the company's current operations and future prospects.

3. Authentic Record: Acts as an authentic record of the terms and conditions of the issuance and allotment of shares or debentures.

4. Protection: Protects investors' interests by holding the company directors responsible for the statements made in the prospectus. Any misstatement in the prospectus can result in criminal and civil liability for those authorizing the prospectus.

TYPES OF PROSPECTUSES

1. Abridged Prospectus:

- A summary of the prospectus containing relevant facts presented concisely.

- Serves the purpose of providing quick and relevant information to facilitate decision-making.

- Exemptions from issuing a prospectus or abridged prospectus apply in specific cases.

2. Shelf Prospectus:

- Allows companies to offer securities to the public without a separate prospectus for each issue of the same class.

- Reduces the burden on companies by providing a valid prospectus for a certain period (usually one year).

- Companies may file an Information Memorandum for any changes during the validity period.

3. Deemed Prospectus:

- A document inviting the public to subscribe to securities when a company allows or agrees to allow them to an intermediary (Issuing House) for sale.

- Treated as a prospectus issued by the company, subject to the rules regarding contents and liability for misstatements.

4. Red Herring Prospectus:

- A preliminary prospectus submitted by a company about a public offering.

- Contains most details about the company's operations and prospects but lacks information on securities' price and quantum.

- Subject to the same obligations as a prospectus, with any variations between the red herring prospectus and the final prospectus highlighted.

CONTENTS OF PROSPECTUS

I. Background:

- Section 26 of the Companies Act ensures full disclosure of essential and relevant information in prospectuses.

- The Companies (Amendment) Act, 2017 amended Section 26, requiring prospectuses to provide specified financial information determined by SEBI in consultation with the Central Government.

II. Contents of Prospectus:

- Every prospectus issued by a company or any person engaged or interested in company formation must be dated and signed.

- The prospectus must contain the following:

  1. Part I of Schedule II: Matters specified in Part I, subject to provisions in Part III.

  2. Part II of Schedule II: Reports specified in Part II.

III. Part I of Schedule II:

The prospectus must include the following particulars:

1. Main Objects: Description of the company's main objects and details of the signatories to the Memorandum of Association.

2. Shareholder Interests: Number and classes of shares, shareholders' interests in the company's property, and profits.

3. Redeemable Preference Shares: Details of any redeemable preference shares intended to be issued.

4. Director Qualification: The number of shares required as director qualification per the Articles of Association.

5. Directors' Details: Names, addresses, descriptions, and occupations of directors, managing directors, or managers.

6. Remuneration and Compensation: Provisions in the articles or contracts regarding the appointment, remuneration, and compensation for loss of office of directors, managing director, or manager.

7. Minimum Subscription: Amount of minimum subscription required.

8. Opening of Subscription: Date for opening the subscription list, not earlier than the fifth day after the prospectus publication.

9. Amount Payable: Amount payable on application and allotment per share, with details of any previous allotments within the last two years.

10. Options or Preferential Rights: Particulars of any option or preferential rights to subscribe for shares or debentures.

11. Fully or Partly Paid Shares: Number, description, and amount of shares and debentures issued or agreed to be issued as fully or partly paid up in the last two years.

12. Premium on Shares: Amount of premium, if any, paid or payable on shares issued or to be issued within two years preceding the prospectus.

13. Underwriters: Names of underwriters of shares or debentures, if any, and directors' opinions on their sufficient resources to fulfill obligations.

14. Vendors: Names, addresses, descriptions, and occupations of vendors from whom the property has been or will be purchased, with details of payment made.

15. Underwriting Commission: Amount of underwriting commission paid or payable within the last two years.

16. Benefits to Promoters: Details of any benefits given to promoters or officers within the preceding two years and the consideration for such benefits.

17. Contracts: Particulars of contracts appointing or fixing the remuneration of managing directors or managers, and material contracts not in the ordinary course of business.

18. Auditors: Names and addresses of the company's auditors.

19. Promoters' Interest: Full particulars of directors' or promoters' interests in the promotion of the company or property acquired within two years.

20. Share Classes: Rights of voting, capital, and dividends attached to different classes of shares, if applicable.

21. Restrictions: Restrictions imposed on members or directors by the articles regarding attendance, speaking, voting, transfer of shares, or directors' powers of management.

22. Business Duration: Length of time the company has carried on the business, or if acquiring a business, the duration of its operation.

23. Capitalization: Capitalization of reserves or profits, with particulars of any revaluation of company assets

24. If any reserves or profits of the company or any of its subsidiaries have been capitalized, the prospectus should include particulars of the capitalization and details of any surplus arising from the revaluation of the company's assets.

25. The prospectus should provide information on a reasonable time and place where copies of all balance sheets and profit and loss accounts, if any, on which the auditors' report under Part II is based, can be inspected.

Part II of Schedule II:

I. General Information:

1. Names and addresses of the Company Secretary, Legal Adviser, Lead Managers, Co-managers, Auditors, Bankers to the company, Bankers to the issue, and Brokers to the issue.

2. Consent of Directors, Auditors, Solicitors/Advocates, Managers to issue, Registrar of Issue, Bankers to the company, Bankers to the issue, and Experts.

3. Expert's opinion obtained, if any.

4. Changes, if any, in directors and auditors during the last 3 years, along with reasons for such changes.

5. Authority for the issue and details of resolutions passed for the issue.

6. Procedure and time schedule for allotment and issuance of certificates.

II. Financial Information:

1. Report by the Auditors:

   - A report by the auditors of the company regarding profits, losses, assets, and liabilities of the company.

   - Rates of dividend, if paid by the company during the last five financial years.

   - If accounts have not been prepared for any part of the 5 years before the issue of the prospectus, the report should cover either the combined profits, losses, assets, and liabilities of the company's subsidiaries or each subsidiary individually.

2. Reports by the Accountants:

   - A report by the accountants on the profits or losses of the business for the preceding 5 financial years and on the assets and liabilities of the business as of a date not more than 120 days before the date of the prospectus.

   - A similar report on the accounts of a body corporate if the proceeds of the issue will be used to purchase shares of that body corporate, making it a subsidiary of the acquiring company.

   - Principal terms of loans and assets charged as security against the loan.

3. Statutory and Other Information:

   - Statutory and other information, including minimum subscription, underwriting commission, and brokerage.

   - Dates of allotment, closing, and refund.

   - Option to subscribe, material contracts, and provisions for inspection of documents.

These requirements ensure that the prospectus contains comprehensive information about the company, its financial position, and relevant details for potential investors.

Part III of Schedule II includes provisions that apply to Parts I and II of the schedule. The summary of the provisions is as follows:

A. Deemed Vendor:

- Any person who has entered into a contract, whether absolute or conditional, for the sale or purchase of any property that the company intends to acquire is considered a vendor.

- This applies in cases where:

  - The purchase money is not paid in full at the date of the prospectus.

  - The purchase money is to be paid, either wholly or partially, from the proceeds of the subscription in the prospectus.

  - The validity or fulfillment of the contract depends on the result of the subscription.

B. Calculation of Financial Years:

- For companies that have been in business for less than five financial years, the reference to five financial years is adjusted to the number of financial years the business has been carried on.

C. Inspection of Documents:

- The prospectus should specify a reasonable time and place where interested parties can inspect copies of all balance sheets, profit and loss accounts, material contracts, and other relevant documents on which the auditors' report is based.

Declaration:

- The prospectus must include a declaration stating that all relevant provisions of the Companies Act, 2013, and guidelines issued by the government have been duly complied with.

- It should also state that no statement made in the prospectus contradicts the provisions of the Companies Act, 2013, the Securities Contracts (Regulations) Act, 1956, the SEBI Act, 1992, and the rules under these acts.

These provisions ensure that vendors, financial years, and inspection of documents are appropriately addressed and that compliance with relevant laws and regulations is affirmed in the prospectus.

IN-TEXT QUESTIONS

1. A prospectus means any invitation issued to the public inviting it to deposit money with the company or to take shares or debentures of the company. True/False

2. Section 55 states that every prospectus must be dated, and that date is deemed to be the date of publication of the prospectus. True/False.

ANSWER:

1. True

2. False

STATUTORY REQUIREMENTS REGARDING THE ISSUE OF A PROSPECTUS

1. Dating of Prospectus:

- A prospectus must be dated, and the date is considered the date of publication.

2. Registration of Prospectus:

- A copy of the prospectus must be delivered to the Registrar for registration before it is issued to the public.

- The copy must be signed by the directors or proposed directors mentioned in the prospectus.

- Relevant documents, such as expert reports and material contracts, must be filed along with the prospectus.

- The prospectus must be issued within 90 days of delivery to the Registrar to be valid.

3. Expert to be Unconnected with the Formation of the Company:

- Statements by experts, such as engineers or accountants, can only be included in the prospectus if the expert is not involved in the company's formation or promotion.

- Written consent from the expert is required and should not be withdrawn before registration.

4. Variation in Objects Given in the Prospectus or Terms of Contracts:

- Changes in the terms of contracts or objects stated in the prospectus can be made through a special resolution in a general meeting.

- A notice of the resolution must be sent to shareholders and published in newspapers.

5. Prohibition of Allotment of Shares in Fictitious Names:

- Companies must prominently display provisions and consequences of applying for shares in fictitious names in the prospectus and application forms.

- Making such applications is punishable under Section 447 with imprisonment and a fine.

6. Issue of Securities Only in Dematerialized Form:

- Companies making a public offer are required to issue securities only in dematerialized form, complying with the provisions of the Depositories Act, 1996.

- Unlisted public limited companies are mandated to hold shares only in electronic form, and existing physical shares must be dematerialized.

EASIER WAY TO REMEMBER

1. A prospectus is like an invitation sent by a company to the public, asking them if they want to buy some special papers called "securities" (like shares) in that company.

2. The company has to follow some important rules when making this invitation:

   a. They need to write the date on the invitation, so everyone knows when it was sent.

   b. They must show the invitation to a special person called the "Registrar" before sending it to people.

   c. They have to include some important papers with the invitation, like reports and contracts.

   d. The invitation must be given to the public within 90 days after showing it to the "Registrar."

3. If the company wants to use some information from an expert, they have to ask that person first and get their permission.

4. If the company wants to change some things that they said in the invitation, they have to ask all the people who are part of the company for permission and tell them about the changes.

5. The company cannot let anyone buy their special papers using fake names or pretend names. They have to tell everyone that it's not allowed, and if someone still does it, they can get in big trouble.

6. When the company gives special papers to people, they have to do it electronically, which means using computers. They can't give paper copies anymore because it's better to use computers.

So, a prospectus is like a friendly letter from a company, but they have to follow these special rules to make sure everything is fair and safe for everyone involved.

MIS-STATEMENTS IN A PROSPECTUS

1. Purpose of a Prospectus:

   - A prospectus serves as an invitation to the public to subscribe to a company's securities, such as shares or debentures.

   - The prospectus should provide accurate and comprehensive information about the company to enable potential investors to make informed decisions.

2. Misstatements and Misleading Information:

   - The prospectus must not contain any fraudulent or misleading statements that could deceive the public.

   - It should not omit relevant facts that might affect an investor's decision to subscribe to the securities.

   - Misstatements include both false statements that create a false impression and the intentional concealment of material facts.

3. Civil Liability:

   - Investors have legal remedies against the company, directors, promoters, and experts if they suffer losses due to misleading prospectus information.

   - Rescission of the contract: An investor can apply to the court to have the contract rescinded if the prospectus contains false statements or misrepresentations. Rescission essentially voids the contract, and the investor can recover their investment.

   - Claiming damages: Investors may seek compensation for the losses or damages they incurred as a result of investing based on the misleading prospectus. To succeed, they need to prove that the company, directors, promoters, or experts acted fraudulently or caused the loss.

4. Remedies against Directors, Promoters, and Experts:

   - Directors, promoters, and experts involved in preparing or authorizing the prospectus can also be held liable for their actions.

   - Compensation for untrue statements: If the prospectus contains false statements, these individuals can be required to pay compensation to investors who suffered losses as a result.

   - Damages for omissions: If the prospectus fails to include material information, investors can claim damages for the harm caused by the omission.

   - Fraudulent misrepresentation: If any fraudulent statements were made by these individuals, investors can sue them and the company for damages.

5. Defence against Civil Liability:

   - Directors, promoters, etc., may avoid liability if they can prove certain defenses:

     - Withdrawing consent before the issue of the prospectus and giving public notice of the withdrawal.

     - Showing a lack of knowledge or consent regarding the prospectus and giving public notice upon becoming aware of its issuance.

     - Demonstrating a reasonable belief in the truth of the statements made in the prospectus.

     - Using a correct and fair representation or copy of an expert's report or an official document, without being aware of any misleading information.

6. Criminal Liability:

   - Issuing a prospectus without proper registration with the relevant authorities can lead to criminal penalties, including fines and imprisonment.

   - Applying for shares using fictitious names or engaging in fraudulent activities related to the prospectus can also result in criminal charges and penalties.

CRIMINAL LIABILITY

1. Criminal Liability:

   - Criminal liability involves punishment through jail terms, penalties, or both.

   - Only promoters and directors can be held criminally liable for misstatements in the prospectus.

   - A company itself cannot be held criminally liable.

2. Liability for Untrue Statement (Section 34):

   - If a prospectus contains misleading or untrue statements, or if the inclusion or omission of any matter is likely to mislead, the person authorizing the issue of the prospectus is liable for fraud under Section 447 and Section 37.

3. Penalty for Fraudulently Inducing Persons to Invest Money (Section 36):

   - Any person knowingly or recklessly making false, deceptive, or misleading statements, promises, or forecasts, or dishonestly concealing material facts, to induce another person to enter into agreements related to shares, debentures, or obtaining credit facilities, is liable for fraud under Section 447 and Section 37.

4. Issue and Allotment of Shares in Fictitious Names (Section 38):

   - Engaging in activities such as applying under fictitious names, making multiple applications in different names, or inducing a company to allot or transfer securities in a fictitious name is liable for action under Section 447.

5. Penalty for Failure to Issue Abridged Prospectus with Share Application Form (Section 33):

   - A company must accompany any form of application for shares or debentures with an abridged prospectus.

   - Failure to comply with this provision may result in a fine of Rs. 50,000 for each default.

BOOK BUILDING

1. Book Building:

   - Book building is an alternative to public issuance where applications are accepted from financial institutions, firms, or high-net-worth individuals.

   - The process of book building is facilitated by the provisions for Red Herring Prospectus under the Companies Act, 2013.

   - It involves the issuance of a draft red herring prospectus initially, followed by the issuance of the final red herring prospectus three days before the offer opens.

   - The issue price of securities is determined based on bids received during the bid period, ranging from a floor price to 120% of the floor price.

   - Book building allows interested investors to place bids for securities at different prices, with the price and quantity with the highest demand ultimately selected.

2. Purpose of Book Building:

   - Companies in need of funds can raise money by selling securities to the public through book building.

   - The offer price is determined based on bids received, making it more realistic compared to fixed prices in public issues.

   - The book is built by the appointed Book Runner Lead, who records daily demand until the bid closing date.

3. Parties Involved:

   - The main parties directly involved in the book-building process are the issuer company, the Book Runner Lead Manager, and the Syndicate Members.

   - The Book Runner Lead Manager is appointed by the issuer company and oversees the book-building process.

   - Syndicate Members, such as stockbrokers, mutual funds, and merchant banks, link investors with the company.

4. Types of Book Building:

   - 100% Book Building: The entire issue is made through book building, without any offer to the public.

   - 75% Book Building: 75% of the issue is made through the placement portion, while the remaining 25% is offered to the public.

5. Steps in the Book Building Process:

   1. Appointment of Book Runner: The issuer company appoints a lead merchant banker as the Book Runner.

   2. Draft Prospectus: A Draft Red Herring Prospectus is prepared, containing all details except the price and size of securities, to gauge perception and demand.

   3. Red Herring Prospectus: A Red Herring Prospectus is prepared, disclosing all information except the price and quantum of securities, indicating a price range.

   4. Filing the Red Herring Prospectus: The Red Herring Prospectus is filed with SEBI and the Registrar of Companies at least three days before the offer opens.

   5. Appointment of Syndicate Members: Syndicate Members are appointed to facilitate investor-company connections.

   6. Circulation: The draft prospectus is circulated among institutional investors and Syndicate Members.

   7. Building an Order Book: Syndicate Members gather demand from various investors, recording the number of shares and prices in an order book.

   8. Determination of Issue Price: The Book Runner and the company determine the issue price based on the bids received, known as the "Market Clearing Price."

   9. Allocation: Bidders are allocated securities based on the final price, with Qualified Institutional Buyers having restrictions on bid withdrawal.

   10. Final Prospectus: The company files the final prospectus with the Registrar of Companies within two days of determining the issue price.

   11. Listing of Securities: Companies must list their shares on exchanges within 12 days after the closing of the public issue, as mandated by SEBI.

Here is a summary of the advantages and disadvantages of the book-building process:

Advantages of Book Building Process:

1. Cost Reduction: Limited number of investors results in reduced costs associated with the issue.

2. Risk Mitigation: Underwriting the issue helps in minimizing the risk of failure.

3. Intrinsic Worth Evaluation: Book building facilitates the assessment of the true intrinsic worth of the securities.

4. Realistic Issue Price: The issue price is determined based on the floor price, providing a more realistic valuation of the securities.

Disadvantages of Book Building Process:

1. Suitability for Big Issues: The book-building process is more suitable for large-scale issues.

2. Requirement of Organized Stock Exchanges: Well-organized stock exchanges are necessary to support the book-building process effectively.

3. Investor Familiarity: The issuer company needs to have a good reputation and be well-known to investors to attract participation in the book-building process.