Meaning and Definition of Prospectus

Section 2(70) of the Companies Act, 2013 defines a prospectus as,

“Prospectus” means 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 body corporate.

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 “to subscribe or purchase”;
4. The invitation must relate to any securities of the company.

Invitation to 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 any one 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.

However, an issue will not be “public” if, it is directed to a specified person or a group of persons.

When a company issues a prospectus, it does not amount to an “offer” in the eyes of law; rather, it is an invitation to offer.

How a Company can issue Prospectus :

Section 23 : Public offer and private placement :—

(1) A public company may issue securities—

(a) to public through prospectus (herein referred to as “public offer”) by complying with the provisions of this Part; or

(b) through private placement by complying with the provisions of this Act; or

(c) through a rights issue or a bonus issue in accordance with the provisions of this Act and in case of a listed company or a company which intends to get its securities listed also with the provisions of the Securities and Exchange Board of India Act, 1992 (15 of 1992) and the rules and regulations made thereunder.

(2) A private company may issue securities—

(a) by way of rights issue or bonus issue in accordance with the provisions of this Act; or

(b) through private placement by complying with the provisions of this Act.

Explanation.—For the purposes of this Chapter, “public offer” includes initial public offer or further public offer of securities to the public by a company, or an offer for sale of securities to the public by an existing shareholder, through issue of a prospectus.

Private Placement :

Section 42 of the Companies Act, 2013 provides that a company can make a private placement to a select group of persons. Private placement by companies means offering its securities or inviting to subscribe its securities for a select group of persons other than by way of a public issue through a private placement offer letter. Private placement of securities can be made only to select persons or identified persons (as identified by the board of the company). A company making a private placement cannot offer its securities through any public advertisements or utilise any marketing, media, or distribution agents or channels to inform the public about such an offer. If the offer is advertised or marketed, it will be considered a public offer and not a private placement by the company.

Private placement to be approved by special resolution.

Private placement under section 42 to be treated as public offer if conditions prescribed there under is not fulfilled.

There should be no public advertisements or utilise any media, marketing or distribution channels or agents to inform the public at large about such offer of private placement.

Deemed prospectus :-

Section 25 :- Document containing offer of securities for sale to be deemed prospectus :— Where a company allots or agrees to allot any securities of the company with a view to all or any of those securities being offered for sale to the public, any document by which the offer for sale to the public is made shall, for all purposes, be deemed to be a prospectus issued by the company; and all enactments and rules of law as to the contents of prospectus and as to liability in respect of mis-statements, in and omissions from, prospectus, or otherwise relating to prospectus, shall apply.

Shelf Prospectus :-

Section 31 is related to Shelf Prospectus. The concept of a shelf prospectus was introduced into Indian Company Law in 2000, by the amendment of the Companies Act, 1956.

As such companies often make repeated offers of securities in the same year, instead of filing a prospectus, they are required to file a shelf prospectus, which has a shelf life of one year.

For any changes, in-between, an information memorandum containing containing such changes is required to be filed. Thus there is less paper work.

As per section 31, any class or classes of companies, as the Securities and Exchange Board may provide by regulations in this behalf, may file a shelf prospectus with the Registrar at the stage of the first offer of securities included therein which shall indicate a period not exceeding one year as the period of validity of such prospectus which shall commence from the date of opening of the first offer of securities under that prospectus, and in respect of a second or subsequent offer of such securities issued during the period of validity of that prospectus, no further prospectus is required.

The advantage of a shelf prospectus is that the company filing such a prospectus is not required to file a prospectus every time it issues securities within a period of validity of such a prospectus.

Red-Herring Prospectus :-

A ‘red herring prospectus’ is an incomplete prospectus. It is one which does not contain complete particulars on (i) the exact price of the shares which are offered and (ii) the quantum of shares offered by the company.

Initial Public Offerings (IPOs) are well-known for attracting the interest of investors and creating a big buzz in the market. However, with so many IPOs being announced by different companies on a regular basis, identifying the right company to invest in can become a challenge. The company’s Red Herring Prospectus can help to assess their potential and understand what they are offering.

A red herring prospectus is a document filed by a company who wishes to raise money by issuing an IPO. This document provides all the useful information to the investors starting from the business model of the company to objective of raising funds.

This document includes information about the company’s financials, business operations, its standing in the industry it operates in and promoters.

What it does not include is details of the number or price of shares being offered, or the amount of issue.

As per section 32, A company proposing to make an offer of securities may issue a red herring prospectus prior to the issue of a prospectus and it shall file it with the Registrar at least three days prior to the opening of the subscription list and the offer.

A red herring prospectus shall carry the same obligations as are applicable to a prospectus and any variation between the red herring prospectus and a prospectus shall be highlighted as variations in the prospectus.

Upon the closing of the offer of securities under this section, the prospectus stating therein the total capital raised, whether by way of debt or share capital, and the closing price of the securities and any other details as are not included in the red herring prospectus shall be filed with the Registrar and the Securities and Exchange Board.

Abridged Prospectus :-

Section 2(1) : ― ”abridged prospectus” means a memorandum containing such salient features of a prospectus as may be specified by the Securities and Exchange Board by making regulations in this behalf.

(It is defined as the brief summary of the prospectus, which includes all useful and materialistic information filed before the registrar.) 

As per Section 33(1) of the Companies Act, 2013, an abridged prospectus must be included with the documents for the purchase of securities issued by a company.

It says, “No form of application for the purchase of any of the securities of a company shall be issued unless such form is accompanied by an abridged prospectus.”

Matters to be stated in Prospectus

In order to avoid frauds, the Act has made stringent provisions as regards the matters which must be set out in a prospectus and has provided deterrent punishments if such matters are not set out or set out in a false or misleading manner.

Section 26 lays down the matters which are required to be stated in a prospectus.

Section 26 (1) : 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.

It must give the information listed in Section 26(1)(a) of the Act which is listed below :

(i) 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;

(ii) dates of the opening and closing of the issue, and declaration about the issue of allotment letters and refunds within the prescribed time;

(iii) a statement by the Board of Directors about the separate bank account where all monies received out of the issue are to be transferred and disclosure of details of all monies including utilised and unutilised monies out of the previous issue in the prescribed manner;

(iv) details about underwriting of the issue;

(v) consent of the directors, auditors, bankers to the issue, expert‘s opinion, if any, and of such other persons, as may be prescribed; (vi) the authority for the issue and the details of the resolution passed therefor;

(vii) procedure and time schedule for allotment and issue of securities;

(viii) capital structure of the company in the prescribed manner;

(ix) main objects of public offer, terms of the present issue and such other particulars as may be prescribed;

(x) main objects and present business of the company and its location, schedule of implementation of the project;

(xi) particulars relating to—

(A) management perception of risk factors specific to the project;

(B) gestation period of the project;

(C) extent of progress made in the project;

(D) deadlines for completion of the project; and

(E) any litigation or legal action pending or taken by a Government Department or a statutory body during the last five years immediately preceding the year of the issue of prospectus against the promoter of the company;

(xii) minimum subscription, amount payable by way of premium, issue of shares otherwise than on cash;

(xiii) details of directors including their appointments and remuneration, and such particulars of the nature and extent of their interests in the company as may be prescribed; and

(xiv) disclosures in such manner as may be prescribed about sources of promoter‘s contribution;

Section 26(1)(b), sets out the following reports for the purposes of the financial information, namely :—

(i) reports by the auditors of the company with respect to its profits and losses and assets and liabilities and such other matters as may be prescribed;

(ii) reports relating to profits and losses for each of the five financial years immediately preceding the financial year of the issue of prospectus including such reports of its subsidiaries and in such manner as may be prescribed;

(iii) reports made in the prescribed manner by the auditors upon the profits and losses of the business of the company for each of the five financial years immediately preceding issue and assets and liabilities of its business on the last date to which the accounts of the business were made up, being a date not more than one hundred and eighty days before the issue of the prospectus;

(iv) reports about the business or transaction to which the proceeds of the securities are to be applied directly or indirectly.

Section 26(1)(c) : Make a declaration about the compliance of the provisions of this Act and a statement to the effect that nothing in the prospectus is contrary to the provisions of this Act, the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992, and the rules and regulations made thereunder

Section 26(1)(d) : State such other matters and set out such other reports, as may be prescribed.

* 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 its 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 duly authorised attorney.

* No prospectus shall be valid if it is issued more than ninety days after the date on which a copy thereof is delivered to the Registrar.

*The Registrar shall not register a prospectus unless the requirements of section 26 with respect to its registration are complied with and the prospectus is accompanied by the consent in writing of all the persons named in the prospectus.

* A prospectus issued under sub-section (1) shall not include a statement purporting to be made by an expert unless(except when) the expert is a person who is not, and has not been, engaged or interested in the formation or promotion or management, of the company and has given his written consent to the issue of the prospectus and has not withdrawn such consent before the delivery of a copy of the prospectus to the Registrar for registration and a statement to that effect shall be included in the prospectus.

* If a prospectus is issued in contravention of the provisions of this section, the company shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to three lakh rupees and every person who is knowingly a party to the issue of such prospectus shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than fifty thousand rupees but which may extend to three lakh rupees, or with both.

* Section 26(1) will not apply, to the issue to existing members or debenture-holders of a company, of a prospectus or form of application relating to shares in or debentures of the company

Section 27. Variation in terms of contract or objects in prospectus :—

(1) A company shall not, at any time, vary the terms of a contract referred to in the prospectus or objects for which the prospectus was issued, except subject to the approval of, or except subject to an authority given by the company in general meeting by way of special resolution

Provided that the details, as may be prescribed, of the notice in respect of such resolution to shareholders, shall also be published in the newspapers (one in English and one in vernacular language) in the city where the registered office of the company is situated indicating clearly the justification for such variation

Dissenting shareholders to variation of terms are to be given exit option :

Section 27(2) : The dissenting shareholders being those 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 exit price, and in such manner and conditions as may be specified by the Securities and Exchange Board by making regulations in this behalf.

Offer of sale of shares by certain members of company :—

Sec 28(1) Where certain members of a company propose, in consultation with the Board of Directors to offer, in accordance with the provisions of any law for the time being in force, whole or part of their holding of shares to the public, they may do so in accordance with such procedure as may be prescribed.

Sec 28(2) Any document by which the offer of sale to the public is made shall, for all purposes, be deemed to be a prospectus issued by the company and all laws and rules made thereunder as to the contents of the prospectus and as to liability in respect of mis-statements in and omission from prospectus or otherwise relating to prospectus shall apply as if this is a prospectus issued by the company.

Advertisement of prospectus :—

Sec 30 : 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

The Golden Rule Or Golden Legacy

It is the duty of those who issue the prospectus to be truthful in all respects. This golden rule was enunciated by Justice Kindersley in New Brunswick & Canada Rly. & Land Co. v. Muggeridge (1860) and has come to be known as the “golden legacy”. 

According to the ‘Golden Rule’ the followings must be kept in mind when preparing the prospectus of a company:

1.The prospectus must be an honest statement of the company’s profile; there must be no misleading, ambiguous or erroneous reference to the company in its prospectus.

2.Every important aspect of a contract of the company should be clarified.

3.The contents of the prospectus should conform to the provision of the Companies Act.

4.The restrictions on the appointment of directors must be kept in mind.

5.The conditions of civil liability as laid down must have strictly adhered to issue and registration of prospectus or legal requirement regarding the issue of the prospectus.

Briefly the rule is : Those who issue a prospectus hold out to the public great advantages which will accrue to the persons who will take shares in the proposed undertaking. Public is invited to take shares on the faith of the representation contained in the prospectus. The public is at the mercy of company promoters. Everything must, therefore, be stated with strict and scrupulous(careful) accuracy. Nothing should be stated as fact which is not so and no fact should be omitted the existence of which might in any degree affect the nature or quality of the principles and advantages which the prospectus holds out as inducement to take shares. In a word, the true nature of the company’s venture should be disclosed.

Liability for Untrue Statement in Prospectus :-

It is now clear that a prospectus must be complete and perfect in all details or in other words nothing should be omitted and nothing should be untrue in a prospectus.

Where an untrue statement occurs in a prospectus, there may arise (i) civil liability (ii) criminal liability. Every person who is a director of the company at the time of the issue of the prossspectus, every promotor of the company and every person, including an expert, who has authorised the issue of a prospectus, shall be liable.

What is an Untrue Statement ? : The law prescribes a wider meaning to this term. Whether a statement is untrue or not is to be judged by the context in which it appears and the totality of impression it would create.

Further, where any inclusion or omission of any matter in a prospectus is likely to mislead, the prospectus shall be deemed, in respect of such omission, to be a prospectus in which an untrue statement is included.

An investor who has purchased shares of a company relying on the misstatements contained in a prospectus has several remedies. The consequences of not making a true and full disclosure in the prospectus as required by the law can be serious and may be summed up as under:

1. Damages under the law of torts for deceit.

2. Rescission of the contract under the law of contracts

3. Fine payable under sec 26 of the Act.

4. Civil liability for compensation under sec 35 of the Act.

5. Criminal liability under Sec 34 and 36 of the Act.