Company Law Final-converted.pdf

JAMIA MILLIA ISLAMIA

COMPANY LAW ASSIGNMENT

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA

PROJECT - PROFILE “STATEMENT IN LEU OF PROSPECTUS & REMEDIES FOR MISREPRESENTATION & PROSPECTUS”

Submitted to-

Submitted by-

Dr. Qazi Mohammad Usman

Azeem Mian

Associate Professor

B.A.LL.B (Hons) Regular

JMI

3rd year, VIth Semester

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA

ACKNOWLEDGEMENT I take this opportunity to express my profound gratitude and deep regards to my teacher Mr. Dr. Qazi Mohammad Usman sir for his exemplary guidance, monitoring and constant encouragement throughout the course of this assignment. The blessing, help and guidance given by his time to time shall carry me a long way in the journey of life on which I am about to embark. I also take this opportunity to express a deep sense of gratitude to my friends for cordial support, valuable information and guidance, which helped me in completing this task through exhaustive research.

AZEEM MIAN! COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA

SYNOPSIS ❖ ❖ ❖ ❖

Definition of Prospectus [Section 2 (70)] Prospectus must be “Issued to the Public” When Prospectus need not be Issued Documents containing offer of securities for sale to be deemed as prospectus [Section 25] ❖ Registration of Prospectus [Section 27 (7)] ❖ Contents of Prospectus ❖ Voluntary Statements in Prospectus ❖ Issuing Houses and Deemed Prospectus [Section 25] ❖ Restriction on Variation of terms in Prospectus [Section 27] ❖ Liability for Omission or Fraudulent Mis-statement in Prospectus • Omission • Fraudulent Mis-statements ❖ Who can be sued? ❖ Remedies against Mis-representation in Prospectus ❖ Civil Liability [Section 35] ❖ Defences to Civil Liability [Section 35 (2)] ❖ Defences Available to an Expert [Section 35 (2)] ❖ Right of Directors and Expert to Indemnity [Section 35 (2)] ❖ False representation distinguished from mis-statement ❖ Limitations on Right to rescind for fraud or Misrepresentation COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA

❖ Criminal Liability for Misrepresentation [Section 34] ❖ Who is entitled to remedies? ❖ Penalty for fraudulent Inducing to Invest Money [Section 36] ❖ Allotment of shares in Fictitious Name [Section 38] ❖ Initial offer of securities to be in dematerialized form [Section 29] ❖ Restriction on Inviting Deposits [Section 73] ❖ Default in acceptance or refund of Deposits to be Cognizable offence ❖ Prospectus of Foreign Companies [Section 387]

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA INTRODUCTION Where a company intends to issue a public appeal for subscription of its shares or debentures, it is essential for it to issue a prospectus. Section 25 of the companies Act, 2013 requires that no application for shares or debentures of a company can be invited unless the appeal is accompanies with a prospectus. A public company may issue securities to public through public offer which is referred to as prospectus.1 A private company may issue securities by way of rights issue or bonus issue to the existing share-holders, through issue of prospectus.2

DEFINITION OF PROSPECTUS [Section 2 (70)] As defined in Section 2 (70) of the Companies Act, 2013, 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 a body corporate. A shelf prospectus means a prospectus in respect of which the securities or class of securities included therein are issued for subscription in one or more issues over a certain period without issue of a further prospectus.3 A red-herring prospectus means a prospectus which does not include complete particulars of the quantum or price of the securities included therein. The essential ingredients of a prospectus are: (i) (ii) (iii) (iv)

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”; and The invitation may relate to shares or debentures.

In Pramatha Nath Sanyal v. Kali Kumar Dutt, the company inserted an advertisement in a newspaper stating, “Some shares are still available for sale according to the terms of the prospectus of the company which can be obtained on application.” It was held that the advertisement constituted a prospectus as it invited the public to purchase shares. The directors were, therefore, penalized for not complying with the requirements a copy thereof with the Registrar of Companies under Section 27 (9) of the Companies Act, 2013.

1

Section 23 (1) of Companies Act, 2013 Section 23 (2). 3 Section 31 Explanation . 2

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA PROSPECTUS MUST BE “ISSUED TO THE PUBLIC” The prospectus of a company may be said to be an advertisement through which the company invites public to purchase its shares or debentures. The forms for purchase of shares or debentures cannot be issued by the company unless an advertisement in the form of prospectus is issued and published in the newspapers. In view of the high cost incurring on the advertisement of detailed prospectus, the concept of ‘abridged prospectus’ was introduced in the company law by the companies (Amendment) Act, 1988 in which only broad features of the prospectus were required to be stated in brief.4 A document to be a prospectus, must be “issued to the public” and the provisions of the Act are not attracted unless the prospectus is issued to the public. The facts of the case Nash v. Lynde,5 make this point further clear. In this case, several copies of a document marked “Strictly Confidential” and containing particulars of a proposed issued of shares, were sent accompanied by application form by the managing directors 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 directors. The House of Lords ruled that there had been no issue to the public and therefore, no action for compensation of loss caused to the allottees would sustain. Again, in Government stock & others Securities Investment Co. Ltd v. Chistopher,6 a circular was issued by the company to the shareholders of other companies to acquire their shares in those companies and issue its own shares in exchange of those shares. Held, it did not amount to a prospectus as there was no public issue in this case. The court ruled that the shares in questions were unissued shares of new company so they could not be a subject of an offer for purchase. Therefore the circular was not prospectus but only a communication for exchange of shares. The word “public” means public at large i.e. any section of the public. It need not be necessarily made to the public as a whole. Thus, a document inviting all the advocates, or all the doctors or all foreigners living in India etc. shall be deemed to have been issued to the public as each of these categories of persons constitute a segment of the public. In Re South of England Natural Gas & Petroleum Co. Ltd.,7 three thousand copies of a document in the form of a prospectus were sent out and distributed among the members of certain gas companies only. It was held that it was a prospectus issued to the public. Section 42 of the Companies Act, 2013 makes it clear that the term ‘public’ includes any section of public whether selected as members or debenture holders of the company concerned. However, issue shall not be deemed to be “public” if (a) it is directed to a specified person, or (b) it is not calculated to result in the shares or debentures becoming available to others persons. Thus, if a private company after increasing its share capital allots new shares declined by nits members, ‘Abridged prospectus’ means a memorandum containing such features of a prospectus as may be specified by Securities & Exchanged Board (SEBI) by making regulations in this behalf [Section 2 (1)]. 5 1929 AC 158 6 (1956) 1 WLR 237 7 (1911) 1 CH 573. 4

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA to persons approved by the directors, the offer so made shall not be regarded as one made to the public.

WHEN PROPSECTUS NEED NOT BE ISSUED The issue of prospectus under Section 26 of the Companies Act, 2013 is not necessary in the following circumstances even though the shares are offered and application forms issued to public by the company: (1) Where a person is a bona fide invitee to enter into an underwriting agreement with regard to shares or debentures. (2) Where shares or debentures are not offered to the public, (3) Where the shares or debentures offered are in all respects uniform with shares or debentures already issued and quoted at a recognised Stock Exchange, (4) Where the shares or debentures are offered to the existing holders of shares or debentures respectively, (5) Where a prospectus is published as a newspaper advertisement, it is not necessary to specify the contents of the memorandum, or the names etc. of the signatories to the memorandum or the number of shares subscribed for by them.8 DOCUMENTS CONTAINING OFFER OF SECURITIES FOR SALE TO BE DEEMED AS PROSPECTUS [SECTION 25] Where a company allots or agrees to allot any securities of the company by offering for sale to the public, any document by which 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 rule of law as to the contents of prospectus and as to liability in respect of misstatements, in and omission from, prospectus, or otherwise relating to prospectus, shall apply with modification as specified in the sub-sections (3) and (4) and shall have effect accordingly, as if the securities had been offered to the public for subscription. Lord Kindersley in New Burnswick Co. v. Muggeriege,9 observed, “Prospectus is one of the means by which the investor is informed about the soundness of the company’s venture.” That being the basic purpose of the prospectus, law through a comprehensive set of regulations seeks to protect the investor by ensuring that the fullest disclosures of all material facts and essential particulars are made by the company in its prospectus so that the public can assess its credibility and financial soundness. The matters as specified in Schedule II, Part I and the Reports stated in Part II of the Companies Act are to be stated in the prospectus.

8 9

Section 30 of the Companies Act, 2013 (1860) 3 LT 651

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA Every prospectus must be dated.10 This provides prima facie evidences of the date of its publications. The date on the prospectus shall, unless contrary is proved, be taken as the date of publication of prospectus. A copy of prospectus has to be filed with the registrar of Companies before its publications. The copy sent for registration must be signed by every persons who is named as director or proposed director of the company or by his agent authorized in writing. Where the prospectus is issued in one or more language, a copy of it as issued in each language should be delivered to the registrar.11

REGISTRATION OF PROSPECTUS [SECTION 27 (7)] Sub-section (7) of Section 27 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 authorized in writing. It must accompany the following documents: (a) The consent of the expert, if his report is to be published in the prospectus; (b) A copy of every contract relating to the appointment or remuneration of managerial personnel; (c) 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; (d) A written statement relating to the adjustment, if any, named in the prospectus as auditor, legal advisor, attorney, solicitor, issue House banker or broker of the company to act in that capacity; (e) The consent of director in respect of new directors, if any, named therein; (f) 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,12 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 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 10

Section 26 (1). Emperor v. Bengal Salt Co., air 1936 Cal 33. 12 Section 26 (8) of the Companies Act, 2013 11

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA be one who 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 cast a statutory duty upon the company to disclose matters specified in Part I of the chapter III and for private placement, compliance with the provision of Part II of the 2013 Act id required. ‘Private placement’ means any offer of securities or invitation to subscribe securities to select of persons by a company (other than by way of public offer) through issue of a private placement offer letter and which satisfied the conditions specified in the respective clause. Other matters to be stated in the prospectus are as follows; (1) The 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.13 (2) The number and classes of shares and the interest of the share-holders 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. (3) Names, addresses, descriptions and occupations of the directors. The qualification shares, if any, held by the directors and terms of their appointment, remuneration and compensation for loss of office etc. (4) Where shares are offered to the public, the 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. (5) The time of the opening of the subscription list. (6) The 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. (7) Particulars of any options to subscribe for shares or debentures, including the time for exercise or option, the price to be paid and the consideration given for the option, and the persons entitled to the option. (8) 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 a premium. (9) The names of underwriters, if any, and the opinion of the directors that the resources of the underwriters are sufficient to discharge their obligations. (10) 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. (11) The amount or rate of underwriting commission. (12) The amount or estimate of preliminary expenses and the expenses of the issue, by whom paid or payable.

13

Section 30 of companies Act, 2013

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA (13) The amount paid or benefit given within two preceding years to the promoters of the company. (14) 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 inn ordinary course of business or more two previous years. (15) The names and addresses of the auditors of the company, if any. (16) Particulars as to interest of every director or promoter in the promotion or property of the company within two years of date of prospectus. (17) 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. (18) The restrictions, if any, imposed by the articles upon the members in respect of their right to participate at company meeting and to transfer shares or upon the directors in respect of their powers of management. (19) In case of existing companies, the 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. (20) If any reserves or profits of the company or any of its subsidiaries have been capitalized, particulars of capitalization and surplus arising from e-valuation of the assets of the company. (21) A reasonable time and place at which copies of all accounts on which the report of thy auditor is based, may be inspected. In addition to the matters stated above, the following Reports14 must also be set out in the prospectus: (1) A report by the auditor of the company 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 then auditors must also state separately the profits and losses of the company’s subsidiaries and also combined profits and losses. (2) 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. (3) Reports about the business and translation to which the proceeds of the securities are to be applied directly or indirectly.

14

Section 26 (1)(b)

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA VOLUNTARY STATEMENTS IN PROSPECTUS In addition to the compulsory particulars stated above, any other information is usually considered voluntary, such an 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. 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 true nature of its ventures. This is known as the ‘Golden Rule’15 as to the framing of prospectus and described as ‘golden legacy’ by Pagewood in Henderson v. Lacon.16 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 the companies usually allot 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. But now every such advertisement sponsored by an ‘Issuing House’ is known as an ‘offer for sale of securities’ and deemed to be prospectus,17 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. The intention of the company in making the allotment 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 tom the shares or debentures, being offered for sale to the public if it is shown: (a) That an offer for sale was made within six months of allotment or agreement for allotment to the Issuing House; or (b) That at the date of the offer for sale, the company had not received whole consideration for the shares or debentures. The prospectus issued by the Issuing House which is known as ‘offer for sale’ shall also set out the following additional information: (i)

The net amount of consideration to be received by the company in respect of those shares or debentures to which the offer relates; and

15

Per Kindersely V.C. in New Burnwick & Canada Rly., and Land Co. v. Muggeridge, (1860) 3 LT 651 (1867) 17 LT 527 17 Section 25 (1) of the Companies Act, 2013 16

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA (ii)

(iii)

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 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 fir buying, trading or otherwise dealing in equity shares of any other listed company. The dissenting share-holders who have not agreed to proposal to vary the terms of contracts or objects referred to in the prospectus, shall be given exist offer by promoters or controlling shareholders at such exit price, and in such manner and conditions, as may be specified by SEBI by making regulations in this behalf.18

LIABILITY FOR PROSPECTUS

OMISSION

OR

FRAUDULENT

MIS-STATEMENTS

IN

OMISSION: Any omission from a prospectus of those matters which are required to be stated as per Section 26 shall render the director any other person responsible for the issue of prospectus, liable to fine not less than fifty thousand rupees, which may extend to three lakh rupees.19 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 for 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(1) (a) of the Companies Act, 2013, will also be covered by Section 34 and 35 of the 2013 Act.20

18

Section 27 (2) Section 26 (8), The quantum of fine is Rs. 50,000 which may be extend to three lakh rupees and also imprisonment 20 Section 26 (4) 19

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA It must be stated that for mere omission, not being deliberate falsity, the subscriber for shares or debentures has no right to rescind the allotment nor any other remedy against the company. He can, however, claim damages for loss suffered against the directors or other persons responsible for omission. In order to succeed, he has to prove that he applied for shares or debentures on the faith of the prospectus and would not have done so if the prospectus had complied with the provision of Section 56 of the Act.21

FRAUDULENT MIS-STATEMENTS Any person who has been induced to invest money in a company relying on a fraudulent statement in the progress can sue the director of the person responsible for issuing it and claim damages. In order to prove a fraud the aggrieved investors has to prove that the false representation was made by the company (a) knowingly, or (b) without belief in its truth, or (c) recklessly whether it be false or true.22 Thus a fraud may be committed by reckless and careless statement in the prospectus without bothering about the truth or false of it.23 A statement included in the prospectus shall be deemed to be untrue, if the statement is misleading in the form and content in which it is included. It also provides that where the omission from a prospectus of any matter is calculated to mislead, the prospectus shall be deemed, in respect of such omission, to be a prospectus in which an untrue statement is included. Thus, it would be seen that the law ascribes a wider meaning to the term ‘fraud’ or ‘untrue statement’. Regarding liability for fraudulent mis-statements in the prospectus, following generalizations may provide sufficient guidelines to proceed in an action for fraud or deceit. Firstly, the aggrieved party has to prove that the person making the suggestion knew that what he is stating in the prospectus is not true or did not believe it to be true or it is an active concealment of some material fact.24 However, if a person making the statement honestly believes it to be true, he is not guilty of fraud even if the statement is not true. This principle has been enunciated by House of Lords in Deery v. Peek.25 The fact of the case are as follows: A special Act incorporating a tramway company provided that carriages might be moved by animal power and, with the consent of the Board of Trade, by steam power. The directors issued a prospectus stating that by their special Act, the company had the right to use steam power instead of horses and this would bring about considerable saving. No reference was made to the Board of Trade who refused their consent. Consequently the company had to wound up. The plaintiff having taken shares on the faith of the statement brought an action for deceit against the directors. The court held that directors were not liable for they honestly believed that once the Act of parliament had authorized the use of steam, the consent of the Board of Trade was almost certain.

21

In Re south of England Natural Gas & Petroleum Co. Ltd., (19110 1 Ch 573 Lord Herschell in Derry v. Peek, (1889) 14 AC 337. 23 Edgington v. Fitznaurice, (1885) 29 Ch D 459 (465) 24 Section 17 of the Indian Contract Act, 1872 25 (1889) 14 AC 337 22

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA Secondly, the false representation must relate to some existing facts which are material to the contract of purchasing shares. The case of Edgington v. Fitznaurice,26 illustrates thin point further. In this case, the directors of a company issued a prospectus inviting subscriptions for debentures, they stated in the prospectus that the objects of issue of debentures were to complete alterations in the building of the company and to purchase horses and vans to expand the trade of the company. It was found that the real object of the loan was to enable the directors to pay-off pressing liabilities. The plaintiff took debentures relying upon the statement in the prospectus. The company became insolvent, therefore the plaintiff sued the directors for fraud. Held that the directors had misrepresented through the statement in the prospectus which was materials to the contract. In S. Chatterjee v. T.B. Sarwate,27 the directors was held liable for fraud in the prospectus. Thirdly, in order to succeed in an action for fraud in prospectus it is necessary that the plaintiff should have taken the shares or debentures directly from the company by allotment and not from any intermediary agency or open market. This in other words means that only the allottees can have remedy against the directors. This rule was for the first time laid down in Peeks v. Gurney.28 In this case, the defendants issued a prospectus containing fraudulent statement on behalf of the company. The plaintiff received a copy of it but did not take any shares originally from the company. A few months after the allotment, he purchased 2000 shares on the stock on the Stock Exchange. His action for deceit against the directors failed because he was not the initial allottee acting on the statement contained in the prospectus. The court held that liability to allottees does not follow the shares in the hands of subsequent tranferees.it was held that the function of prospectus had exhausted with the allotment of shares or debentures by the company. Fourthly, in the absence of a contractual relationship a person who makes a statement owes a duty of care to anyone whom he knows or has reasonable grounds for expecting will rely on his statement. If he fails in that duty of care and the party which is misled suffers loss, he shall be liable for negligence.29

WHO CAN BE SUED? It may be reiterated that Section 26 of the Companies Act, 2013 imposes liability for omission which are required to be disclosed in the prospectus whereas Section 35 imposes liability for misstatements or untrue statements. The persons liable for mis-statements are enumerated in Section 35(1) of the Act. Thus, a person who has subscribed for any shares or debentures on the faith of an untrue statement in the

26

(1885) 29 Ch D 459 AIR 1960 MP 322. 28 (1873) 43 LJ Ch 19. See also Collins v. Associated Grayhound Racecourses Ltd., (1930) 1 Ch. 1. 29 Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd., (1964) A C 465 (HL) 27

COMPANY LAW ASSIGNMENT

JAMIA MILLIA ISLAMIA prospectus and sustained any loss or damages may sue for compensation, all or any of the following: (a) (b) (c) (d) (e)

The directors at the time of issue; Persons named in the prospectus as present or future directors; The promoters; Persons who have authorized the issue of prospectus; and An expert referred to in sub-sections (5) on Section 26.

The burden of proof, however, lies on the allottees to show that he has been misled by the mis-statement in the prospectus and incurred loss. Again, the mis-representation should be in respect of some material fact. What is a material statement of fact shall, however, depend upon the circumstances of each case. Thus a statement in the prospectus that a particular mine was in operation and making large profits,30 and that no promotion money was to be paid,31 were held to be material statements of fact and the directors were held liable for making untrue statement. It should, however, be noted that Section 62 provides no remedy against the company. Therefore, action must be taken against persons falling within one of the categories stated above. But where a person has subscribed for shares or debentures of a company relying on the prospectus which contained an untrue or misleading but not fraudulent statement; he may repudiate the contract and sue the company for the return of money paid to it. This remedy is merely an ordinary contractual remedy available to any person who has been induced by a mis-representation to make a contract.32

REMEDIES AGAINST MIS-REPRESENTATION IN PROSPECTUS Besides damages for deceit and fraud, the company may also be sued for damages provided it is shown that the fraud was committed by the directors within the scope of their authority i.e. with the authority of the company. The company is also liable if the prospectus is issued by the promoters and ratified by the Board which adopts the issue, for the prospectus is the basis of the contract for share. Thus the first remedy against the company is to rescind a contract and claim the money back. Then allottee, however must act within a reasonable time. He shall lose his right to rescind if he attempts to sell the shares or attends a general meeting of the company or receives dividends from the company.

30

Reese River Silver Mining Co. v. Smith, (1869) LR 4 HL 64. Lodwick v. Earl of Perth 32 Sen Gupta, B.K. : Company Law, (2nd Ed. 1990) p. 85 31

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JAMIA MILLIA ISLAMIA CIVIL LIABILITY [SECTION 25] The inadequacy of action for damages for deceit came to light in the House of Lords decision in Derry v. Peek,33 and this remedy was found to be inadequate to protect the interest of investors. It was realized that a common investor is hardly concerned whether the mis-statement in the prospectus was a deliberate falsehood or made by the directors in good faith innocently. What he is concerned with is that he should be compensated for the loss caused to him due to misrepresentation. It is for this reason that within a year of the decision in Derry v. Peek, an Act called the Director’s Liability Act, 1890 was passed in England whereby the directors were made liable for mis-statement in the prospectus although they might have believed that the statement was substantially true. Subsequently, this provision was incorporated in Section 43 of the English Companies Act, 1948 and a corresponding provision to this effect is to be found in Section 35 of the Companies Act, 2013 in India. The section provides that the directors, promoters and every other person who is authorized to issue the prospectus of a company shall be liable to pay compensation to the investor for any loss sustained by him due to untrue statement in the prospectus. The liability of the directors or promoters, as the case may be, is joint and several and they may recover contribution from others who are guilty of misrepresentation.34 A statement is deemed to be untrue if it is false in form and context in which it is included. This is well illustrated by the case in Greenwood v. Leather Shod wheel Co.35 In that case, a wheel manufacturing company issued a prospectus in which it was stated that orders had already been received from House of Commons to supply wheels for the trolleys in use in the House. In fact, not a single order was obtained except for trial and by way of experiment. The court held that the prospectus contained untrue statement and the directors were held liable.

DEFENCES AVAIBLE TO AN EXPERT [SECTION 35 (20] Section 35 (2) of the Act provides that following defenses shall be available to an expert for misstatements in the prospectus(i) (ii)

(iii)

Having given his consent under Section 26 to the issue of the prospectus, he withdraw it in writing before delivery of the copy of prospectus for registration; or After delivery of a copy of prospectus for registration but before allotment, he became aware of the untrue statement, hence withdrew his consent in writing giving reasonable public notice of such withdrawal; or That he was competent to make the statement and that he had reasonable ground to believe that it was true.

33

(1889) 14 AC 337 Section 35 (1) 35 (1900) 1 Ch 421. 34

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JAMIA MILLIA ISLAMIA RIGHT OF DIRECTORS AND EXPERTS TO INDEMNITY [SECTION 35(2)] Section 35 (2) of the Companies Act, 2013 provides that the directors and experts have a right to indemnity and contribution where: (a) The prospectus names any person as director, or having agreed to become a director, he has not given his consent, or has withdrawn his consent before the issue of the prospectus, and has not authorized or consented to its issue [Section 35 (2) (a)]; and (b) The consent of a person is required under Section 26 to the issue of the prospectus and h either has not given that consent or has withdrawn it before the issue of the prospectus [Section 35 (2) (b)]. The directors of the company excluding those without whose knowledge or consent the prospectus was issued, and every other person who authorized the issue thereof, shall be liable to indemnify the person referred to in clause (a) clause (b), as the case may be made liable by reason of his name having been inserted in the prospectus or for the inclusion therein of a statement purporting to be made by him as an expert, as the case may be, or in defending against any suit or legal proceeding brought against him in respect thereof. Section 35 (3) further provides that every person who becomes liable to make any payment by way of compensation for loss or damages through untrue statements in a prospectus may recover contribution, as in cases of contract from any other persons who, if sued separately, would have been liable in respect of the same loss, unless the former person was and the latter person was not, guilty of fraudulent misrepresentation.

FALSE REPRESENTATION DISTINGUISHED FROM MIS-STATEMENT From the foregoing discussion it is clear that false representation is something different mere misrepresentation. The former includes active assertion of facts which are specifically known to be false and have been made deliberately to deceive. It also includes within it active concealment of material facts. Generally speaking, a mere non-disclosure does not amount to false misrepresentation. Again, mere silence is not fraud unless there is duty to speak, or silence is, in itself equivalent to speech.36 A few cases would illustrate this discussion. In Re Metropolitan Coal Consumers Association37 the company stated in its prospectus that B and M, two leading businessman of repute have agreed to become directors of the company. Whereas they had actually expressed their willingness to help the company. The court held that the statement was false and misleading hence the subscribers had the right to rescind the contract. In Shiromani Sugar Mills Ltd. v. Debi Prasad,38 the High Court of Allahabad, however, took a contrary view and held that the statement was not false in as much as the only fact asserted was the existence of promise which was not falsified by breach of it. In this case the prospectus on its 36

Explanation to Section 17 of the Indian Contract Act, 1872 (1982) 3 Ch. 1. 38 AIR 1950 ALL 508. 37

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JAMIA MILLIA ISLAMIA cover page contained a statement printed in red ink that “the managing agents with their friends, promoters and directors have already promised to subscribed shares worth rupees six lakh”., but in fact they had taken much less than that value. It was not held to be a misrepresentation of facts. At times the prospectus may contain an ambiguous statement capable of bearing two meaning one of which true while the other untrue. In such a situation the subscriber can recover if he entered into the contract relying on untrue part of the statement and the company cannot take the plea that he ought to have put reliance on true part of the statement. This is explained in the case of Smith v. Chedwick,39. In this the prospectus of a company which was under formation to take over certain iron works contained a statement, “the present value of the turnover is Euro 1,000,000 sterling per annum”. Now, if the statement meant that the works had actually in one year turned out produce worth more than a million, it was untrue. But if it meant that works were capable of turning out that amount of produce, it was true. The court held the directors liable as the plaintiff had relied on the untrue part of the statement and was thus misled.

LIMITATIONS ON THE MISREPRESENTATION

RIGHT

TO

RESCIND

FOR

FRAUD

OR

A contract induced by misrepresentation can be rescinded by the aggrieved subscribers. However, such a contract shall be valid until it is rescinded. But the right to rescind is not unlimited. It shall be lost in the following situation: (1) By Affirmation- if the allottee having the knowledge of misrepresentation affirms the contract and does not rescind it, he would lose the right to rescind. The affirmation may either be express or implied. Thus, where on discovering the misrepresentation the subscriber instead of rescinding the contract sells his shares or attends meeting of the company or receives dividend or pays call, he shall be deemed to have affirmed the contract thereby losing his right to rescind. (2) Undue delay- unreasonable delay in exercising the right to rescind the contract on the basis of mis-statement shall adversely affect the right of subscriber. In Re Christineville Estates Ltd.,40 the plaintiff came to know about misrepresentation in the prospectus in July but he moved an application to have his name removed from the company’s register in December. It was held that the delay of five months disentitled him from exercising his right to rescind. (3) On commencement of winding up- the right to rescission is lost on commencement of winding up of the company and shareholders shall not be permitted to escape liability.

39 40

(1884) 9 AC 187 (1911) 81 LJ Ch 63.

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JAMIA MILLIA ISLAMIA CRIMINAL LIABILITY FOR MISREPRESENTATION [SECTION 34] Apart from civil liability for misrepresentation in the prospectus, the company law also provides for criminal liability under Section 34 of the Companies Act, 2013. The section says that where prospectus includes any untrue statement, every person who has authorized the issue of the prospectus shall be punished under Section 447 of the Act, which provides punishment for fraud. Any person found guilty of fraud may be punished with: (a) Imprisonment for a term which may not be less than six months but which may extend to ten years, and (b) 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, or (c) Both imprisonment and fine.41 However, he shall not be criminally liable if he proves that the statement was immaterial or that he had a reasonable ground to believe that it was true. An expert who has given the consent as required by Section 26, shall not be criminally liable for the purpose of Section 35 (1).

WHO IS ENTILED TO REMEDIES? As stated earlier, the right to claim damages for the loss sustained by reasons of any untrue statement in a prospectus is available only to a person who has subscribed, for shares or debentures on the faith of the prospectus containing untrue statement. He shares must have been directly acquired from the company by allotment. A subsequent purchaser of shares in open market has no remedy against the company or the directors or promoters. However, where a prospectus is issued with the object of inducing persons to buy shares in the open market, any person who buys on the basis of false representation in the prospectus, has a right of action for fraudulent misrepresentation.42 Where the plaintiff filed PIL writ43 against the company alleging that it had issued a prospectus containing false statements which might mislead or adversely affect the public but he himself had no interest in the matter now was in any way affected thereby, the Bombay High Court dismissed the cased on the ground of locus standi holding that plaintiff has no cause of action.

PENALTY FOR FRAUDULENTLY INDUCING TO INVEST MONEY [SECTION 36] Section 36 of the Companies Act, 2013imposes additional criminal liability of imprisonment up to ten years or fine or with both where a person who either knowingly or recklessly has made a 41

Section 447 of the Companies Act, 2013 See Peek v. Gurney, (1873) 43 LJ Ch 19; Andrews. V. Mockford, (1869) 1QB 372 43 Kiran Mehta v. Universal Luggage Manufacturing Co. Ltd., (1988) 63 Camp Cas 398. 42

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JAMIA MILLIA ISLAMIA false, deceptive or misleading statement or promises or forecasted or had dishonestly concealed certain material facts to induce another person to enter into(a) Any agreement for acquiring, disposing of, subscribing for or underwriting shares or debentures; or (b) Any agreement with the purposes of securing a profit to any of the parties from the income of shares or debentures or by reference to fluctuations in the value of shares or debentures.

ALLOTMENT OF SHARES IN FICTITIOUS NAME [SECTION 38] The law prohibits impersonation for the acquisition of shares in fictitious name and makes it punishable under Section 447 of the Act. Both, making an application to a company for acquiring or subscribing for shares under fictitious name, or inducing a company to allot or register any transfer of shares in a fictitious name are made punishable under Section 38 of the Companies Act, 2013. Section 38 (3) of the Act further provides that where a person has been convicted under this section, the court may also order disgorgement of gain, if any, made by, and seizure and disposal of the securities in possession of such person. The amount received through disgorgement or disposal of securities under sub-section (3) shall be credited to the investor Education and Protection Fund. In A.V. Mohan Rao & another v. M. Krishna Rao & another,44 the accused were inducing persons to invest money by making false, deceptive and misleading statements and suppressing relevant facts. They raised millions of dollars from NRIs by inducing them to pay money for purchase of shares of Spectrum Power Company and thus siphoned off funds into bogus companies exclusively owned by them in off-shore areas. Therefore, a complaint against offences under Sections 60, 68, 68A read with Section 621 of the Companies Act, 1956 (the corresponding Sections of 2013 are Sections 26, 34, 36 and 38 read with Section 439) was filed against the accused persons. It was specifically alleged in the complaint petition that the accused persons have in effect committed fraud on the SPECTRUM POWER COMPANY in whose name they collected money, invested that in their own companies and thus defrauded the investors and these acts constituted offences under Section 68 and 68-A of the Companies Act. On receipt of the complaint the special Judge for Economic Offences, Hyderabad summoned the accused to appear before the Court in person on 13-4-99. The accused thereupon filed petition dated 28-6-94 in High Court of Andhra Pradesh under Section 482 Cr.P.C. to quash the proceedings in the C.C.No 24/99 exercising its inherent powers. Their contention was that the complaint against them does not make out any of the offences alleged by the complainant as such it is bad in law and not maintainable. They also pleaded that the Act has no application to the transactions alleged in the complaint as the petitioners are in the citizens of U.S.A. and they are Directors of the Overseas Company which has been incorporated and functioning abroad and that 44

AIR 2002 SC 2653

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JAMIA MILLIA ISLAMIA the offer for investment was made to NRIs in U.S.A. The) was not at all attracted because the Section requires registration of prospectus before it is passed by the existing company or an intended company since no prospectus was issued by the accused persons. The High Court declined to quash the complaint and drop the case against the accused persons holding that the allegations were serious in nature and could be decided only when all the documents relied upon by the complainant are duly examined, which can only be done after appropriate evidence and examination of witnesses by the Trial Court. The Court also referred to the case of State of Haryana v. Bhajan Lal,45 wherein the Apex Court has ruled that the power of quashing a criminal proceeding in exercise of the inherent power under Section 482 of Cr.P.C should be exercised sparingly in rarest of rare cases and it should not be used arbitrarily. As regards claim of the accused persons that they are citizens of USA and hence the provisions of Companies Act were not attracted in their case, the High Court took the view that this fact had to be ascertained from the evidence to be led by parties at the trial of the case. The appellants filed an appeal in the Supreme Court against this order of the High Court. The Supreme Court dismissed the appeal and observed that from the complaint petition and the materials produced by the complainant and in the light of provisions in Sections 60, 63. 68 and 68A of the Companies Act, 195646 it cannot be said that the allegations made in the complaint taken entirely do not make out, even prima facie, any of the offences alleged in the complaint petition. The allegations made are serious and relate to a power company registered under the Companies Act having its head office in India. Whether the appellants were or were not citizens of India at the time of commission of the offences are questions to be considered on the basis of evidence to be placed before the Trial Court. Therefore, in the context of the facts and circumstances of the case, the High Court was right in declining to quash the complaint petition and proceedings initiated on its basis. In result, this appeal being devoid of any merit is dismissed.

INITIAL OFFER OF SECURITIES TO BE IN DEMATERIALISED FORM [SECTION 29] Section 29 of the Companies Act, 2013 provides that ‘Initial Public Offer’ of any security by a listed company shall be only in dematerialized form so as to comply with the requisite process of Depositories Act, 1996 (22 of 1996) and regulations made thereunder.47

RESTRICTIONS ON INVITING DEPOSITS [SECTION 73] Prior to 1996 there were no restrictions on acceptance of deposits by companies from public but it was subsequently realized that many companies failed not only to refund the deposits on their maturity but also were unable to pay periodical interest to investors. Therefore, in order to protect

45

AIR 1992 SCW 237 The corresponding sections in the Companies Act, 2013 are Sections 26, 34. 36 and 38. 47 Mukesh Malhotra v. SEBI, (2005) 124 Comp Cas 336 (SAT) 46

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JAMIA MILLIA ISLAMIA the creditors and depositors, the Central Government had taken the power under Section 58-A of Companies Act, 1956 to regulate acceptance of deposits in consultation with the Reserve Bank of India. Protection to unsecured creditors i.e. depositors was provided in the Companies (Amendment) Act, 1974 whereby Section 58-A were inserted. Section 58-A (now Section 73 of the 2013 Act) provide that the Central Government, may in consultation with the Reserve Bank of India prescribe the limits up to which, the manner in which and the conditions subjects to which deposits may be invited or accepted by a computer either from the public or rom its members. The advertisement meant for inviting deposits under Section 73 of the Companies Act, 2013 must include a statement indicating the financial position of the company in prescribed form.48 The Central Government, in Consultation with the Reserve Bank of India have formed separate rules known as the Companies (Acceptance of Deposits) Rules, 1975 which came into force on 3rd Feb, 1975. It must be stated that the main purpose of regulating acceptance of deposits by non-banking non-financial companies is to keep the magnitude of these deposits within limits and to control and regulate deposits outside the banking system in the interest of public in general and depositors in particulars. The Companies (Acceptance of Deposits) Rules, 1975 also contain provisions relating to repayment and renewals of deposits accepted by companies before 1975. The provision of Section 73, however, do not apply in case of banking companies or such other companies as the Central Government, in consultation of the Reserve Bank of India, may notify. Section 58-A (9) of the Companies Act, 1956 (Section 73 of the 2013 Act) provided that if a company has failed to repay any deposit or part thereof in accordance with the terms and conditions of such deposits, the Company Law Board, may, if it is satisfied, either on its own motion or on the application of a depositor, direct the company to make payment of such deposit or part thereof forthwith or within such time as may be specified in the order. Tribunal may, however, give a reasonable opportunity of being heard to the company or any person interested in the matter.49 Consequent to the passing of the Companies Act, 2013, as per Section 73 of the Act, only public companies having such net worth or turnover as may be prescribed, may invite accept or renew deposits from the public as provided in Section 76 of the 2013 Act. Other Companies shall not invite, accept or renew deposits from the public, other than the company’s members. The new Act further makes deposit insurance compulsory for acceptance of deposits from public or from its own members. Section 76 of the Companies Act, 2013 provides that a company having net worth and turnover of such amount as may be prescribed, may accept deposits from persons other than its

48 49

Section 73 of Companies Act, 2013 (Chapter V- Acceptance of Deposits from Public). In Re Pure Drinks (New Delhi) Ltd., (1995) 83 Comp Cas 174 (CLB).

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JAMIA MILLIA ISLAMIA members subject to compliance with the Section 73 (2) of the Companies Act, 2013 and subject to rules made by the Central Government in consultation with the Reserve Bank of India (RBI). Such companies shall also be required to obtain credit rating from the recognised credit rating agency for informing to the public about the credit rating at the time of invitation of deposits. The credit has to be obtained every year during the tenure of deposit. Section 75 of the Companies Act, 2013 contains new provisions relating to deposits accepted before the commencement of the 2013 Act therefore, they are transitional provisions, whereas Section 74 deals with repayment of deposits etc. accepted before the commencement of the new Companies Act, 2013. The Company Law Board (now Tribunal) in Vijay Kumar Gupta v. Eagle Paint & Pigment Industries Ltd.,50 held that private companies cannot issue advertisement for inviting deposits. When a company accepts deposits from its members or directors, it has to obtain a declaration from them that they are not taking deposit as a debt on the company. Rule 3-A promulgated by the Government under rule making power conferred by Section 73 read with Section 469 of the Companies Act, 2013 requires a company to deposits or invest a sum equal to at least ten percent of the amount maturing during the year in certain specified accounts in a Scheduled Bank or in specified securities. This is kept in a free deposit in order to protect the depositors and ensure that they get their refund readily. Some of the companies,51 challenged the validity of this rule but the Supreme Court rejected the petitions. It has been further held that there is no violation of any fundamental right by these deposit rules.52 In Assistant Registrar of Companies v. R. Narayansawamy,53 it was held that the offence of non-payment of deposit money is not a continuing offence and therefore subsequent directors shall not be liable for earlier defaults.

DEFAULT IN ACCEPTANCE OR REFUND OF DEPOSITS TO BE COGNIZABLE OFFENCE Any company which has committed a default in returning the deposit amount taken as debt from depositors, on expiry of maturity date, cannot invite fresh deposits or renew the existing deposits until it has made payment of deposit amount with interest thereon, to the existing depositors. This provision shall, however, not apply to banking companies and companies which have been granted exemption by the Central Government in consultation with the Reserve Bank of India such as deposit for booking purchase of a vehicle, housing deposit, mutual chit funds or Mutual Benefits

50

(1997) 26 Comp LA 236 (CLB) Notably the Delhi Cloth & General Mills, the Arvind Mills, the Modi Spinning and Weaving Mills etc. See also Goetze (India) Ltd. v. Union of India, (1983) 4 SCC 166. 52 A.S.N. IYER V. Reserve Bank of India, (1984) 56 Comp. Cas. 352 (Mad). 53 (1985) 57 Com. Cas 787. 51

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JAMIA MILLIA ISLAMIA Companies etc. but in spite of this exemption, it is mandatory for them to issue advertisement for inviting deposits. In Gopal Maheshwar v. Hawk Multi-Media (P) Ltd. Co.,54 the petitioner gave loan to the respondent company at the interest rate of 18 per cent per annum. He filed a petition against the respondent for non-payment of debt under Section 598-A of the Companies Act. Dismissing the petition the Company Law Board held that this transaction cannot be treated as ‘public deposit’ and the respondent company had not given a receipt for the debt amount to the petitioner. Therefore, it cannot be said that there has been violation of provision relating to public deposits in this case.

PROSPECTUS OF FOREIGN COMPANIES [SECTION 387] No person shall issue, circulate or distribute in India any prospectus offering to subscribe for securities (Shares etc.) of a company incorporated or to be incorporated outside India, whether the company has or has not established, or when formed will or will not established, a place of business in India, unless the prospectus is dated and signed and contains particulars with respect to following matters: (i) (ii) (iii) (iv) (v)

Documents or instrument relating to the formation of the company; Rules by which incorporation of the company was effected; The name of the place in India where above documents of the foreign company can be inspected and copies thereof in the English language; The place, date and Country where company has been incorporated; In case the company has established its business in India, the Principal offices of the company in India with full address thereof.

No person shall issue to any person in India a form of application for securities of such company or intended company as it is mentioned above, unless the form is issued with a prospectus which complies with the above provision and does not contravene the provision Section 388 regarding expert’s, consent and allotment. From the foregoing analysis it is evident that the public subscribed for shares or debentures of a company on the basis of statements in its prospectus. It is therefore, necessary that a company must exercise due care and caution while issuing its prospectus. It is for this reason that stringent civil and penal provisions have been incorporated in Section 447 of the Companies Act, 2013 to prevent violation of law relating to prospectus and protect the innocent investors from being defrauded by the companies.

54

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BIBLIOGRAPHY Online material source. • SCC ONLINE • LEGAL SERVICE INDIA • LAWYERS CLUB • THELEGALHIGHNESS • SHODHGANGA

Book referred. • DR. N.V. PRANJAPE, COMPANY LAW, CENTRAL LAW AGENCY, ALLAHBAD, 17TH EDITION, 2016

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Thank you! COMPANY LAW ASSIGNMENT