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Golden rule as to the framing of prospectus. A prospectus constitutes the basis of the contract between the company and the person who purchases shares or debentures. The persons who are behind the company have all the knowledge or means of knowledge as to the present position and future prospects of the enterprise and the investing public has none. It is but fair that the former should not only disclose all the matters within their knowledge relating to the enterprise, which might affect the investing mind but should state them accurately, correctly. A prospectus must, therefore, tell the truth, the whole truth and nothing but truth. Also it must not conceal any fact which ought to be disclosed. LIABILITY FOR MIS-STATEMENTS IN PROSPECTUS

Liability for Mis-statements in Prospectus

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Page 1: Liability for Mis-statements in Prospectus

Golden rule as to the framing of prospectus. A prospectus constitutes the basis of the contract between the company and the person who purchases shares or debentures. The persons who are behind the company have all the knowledge or means of knowledge as to the present position and future prospects of the enterprise and the investing public has none. It is but fair that the former should not only disclose all the matters within their knowledge relating to the enterprise, which might affect the investing mind but should state them accurately, correctly. A prospectus must, therefore, tell the truth, the whole truth and nothing but truth. Also it must not conceal any fact which ought to be disclosed.

LIABILITY FOR MIS-STATEMENTS IN PROSPECTUS

Page 2: Liability for Mis-statements in Prospectus

According to section 65(1)(a), “a statement included in a prospectus shall be deemed to be untrue, if the statement is misleading in the form and context in which it is included.

Greenwood V. Leather Shood Wheel Co. (1900)

Point decided is

The mis-statement contained in the prospectus must be material.

What is an untrue statement:

Page 3: Liability for Mis-statements in Prospectus

Where a person has bought shares on the faith of a prospectus which is misleading because of a mis-statement in or omission from the prospectus, he may have a legal remedy against all or any of the following:

(i) the company;

(ii) every director;

(iii) every person whose name appeared in the prospectus as a proposed director;

(iv) every promoter;

(v) every person who authorized the issue of the prospectus.

Who can be sued?

Page 4: Liability for Mis-statements in Prospectus
Page 5: Liability for Mis-statements in Prospectus

An allottee must prove that:

(i) the misrepresentation was of fact;

(ii) it was in respect of a material fact;

(iii) he acted on the misrepresentation; and

(iv) he has suffered damages in the consequence

Onus of Proof

Page 6: Liability for Mis-statements in Prospectus

A person who has subscribed for shares on the faith of the misleading prospectus has remedies against –

(a) the company, and

(b) the directors, promoters and experts

Remedies against the company. A person who has been induced to subscribe for shares may (1) rescind the contract to take the shares; (2) claim damages.

CIVIL LIABILITY

Page 7: Liability for Mis-statements in Prospectus

1. Rescission of the contract. Where a person has purchased the shares of a company on the faith of a prospectus which contained an untrue or misleading statement, he can seek rescission of the contract. This right is based on the general rule that a contracxt induced by a material misrepresentation is voidable and may, at the option of the party so induced be rescinded.

The right to rescind the contract is available if he proves the following:-(i) Prospectus was issued by or on behalf of the company. It must be established that the prospectus was issued by the company or by some one duly authorized by the company. If the prospectus was issued by the promoters and the Board of directors have ratified or adopted the issue, the company will be responsible for it.

Page 8: Liability for Mis-statements in Prospectus

(ii) Statement must be untrue. The prospectus must contain a false statement whether fraudulent or innocent.

(iii) Statement must be a material misrepresentation. The false statement contained in the prospectus must be material to the contract to take shares or debentures.

(iv) The Misrepresentation must have induced the shareholder to take the shares and he must have relied on the statement in applying for shares - But it is not necessary that he should have verified it before relying upon it. Misrepresentation must have been at least one of the inducements for the contract to purchase the shares, only then the contract can be rescinded

Page 9: Liability for Mis-statements in Prospectus

(v) Misrepresentation must be of facts and not of law. The statement which induced the shareholders to take shares must be one of the facts and not merely an expression of opinion and expectation.

(vi) That he has taken action promptly to rescind the contract. The shareholder must start proceedings for rescission within a reasonable time and before the company goes into liquidation

Page 10: Liability for Mis-statements in Prospectus

The subscriber loses his right to rescind the contract in the following cases:

(a) Unreasonable delay. The right to rescind is lost if the shareholder fails to take any action within a reasonable time after he has come to know the misrepresentation in the prospectus.

(b) Affirmation. If the shareholder, with full knowledge of misrepresentation in the prospectus, affirms his contract for purchase of shares, he cannot rescind the contract afterwards.

2. Right of action for damages to deceit. In cases where misstatement in the prospectus amounts to fraud, injured party is also entitled to sue the company for damages provided he has rescinded his contract in time.

Loss of Right to rescind the contract

Page 11: Liability for Mis-statements in Prospectus

The company will be liable for damages for fraudulent misrepresentation in the prospectus only if the following conditions are proved by the allottee.1. That the persons who had issued the prospectus knew that the statement was false;2. That the person who had issues the prospectus were authorised to issue the prospectus on behalf of the company;3. That the allottee had suffered a loss on account of the fraudulent misrepresentation in the prospectus.

Page 12: Liability for Mis-statements in Prospectus

Any person who has purchased shares or debentures on the faith of the prospectus containing the untrue statement may sue:

1. every director;

2. every person whose name appeared in he prospectus as a proposed director;

3. every promoter; and

4. every person who authorized the issue of the prospectus.

The aggrieved person may claim:

(a) Compensation under section 62;

(b) Damages for non-compliance with the requirement of section 56;

(c) Damages under the general law.

Remedies against the directors, promoters and experts

Page 13: Liability for Mis-statements in Prospectus

1. Compensation under section 62. Directors , promoters, and all others who authorized the issue of prospectus are liable to compensate persons who subscribe for the shares on the faith of the prospectus for the loss sustained by reason of any untrue statement in it. The liability consists in paying damages by way of compensation to the aggrieved party. The principle for measuring damages is same as stated in section 73 of the contract act 1872. The compensation payable will be the difference between the price paid for shares or debentures and their value at the date they were allotted to the subscriber.

Page 14: Liability for Mis-statements in Prospectus

The person sued for damages can escape liability for damages by successfully pleading any of the following defences:

(i) Withdrawal of consent. A director may escape liability if he proves that he withdrew his consent to act as a director before the prospectus was issued and it was issued without his authority or consent.

(ii) Issued without knowledge. A director will not be liable if the prospectus was issued without his knowledge or consent and that on becoming aware of its issue, he gave reasonable public notice to that effect.

(iii) Ignorance of untrue statement. Some times a director may be ignorant of the untrue statements contained in the prospectus. Such a director can defend himself by proving that after the issue of the prospectus and before allotment, he on becoming aware of the untrue statement in it, withdrew his consent and gave reasonable public notice of the withdrawal and the reasons for it.

Defences of directors, promoters, etc. (Section 62 (2))

Page 15: Liability for Mis-statements in Prospectus

(iv) Reasonable ground for belief. A director will also be proteced if he proves that he had reasonable grounds to believe and did believe upto the time of allotment of shares or debentures that the statement was true.(v) Statement of expert. A director will also be not liable if he proves that the statement was a correct copy or a correct and fair extract from the report of an expert who was competent to make it and that person had given the consent to the issue of the prospectus.(vi) Correct copy of an extract. A director will also be protected if he proves that the statement was a correct and true copy of an official document.

Page 16: Liability for Mis-statements in Prospectus

An expert will not be liable if he can prove

(i) that he withdrew in writing his consent to the issue of the prospectus before it was delivered to the Registrar for registration;

(ii) that after delivery but before allotment of shares he became aware of a false statement in the prospectus, and he publicly withdrew his consent in writing and gave the reasons thereof;

(iii) that he was competent to make the statement and had reasonable grounds to believe and did upto the allotment of shares believe that the statement was true.

Defences of an expert (Section 62(3)

Page 17: Liability for Mis-statements in Prospectus

2. Damages for non- compliance with section 56. Section 56(1) requires that a company is prospectus must contain the prescribed particulars. Hence the allottee can recover damages from the directors for failure to comply with the provisions of section 56(1). But the allotment must prove that he has sustained damages.

However, the director or person would not be liable if he proves that

(a) he had no knowledge of the matter not disclosed in the prospectus;(b) the non-compliance arose from an honest mistake of fact on his part, or(c) the non-compliance was not material and the court thinks that he ought to be excused.

Page 18: Liability for Mis-statements in Prospectus

3. Damages under General Law. An allottee may bring an action for deceit against the directors under general law as provided by action 19 of the Indian Contract Act, 1872.

The remedy under general law shall be available even where:(i) the right of rescission as against the company is lost either through latches or negligence.(ii) The company goes into liquidation.

But the plaintiff will have to establish the following:(a) There was a fraudulent misstatement. In a suit for deceit against the directors the allottee must prove affirmatively that the statement upon which he acted was false.(b) False representation related to some existing material facts. The aggrieved shareholder must also prove that the fraudulent statement was made in respect of some existing facts which are material to the contract of purchasing shares.

Page 19: Liability for Mis-statements in Prospectus

(c) Plaintiff was the original allottee. A false statement in a prospectus will render the directors liable to the original allottees only and not to subsequent p0urchases from them.

If a prospectus contains an untrue statement, the company is liable to an original allottee. If a person purchase shares in the open market he has no remedy against the company.

Page 20: Liability for Mis-statements in Prospectus

Every person who authorized the issue of a prospectus containing untrue statement shall be punishable with imprisonment which may extend to two years or with fine which may extend to Rs. 50,000 or with both.

The accused person, however, may not be liable if he proves –

(a) that the statement was immaterial, or

(b) that he had reasonable ground to believe and did believe upto the time of the issue of the prospectus that the statement was true.

Criminal liability of directors.

Page 21: Liability for Mis-statements in Prospectus

Any person who makes an untrue, deceptive or misleading statement in a prospectus with a view to inducing persons to invest money shall be liable for imprisonment for a term which may extend to five years or fine upto Rs. 1,00,000 or both. This section attempts at preventing fraud in connection with obtaining capital from public.

Penalty for fraudulently inducing persons to invest money (Section 68)

Page 22: Liability for Mis-statements in Prospectus

Benami shareholding and shareholding in the name of fictitious or non existing persons are common. The object is to avoid tax. Section 68-A makes it an offence to make applications for shares in the name of, or to induce the allotment or transfer of shares to fictitious persons. The punishment in such cases is imprisonment which may extend to five years.

Issue and allotment of shares in fictitious names (Section 68-A)

Page 23: Liability for Mis-statements in Prospectus

When a company offers its shares to public, its often wants that the whole issue should be taken up. Consequently, a company is usually willing to pay a small commission on all the shares offered to the public to any one who undertakes to take all the shares, if the public do not take. This is known as ‘underwriting’. It consists of an undertaking by some persons and persons that if the public fails to take up the issue, he or they will do so. In return for this underwriting, the company agrees to pay the underwriters a commission on all shares, whether taken by the public or by the underwriters.

Underwriting commission(section 76)

Page 24: Liability for Mis-statements in Prospectus

Brokerage is a remuneration paid to middlemen for services performed under a contract in procuring subscription of the public issue of shares and debentures. However, the term ‘brokerage’ is not defined in the Companies Act.

The following conditions should be kept in view :

1. There must be an authority in the articles to pay brokerage;

2. The prospectus or a statement in lieu of prospectus relating to issue should disclose the rate of brokerage;

3. A contract relating to such brokerage should be filed with the Registrar of Companies along with the prospectus or a statement in lieu of prospectus.

Brokerage

Page 25: Liability for Mis-statements in Prospectus

Underwriting Brokers

1. A broker gives no such undertaking to take up shares or debentures in the event of under- subscription.

2. a broker gets brokerage for his work.

3. A broker is entitled to get such brokerage which has been lawful for companies to pay.

4. There is no such requirement in case of brokers.

1. An underwriter is a person who agrees to takes specified number of shares or debentures, or specified amount of debentures stock in case of under- subscription.

2. An underwriter gets underwriting commission for his work.

3. An underwriter is entitled to under- writing commission at rate not exceeding 5% of the issue price of shares and 2.5% of the issue price of debentures.

4. The name, address, and occupation of each underwriting will have to be disclosed in the prospectus.