THE LEGAL BRIDGE

Judiciary & Law Notes Series

THE COMPANIES ACT, 2013

CHAPTER III

Prospectus & Allotment of Securities

Sections 23–42

For Judicial Service Aspirants & Law Students

RJS • DJS • PCS-J • HJS • UPJS • BJS • MPCJ

Public Offer • Misstatement • Private Placement • Sahara Case

— Enriched with landmark judgments and illustrative case law —

Chapter III — Prospectus and Allotment of Securities (Sections 23–42)

Chapter III governs the process by which a company raises capital from the public or from a select group of investors. It is divided into two parts — Part I (Public Offer) and Part II (Private Placement). The chapter is central to investor protection, regulatory disclosure, and the civil/criminal liability of promoters and directors for misstatements.

Section 23: Public Offer and Private Placement

Section 23 delineates the methods by which a public or private company may issue securities:

Public Company — methods of raising capital

• Public offer (which includes an initial public offer, further public offer, or an offer for sale by existing shareholders).
• Private placement in accordance with Section 42.
• Rights issue or bonus issue in accordance with Sections 62 and 63.

Private Company — methods

• Rights issue or bonus issue.
• Private placement through Section 42.

A private company cannot make an offer to the public — that is definitionally forbidden by Section 2(68). The insertion of Section 23(2) by the Companies (Amendment) Act, 2020 enables certain classes of unlisted public companies to issue securities for the purposes of listing on a permitted stock exchange in a permissible foreign jurisdiction — a statutory foundation for direct overseas listings.

Section 24: Power of SEBI to Regulate Issue and Transfer of Securities

In relation to issue and transfer of securities and non-payment of dividend by listed companies or by those companies which intend to get their securities listed on any recognised stock exchange, the powers of administration of the relevant provisions (including rule-making) shall vest in the Securities and Exchange Board of India (SEBI). In all other cases, the Central Government, the Registrar, and the Tribunal exercise jurisdiction as the case may be.

This section resolves what was historically a jurisdictional tug-of-war between the Companies Act regulator and SEBI, clarifying that for listed-company matters concerning issue and transfer, SEBI leads.

Section 25: Document Containing Offer of Securities for Sale to be Deemed Prospectus

Where a company allots or agrees to allot any securities with a view to those securities being offered for sale to the public, any document by which the offer for sale is made shall, for all purposes, be deemed to be a prospectus issued by the company. All enactments and rules of law applicable to prospectuses shall apply with such modifications as may be prescribed.

This section targets the 'offer-for-sale' device — a company allots shares to an intermediary who immediately offers them to the public. Without Section 25, such an offer would evade the rigour of the prospectus regime. The device now fails.

Section 26: Matters to be Stated in Prospectus

Section 26 specifies the exhaustive contents which every prospectus issued by or on behalf of a public company (either with reference to its formation or subsequently) or in relation to an intended company shall contain. Among the matters required to be stated are:

• Names and addresses of the registered office, company secretary, Chief Financial Officer, auditors, legal advisers, bankers, trustees, underwriters and such other persons as may be prescribed.
• Dates of the opening and closing of the issue, and declaration about the issue of allotment letters and refunds within the prescribed time.
• A statement by the Board of Directors about the separate bank account where all monies received out of the issue are to be transferred.
• Details about underwriting of the issue.
• Consent of the directors, auditors, bankers to the issue, expert's opinion, if any, and of such other persons, as may be prescribed.
• The authority for the issue and the details of the resolution passed therefor.
• Procedure and time schedule for allotment and issue of securities.
• Capital structure of the company in the prescribed manner.
• Main objects of public offer, terms of the present issue and such other particulars as may be prescribed.
• Main objects and present business of the company and its location, schedule of implementation of the project.
• Particulars relating to — (i) management perception of risk factors specific to the project; (ii) gestation period of the project; (iii) extent of progress made in the project; (iv) deadlines for completion of the project; and (v) any litigation or legal action pending or taken by a Ministry/Department against the promoter during the last five years immediately preceding the year of the issue of prospectus and any direction issued by such Ministry/Department.
• Minimum subscription, amount payable by way of premium, issue of shares otherwise than on cash.
• 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.
• Disclosures as may be prescribed about sources of promoters' contribution.

Further, the prospectus must contain the reports for the purposes of financial information specified in Section 26(1)(b) — reports by auditors on profits and losses and assets and liabilities, reports relating to profits and losses for each of the five financial years preceding the issue, reports by the auditors on business to be acquired, and so on.

Registration of Prospectus

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. A prospectus shall not be valid if it is issued more than ninety days after the date on which a copy thereof is delivered to the Registrar.

Contravention — the company is punishable with a fine which shall not be less than Rs. 50,000 but may extend to Rs. 3,00,000 and every person who is knowingly a party to the issue of such prospectus is punishable with imprisonment up to three years or with fine of Rs. 50,000 to Rs. 3,00,000, or both.

Section 27: Variation in Terms of Contract or Objects in Prospectus

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.

The dissenting shareholders — being those who have not agreed to the proposal — shall be given an exit offer by the 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.

Section 28: Offer of Sale of Shares by Certain Members of Company

Where certain members of a company, in consultation with the Board, propose to offer, in the prescribed manner, whole or part of their holding of shares to the public, the document by which the offer is made shall be deemed to be a prospectus issued by the company. The members offering such shares shall be liable under Sections 34 and 35 for any misstatement therein. The provisions relating to prospectus apply mutatis mutandis, and all laws and rules made thereunder relating to issue of a prospectus apply.

Section 29: Public Offer of Securities to be in Dematerialised Form

Every company making public offer; and such other class or classes of public companies as may be prescribed, shall issue the securities only in dematerialised form by complying with the provisions of the Depositories Act, 1996 and the regulations made thereunder. Any other company may also convert its securities into dematerialised form or issue its securities in physical form in compliance with the Act or in dematerialised form in compliance with the Depositories Act and the regulations.

Rule 9A of the Companies (Prospectus and Allotment of Securities) Rules, 2014, introduced in 2018, mandates dematerialisation for unlisted public companies — a significant compliance push.

Section 31: Shelf Prospectus

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, which shall indicate a period not exceeding one year as the period of validity of such prospectus. A company filing a shelf prospectus is required to file an information memorandum with the Registrar, containing all material facts relating to new charges created, changes in the financial position of the company between the first offer of securities and the succeeding offer of securities and other prescribed changes.

Section 32: Red Herring Prospectus

A company proposing to make an offer of securities may issue a red herring prospectus prior to the issue of a prospectus. A company proposing to issue a red herring prospectus 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. Upon the closing of the offer of securities, the prospectus stating therein the total capital raised (whether by way of debt or share capital), 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 SEBI.

'Red herring prospectus' means a prospectus which does not include complete particulars of the quantum or price of the securities included therein.

Types of Prospectus — At a Glance

Section 33: Issue of Application Forms for Securities

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. The abridged prospectus is a memorandum containing such salient features of the prospectus as may be specified by SEBI. The rule does not apply to a bona fide invitation to a person to enter into an underwriting agreement or where the securities are not offered to the public.

Misstatements in Prospectus — Civil and Criminal Liability

A prospectus is, in essence, the invitation on the faith of which investors part with their money. The integrity of its disclosures is therefore jealously guarded by the Act. Sections 34 through 37 form a detailed code of liability for untrue statements in prospectuses.

Section 34: Criminal Liability for Misstatements in Prospectus

Where a prospectus issued, circulated or distributed under this Chapter includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, every person who authorises the issue of such prospectus shall be liable under Section 447 (fraud).

The section carves out a defence: a person shall not be so liable if he proves that such statement or omission was immaterial or that he had reasonable grounds to believe, and did up to the time of issue of the prospectus believe, that the statement was true or the inclusion or omission was necessary.

Section 35: Civil Liability for Misstatements in Prospectus

Where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and every person who —

• is a director of the company at the time of the issue of the prospectus;
• has authorised himself to be named and is named in the prospectus as a director of the company, or has agreed to become such director, either immediately or after an interval of time;
• is a promoter of the company;
• has authorised the issue of the prospectus; and
• is an expert referred to in sub-section (5) of Section 26,

shall, without prejudice to any punishment to which any person may be liable under Section 36, be liable to pay compensation to every person who has sustained such loss or damage.

Defences Available under Section 35(2)

1. Withdrawal of consent before the issue of the prospectus and non-authorisation of the issue thereafter.
2. That the prospectus was issued without his knowledge or consent and on becoming aware of its issue, he forthwith gave a reasonable public notice that it was issued without his knowledge or consent.
3. That he had reasonable ground to believe, and did up to the time of allotment of the securities believe, that the statement was true, or the inclusion or omission was necessary.

Additional Liability for Fraudulent Inducement

Where it is proved that a prospectus has been issued with intent to defraud the applicants for the securities of a company or any other person or for any fraudulent purpose, every person referred to in sub-section (1) shall be personally responsible, without any limitation of liability, for all or any of the losses or damages that may have been incurred by any person who subscribed to the securities on the basis of such prospectus.

Section 36: Punishment for Fraudulently Inducing Persons to Invest Money

Any person who, either knowingly or recklessly, makes any statement, promise or forecast which is false, deceptive or misleading, or deliberately conceals any material facts, to induce another person to enter into, or offer to enter into — (a) any agreement for, or with a view to, acquiring, disposing of, subscribing for, or underwriting securities; or (b) any agreement, the purpose or the pretended purpose of which is to secure a profit to any of the parties from the yield of securities or by reference to fluctuations in the value of securities; or (c) any agreement for, or with a view to obtaining credit facilities from any bank or financial institution, shall be liable for action under Section 447.

Section 37: Action by Affected Persons

A suit may be filed or any other action may be taken under Section 34, 35 or 36 by any person, group of persons or any association of persons affected by any misleading statement or the inclusion or omission of any matter in the prospectus. This introduces a statutory representative-action mechanism, a forerunner of the class action architecture of Section 245.

Landmark Cases on Misrepresentation in Prospectus

Allotment of Securities

Section 38: Punishment for Personation for Acquisition of Securities

Any person who —

• makes or abets making of an application in a fictitious name to a company for acquiring, or subscribing for, its securities; or
• makes or abets making of multiple applications to a company in different names or in different combinations of his name or surname for acquiring or subscribing for its securities; or
• otherwise induces directly or indirectly a company to allot, or register any transfer of, securities to him, or to any other person in a fictitious name,

shall be liable for action under Section 447. The court is empowered to order disgorgement of gain to the Investor Education and Protection Fund.

Section 39: Allotment of Securities by Company

No allotment of any securities of a company offered to the public for subscription shall be made unless the amount stated in the prospectus as the minimum amount has been subscribed and the sums payable on application for the amount so stated have been paid to and received by the company by cheque or other instrument.

Minimum amount payable on application shall not be less than five per cent (5%) of the nominal amount of the security, or such other percentage or amount, as may be specified by SEBI by making regulations.

If the stated minimum amount has not been subscribed and the sum payable on application is not received within a period of thirty days from the date of issue of the prospectus, or such other period as may be specified by the SEBI, the amount received shall be returned within such time and manner as may be prescribed. The company must file a return of allotment with the Registrar in the prescribed manner.

Section 40: Securities to be Dealt With in Stock Exchanges

Every company making public offer shall, before making such offer, make an application to one or more recognised stock exchange or exchanges and obtain permission for the securities to be dealt with in such stock exchange or exchanges. The prospectus shall state the name/names of the stock exchange(s) and that an application has been made. Any allotment made on the basis of a prospectus which does not comply with this requirement shall be void.

All monies received from the public on the application shall be kept in a separate bank account maintained with a scheduled bank and shall not be utilised for any purpose other than — (a) adjustment against allotment of securities, where the securities have been permitted to be dealt with in the stock exchange(s) named in the prospectus; or (b) the repayment of monies, within the prescribed time, received from applicants where the company is, for any other reason, unable to allot.

Section 41: Global Depository Receipt

A company may, after passing a special resolution in its general meeting, issue depository receipts in any foreign country in such manner, and subject to such conditions, as may be prescribed. This enables Indian companies to tap overseas capital markets via GDRs/ADRs.

Section 42: Issue of Shares on Private Placement Basis

'Private placement' means any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of public offer) through private placement offer-cum-application, which satisfies the conditions specified in Section 42.

Key Conditions under Section 42 (as amended by the 2017 Amendment)

• The offer can be made only after approval of shareholders by special resolution, for each of the offers or invitations. In case of offer or invitation for non-convertible debentures, a special resolution passed once in a year for all the offers or invitations for such debentures during the year is sufficient.
• The offer can be made to not more than two hundred (200) persons in the aggregate in a financial year, excluding qualified institutional buyers (QIBs) and employees under a scheme of employees stock option. Any offer beyond 200 is a 'deemed public offer' inviting the rigour of the public-offer regime.
• The number of 200 is reckoned individually for each kind of security — equity shares, preference shares, debentures — separately.
• The minimum investment size (face value) shall be Rs. 20,000 per person.
• The payment to be made for subscription to securities shall be by cheque, demand draft or other banking channels, and not by cash; and such payment shall be made from the bank account of the person subscribing.
• No fresh offer or invitation under this section shall be made unless the allotments with respect to any offer or invitation made earlier have been completed or that offer or invitation has been withdrawn or abandoned by the company.
• The company making offer or invitation shall allot its securities within sixty days from the date of receipt of the application money; failing which it shall repay the application money to the subscribers within fifteen days from the expiry of sixty days and if the company fails to repay within this time, it shall be liable to repay with interest at the rate of 12% per annum from the expiry of the sixtieth day.
• The company shall not release any public advertisements or utilise any media, marketing or distribution channels or agents to inform the public at large about such an issue.
• No company issuing securities under this section shall use any media, marketing or distribution channels or agents to inform the public at large about such an issue.
• The return of allotment shall be filed with the Registrar in the prescribed form within fifteen days of allotment. Monies received on application shall be kept in a separate bank account in a scheduled bank and shall not be utilised for any purpose other than (a) for adjustment against allotment of securities; or (b) for repayment of monies where the company is unable to allot.

Penalty for Contravention of Section 42

If a company defaults in filing the return of allotment within the period prescribed, the company, its promoters and directors shall be liable to a penalty of one thousand rupees for each day during which such default continues but not exceeding twenty-five lakh rupees. Subject to the provisions of sub-section (11), if a company makes an offer or accepts monies in contravention of this section, the company, its promoters and directors shall be liable for a penalty which may extend to the amount raised through the private placement or two crore rupees, whichever is lower, and the company shall also refund all monies with interest as specified in sub-section (6) to subscribers within a period of thirty days of the order imposing the penalty.