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Liability for Misrepresentations in Prospectuses of Companies

By Nevin Clinton

What is a prospectus?

A prospectus is a document issued by a company that has important information on the investments that investors can make. The document offers (or must offer) a transparent look at the company, its securities in the market, and so on. The prospectus is among the first documents that is usually referred to when an individual contemplates making investments.

Section 2(70) of the Companies Act, 2013 defines a prospectus as “a document that invites offers from the public for the subscription or purchase of the securities of a company.”  Also, Section 28(2) of the Act states that just about any document that offers sale of shares will be considered to be a prospectus.

Need for a clear and transparent prospectus

A prospectus is of paramount importance to both companies and investors as it offers a clear view on the securities offered. The document helps in both the companies and investors identifying the right match. Therefore, a prospectus must always be clear, transparent and true. Even if there are future predictions or projections that are mentioned in the prospectus, they must be reasonable. 

Will inaccurate future projections fall under ‘misrepresentation’?

Misrepresentations in prospectuses warrant punishment and the Companies Act has provisions for the same. Now, blatant false statements in the document can be easily deemed to be misrepresentation and be punished. 

But, the situation gets tricky when there are future projections made. The question arises as to when future projections will be deemed to be misrepresentation. It is obvious that not all future projections will be accurate. Therefore, the issuer of a prospectus will not be held responsible for every minor error. Rather, he will be held liable when false statements are not made in good faith. The basis and materiality of the statement will be examined to determine the same as has been laid down by the National Company Law Tribunal (NCLT) in various cases.

Liability in case of misrepresentations

The liability for misrepresentations in a prospectus can be either civil or criminal or both. Civil liability will occur when an individual has suffered damage because of buying shares on the basis of misrepresentations in the prospectus. Here, a lawsuit under Section 37 of the Companies Act can be filed and the issuers of the prospectus will be punished under Section 447. The aggrieved property can also call for rescission of contracts and other relationships with the company. 

Criminal liability will also arise in case of misrepresentation as all individuals who authorize the misstatement in the prospectus will be liable for fraud. Punishments will include imprisonment for a minimum of six months and a maximum of ten years along with a fine. It is noteworthy here that apart from civil or criminal liability, action can also be taken under the Indian Contracts Act, 1872 which defines misrepresentation under Section 18. So if misrepresentation is proved, all the contracts that are signed with regard to the prospectus will become voidable at the option of the investor. Also, compensation can be claimed under Section 75 of the Contracts Act. 

Who can be held liable for misrepresentations in the prospectus?

Every person who has given consent to the prospectus by signing will be held liable in case of misrepresentations. This could be all those concerned with the management of the company like directors, managers, secretaries, etc.

Exceptions from liability

An individual or the issuer of a prospectus can escape liability for misrepresentation in a prospectus if he can prove materiality in his statements and that he had ‘reasonable grounds to believe that the statement was true or the inclusion or omission was necessary and believed in it at the time of issue of the prospectus’. Similarly, if he can prove that the prospectus and the statement was made without his authority, consent or knowledge, liability can be escaped from.

Conclusion

It is necessary for every company to understand that the prospectus is a crucial document in which misrepresentations will only cause harm rather than good. Complete transparency will lead to getting the perfect investor while also ensuring smoothness in how the company runs and therefore, great care must be taken while drafting it.