Aschematic arrangement of multiple contracts gives birth to a corporation. Post the infamous and, the legislature acknowledged an inherent need to strengthen the liability of corporate officials and directors. As a result, Companies Act, 2013 was conceived. This act brought a paradigm shift in liability of chief officials of a corporation. This paper primarily focuses on the issue of prospectus and the liability surrounding a mis-statement in the prospectus.
Directors of a company face multiple liabilities vis-a-vis the significance of their position in the company. One such liability would be the one incurred due to misstatement in prospectus. However, it is essential to highlight that not only the directors but the promoters and the company itself are liable for issuing a misstatement in prospectus.
Section 2(70) of the Act, defines ‘prospectus’. It essentially refers to a document that is issued to the public for subscription of shares and debentures of a company. All such documents that offer such subscriptions are deemed as prospectus. They are the fundamental contracts between a company and the people who invest in its shares and debentures. Owing to their substantial importance, a golden rule was formulated in New Brunswick and Canada Railway and Land Co. v. Muggeridge, wherein the court spelt out the three pillars of drafting a prospectus. Firstly, disclosures of the true nature of a company have to be made. Secondly, representations in the prospectus have to be accurate as the person who invests in the company acts on them. Thirdly, a voluntary disclosure of facts, those are institutional for the fair investment by the public.[i]
The approach of this paper is three faceted. Primarily, we have analysed the provisions of liability envisaged in Companies Act, 2013 and their corresponding sections in the 1956 Act with regard to misstatement in prospectus. In doing so, we have discussed the scope of civil and criminal liability. Secondly, we have discussed the role of minor as a promoter in issuing a misstatement in the light of Supreme Court Judgement in Ritesh Agrawal V SEBI. Thirdly, we have discussed the order of SEBI slapping a Rs 85 crore penalty in the DLF-IPO disclosure case making the order an unprecedented one.
Civil Liability for Misstatement
As per the provisions of section 35 of the Companies Act, 2013, a person authorising the issue of the prospectus containing untrue statements would be liable to pay compensation to every person who had subscribed for any securities relying on such misstatements. This would include Directors of the company or any person who is named as director in the prospectus, promoter, any person who has authorised the issue of prospectus or is an expert within the meaning of sub-section (5) of Section 26 of the Act.
However, for a director to escape liability under sub-section (1) of Section 35 of the act, it has to be proved that having consented to become a director of the company, the person withdrew consent before the issue of such prospectus containing misstatements, and that such prospectus was issued without his knowledge, authority or consent. For an expert to escape liability, it has to be proved that the prospectus was issued without his knowledge or consent and he issued a public notice stating that such prospectus was issued without his knowledge and consent on becoming aware of its issue. Section 34 of the 2013 Act corresponds to Section 62 of the 1956 Act.
Criminal Liability for Misstatement
Section 34 of the Companies Act, 2013, incorporates criminal liability against every person who authorises the issue of a prospectus which includes untrue or misleading statements or where any inclusion or omission of any matter is likely to mislead. Such person shall be held liable for fraud under Section 447 of the Indian Penal Code. Proviso to this section states the exceptions from criminal liability – if the person authorising the issue proves that such untrue statement or omission or inclusion was immaterial or that he had reasonable grounds to believe that the statement was true and the inclusion or omission was necessary. Section 35 of the 2013 Act corresponds to Section 63 of the 1956 Act.
Promoters are defined in section 2(69) of the Act. As noted in the language of law, the directors along with the promoters are liable if a misstatement is found in the prospectus. Promoters incur civil and criminal liability for issuing a misstatement or untrue statement in the prospectus. Although, the provisions state grounds using which the promoters could evade liability, there is ambiguity regarding the position of minors.
Facing such a dilemma, Supreme Court was approached by Ritesh Agrawal. He was a minor when the prospectus was issued to the public. His father, Surendra Agrawal was a promotor of Reteish Polysters Limited, company which was later accused of making untrue statements in its prospectus. Owing to certain contributions made on behalf of him, he was deemed to be a promoter of the company. Subsequently, irregularities in the prospectus surfaced and SEBI after enquiry directed the company to disassociate from the market and all related activities for a period of ten years and a penalty was imposed upon the directors, promoters and the company.
The issue before court was whether a penalty could be imposed upon Ritesh Agrawal for breach of his duties as a promoter and holding him liable for issuing untrue statements in the prospectus. The Court held in the negative. Strong reliance was placed on the Indian Contracts Act, 1872. It was observed by the court that Surendra Agrawal who was the father had suppressed the fact that his sons were minors at the time of making them promoters. Hence, SEBI should take action against him. Further, the court emphasised that since a minor is not capable of making a promise or an offer, he is not capable of entering into a contract. Therefore the contract would be void. The Indian Contracts Act supports this position as section 11 clearly states that for a person to enter into a contract, he must have attained majority. Hence, a minor could not be held guilty for the irregularities in prospectus.
There is ambiguity surrounding what is to be construed as material information and has to be inspected along with the facts and circumstances of each case.
This issue can be addressed through an analysis of the SEBI order in the DLF case. The chain of events began in 2007 when DLF in its initial public offer suppressed material information including one ‘sham transaction’ with an associate company ‘Sudipti Estates’.
Reportedly, DLF raised around Rs 9,000 crores in its IPO. Interestingly, an FIR was lodged by an individual after the associate Sudipti Estates reportedly cheated him of a few crore rupees in a land transaction.
It was asserted that there was a camouflage of association between Sudipti and DLF which degraded the integrity of the market. Multiple subsidiary companies were functional under DLF and the binding point was suppression of material facts regarding transactions, nature of business, pending litigation amounting to mis-statement and mis representation. Moreover, it was observed that there was deliberate and active suppression of facts giving rise to fraud. Here, the cumulative effect can be witnessed by the investor as he is deprived of the choice of making an informed decision.
Considering these reasons, SEBI slapped a Rs 85 crore penalty on DLF and its executive directors, functionaries etc holding them liable for the misstatement. Although, the order is under appeal, it brought a big hope for justice in Indian Corporate Market.
The rosy picture painted to the investor is not always true. Keeping the same in mind, the legislature affirmed the stringent provisions of liability of directors, promoters and company for misleading the public. Law makers have developed various investor protection schemes to curtail the losses suffered because of mala fide intentions of a company. A neutralisation reaction is maintained through defenses present with corporate bodies and officials. The most commonly used is of a reasonable belief that the statement was true. Further, the recent orders of SEBI and Supreme Court have shown the progressive nature of the statute and its intention to serve the common public. Arguably, the act has put the public on a high pedestal by extending liability, penal actions and consequences of the directors and corporations.
The writers are fourth-year students of the West Bengal National University for Juridical Sciences, Kolkata.