Civil Liability for Misstatements in a Prospectus by Company

A company’s prospectus serves as a critical document that provides potential investors with key information about the company’s operations, financial position, and future prospects. Since investment decisions are heavily influenced by the contents of a prospectus, any false or misleading statements in it can cause financial harm to investors. Section 35 of the Companies Act, 2013, establishes the civil liability for any misstatements made in a prospectus, holding responsible individuals accountable for compensation if investors suffer losses due to such misleading information.

This provision is a significant departure from general contract law, as it imposes a statutory obligation on certain individuals connected with the company to compensate investors for their losses, over and above the principles of liability found in the Indian Contract Act, 1872.

Persons Liable Under Section 35

Section 35(1) lists the individuals who bear responsibility for misstatements in the prospectus. These include:

• The company issuing the prospectus
• The directors in office at the time of issuance
• Any person who has agreed to be named as a director in the prospectus
• The promoters of the company
• Any individual who has authorized the issuance of the prospectus
• Experts such as auditors, accountants, valuers, or legal advisors, whose statements are included in the prospectus

If any misrepresentation is found in the prospectus, all these individuals are jointly and severally liable to compensate investors for losses suffered due to the misleading information.

Defences Available to Those Held Liable

Section 35(2) provides certain defenses for individuals who are facing claims under this provision. A person accused of issuing a misleading prospectus may escape liability by proving that:

1. They had withdrawn their consent to be a director before the issuance of the prospectus, meaning their name was used without proper authorization.
2. They were unaware that the prospectus was issued and took prompt action by publishing a public notice once they discovered their name had been associated with it.
3. They had relied on statements made by an expert, believing them to be true, provided that:
   • The expert had consented in writing to the inclusion of their statement in the prospectus.
   • The expert had not withdrawn their consent before the prospectus was filed with the Registrar of Companies.

These provisions ensure that genuine and innocent individuals are not held liable for misstatements they had no control over.

Intentional Misstatements and Unlimited Liability

Section 35(3) specifically addresses cases where misstatements in the prospectus are intentional and fraudulent. In such instances, those found responsible are liable for unlimited compensation, meaning they must personally bear all losses and damages suffered by investors.

To invoke this enhanced liability, it must be proven that the misrepresentation was made fraudulently, with intent to deceive investors. This means the state of mind of the accused person plays a crucial role in determining liability. Unlike cases of negligent misstatements, where liability may be limited, fraudulent misrepresentations eliminate any contractual limitation of liability that may have been agreed upon.

Regulatory Oversight and SEBI’s Role

 The Securities and Exchange Board of India (SEBI) has been entrusted with enforcing the provisions of Section 35. If a company or its promoters issue a fraudulent or misleading prospectus, SEBI can initiate punitive action under the SEBI Act, 1992. The Issue of Capital and Disclosure Requirements (ICDR) Regulations mandate that Section 35 must be reproduced in full in both the Prospectus and the Abridged Prospectus, ensuring transparency and investor awareness.

Judicial Interpretation and Case Law Precedents

Courts have analysed misstatements in prospectuses to differentiate between mere predictions about the future and misrepresentations of present facts. A key distinction is that:

• A mere promise or forecast about future events does not constitute a misrepresentation.
• A false statement about an existing fact, particularly regarding the intended use of funds raised from investors, amounts to a misrepresentation.

This principle was established in Bentley v. Black (1893) 9 TLR 580 (CA), where it was held that future profit projections are not statements of fact. However, in Edgington v. Fitzmaurice (1885) 29 Ch D 459, the court ruled that a misrepresentation about how the funds raised in the prospectus would be utilized is a misstatement of present fact, making those responsible liable for deception.

Liability for Omissions in a Prospectus

 Section 35 not only covers false statements but also omissions of material information. If a company fails to disclose key facts in its prospectus, and investors suffer losses as a result, the directors and other responsible individuals may be held liable for damages.

The measure of damages is typically calculated as:

• The difference between the actual value of the shares and the value they would have had if the prospectus contained truthful disclosures.

This ensures that investors who relied on misleading prospectuses are adequately compensated for their losses.

Relationship with Other Legal Provisions

The liability imposed by Section 35 does not diminish or override any liability under other laws. Any individual who issues a fraudulent prospectus can also face consequences under:

• Section 447 of the Companies Act, 2013, which deals with fraud and imposes criminal penalties.
• Section 62 of the Companies Act, 1956, which allowed investors to seek compensation through civil courts for losses arising from misstatements.

These overlapping provisions reinforce the legal safeguards available to investors and ensure that companies and their promoters remain accountable.

Conclusion

Section 35 of the Companies Act, 2013, serves as a critical investor protection mechanism by holding companies and their key personnel accountable for misstatements in prospectuses. The law establishes a statutory obligation to compensate investors, going beyond contractual liability principles.

While the provision offers defences to innocent individuals, it imposes severe penalties on those who intentionally mislead investors. The role of SEBI in regulating prospectuses further strengthens investor confidence in the securities market.

By enforcing civil liability for misstatements, Section 35 promotes transparency, ethical corporate behaviour, and responsible investment practices. It ensures that investors can make informed decisions based on accurate and complete disclosures, thereby safeguarding the integrity of financial markets.

Related Resources

• Section 35, The Companies Act, 2013 
• Section 447, The Companies Act 2013