January 23, 2022

Misstatement and Liability of Misstatement in a Prospectus

Companies Act

Misstatement or Untrue statement

If a company provides for misleading statement or omits any matter which misleads, then this shall constitute as an untrue statement or a mis-statement.[1]The Companies Act does not provide any exact definition of such untrue statement in its definition clause, it can be understood through the medium of various precedents.

For the purpose of holding a prospectus fraudulent, it’s not necessary for a false representation to be present, the mere suppression of facts renders the whole prospectus fraudulent. To know the effect of it, the prospectus should be read as a whole.[2]

Liabilities in case of Mis-statement or Untrue statement

Untrue statement accounts for two kinds of liabilities:

1.Criminal liability, and

2. Civil Liability

Criminal Liability

Any prospectus which is untrue is a mis-statement then every person who authorises it would be liable under section 447 of the act.[3]

Section 447 of the act states that any person guilty of fraud shall be punishable with an imprisonment for a term not less than six months but may extend to ten years and shall also be liable to a fine which shall not be less than the amount of the fraud and can be extended to three times of it.[4]

Although a person can defend himself if he can prove the following things:

  • Omission or the untrue statement was immaterial
    • There were reasonable grounds to believe that the statement was true and the grounds continued up to the time of the issue of the prospectus.
    • The inclusion or the omission was necessary.

Civil Liability

The following civil remedies are available for mis-statement or untrue statement:

  1. Recission of the contract

An original allottee can rescind the contract if it has been made by mis-statement be it innocent or fraudulent. By the essential requirement s of this would be:

  • There is a false representation in the prospectus
  • The false representation is of fact and not that of law
  • The allottee must have relied and acted on the false statement
  • The prospectus was issued by the company or with someone with the authority of the company.

In R v. Kylsant, the whole prospectus was held to be false not because of what is stated but due to the things it did not state.[5]

Limits of recession and loss of right

Although the option of rescinding is available but there can be a loss of this right, if

  • The allottee with the knowledge of misrepresentation affirms the contact.
  • If There is an unreasonable delay in rescinding the contract.
  • If there is commencement of winding up of the company.
  • If the company has become insolvent, irrespective of whether winding up has commenced or has not.

2. Damages for deceit

An original allottee can claim damages for the loss caused due to the untrue statement of misrepresentation.

To claim damages on the basis of deceit, fraud must be proved which can be proved by showing that the false representation has been made:

  1. Knowingly
  2. Without belief in truth
  3. Recklessly, whether true or false, as said by Lord Herschell in Derry v. Peek[6]

3. Liability for omission under section 26

Section 26 states the particulars to be stated in the prospectus and imposes penalty for its contravention. The section does not entitle an allottee to rescind the contract by reason merely of the omission of any of the facts required to be disclosed by the section provided there is no fraud or misrepresentation within the meaning of section 17 and 18 of the Indian Contract act, 1872.

If the prospectus is issued in contravention of Section 26 (it does not contain the particulars which have to be stated in the prospectus) , the company shall be punishable with fine which shall not be less than rupees fifty thousand but can be extended to three lacks rupees and a person who knowingly is a party to such prospectus shall be punished with an imprisonment for three years or with fine which shall not be less than fifty thousand rupees and can be extended up to three lacks rupees or can be punished with both imprisonment and fine.

4. Compensation for untrue statement under section 35

Persons mentioned under section 35 are personally liable to compensate the investor for any loss sustained by due to untrue statement in the prospectus. Those people are:

  1. Ever person who is a director of the company at the time of the issue of the company.
  2. Every person who 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.
  3. Every promoter of the company
  4. Every person who authorised the issue of the prospectus, and
  5. An expert

Defences against Misstatement

Although the following defences are available to these people:

1. Withdrawal of consent:

A person who has consented to become director will not be liable if he proves that he withdrew his consent before the issue of the prospectus and it was issued without his authority or consent.

2. Issue without knowledge:

A person will not be liable if he proves that the prospectus issued without his knowledge or consent, and that on becoming aware of its issue, he forthwith gave reasonable public notice that it was issued without his knowledge or consent.

3. Reasonable ground for relief

A person will not be liable if he proves that he had reasonable ground to believe that the statements were true and believed them to be true.

4. Statement of experts

A person will not be liable if he proves that the statement was correct and fair summary of an expert report.

5. Fair copy or fair extract from an official document:

A person will not be liable if he proves that the statement represented a fair copy or fair extract from an official document or from the statement made by an official person.

Conclusion

Hence, it can be seen that the prospectus of the company is a very vital document for a company. And a lot of factors have been considered by the law makers to make sure that there is no scope for any individual or the company for that matter to escape any liability which make take place.

Thus, the prospective of the company makes sure that there is effective and efficient working in the company.


[1] The Companies Act,2013, s. 65(1).

[2] (1949) Comp. Cas. 193 (Mad.).

[3] The Companies Act,2013, s. 34.

[4] The Companies Act,2013, s. 447.

[5] (1932) 1KB 442

[6] (1889) 14 AC 337.


Author Details- Bhavi Mago [Student, Vivekananda Institute of Professional Studies]

Law Library LawBhoomi

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