ProspectusShare Capital

&Borrowings

An Invitation to the public: The Prospectus

A public company issues PROSPECTUS to invite public to subscribe to its share capital

The Document U/Sec. 2(36) which includes:

• any notice, circular, advertisement or other documents for inviting deposits fromdeposits from the public, or • for inviting offers from theinviting offers from the public for purchase of shares or

debentures

• Ex. An advertisement in news-paper – some shares are available for sale- held as a prospectus

•Before issued of a prospectus the following steps are required:

• appointment of bankers, auditors, secretary, brokers etc• arrangements for listing of shares on stock exchanges

Who decides the time of issue of prospectus?

The Board of directors after considering:

•conditions of the capital market,

•investors’ mood,

•fiscal and monetary policies of the Government and

•state of business conditions.

Contents of a prospectus•Three parts:•First part: Salient features of the prospectus

•(name and address of the company , name of the stock exchange,date of opening and closing of the issues,capital structure, terms and particulars of the present issue, promoters and their backgrounds, nature of the products and the future prospects of the Co. etc.)

Part two: General information, financial, statutory and other information

(Consent of the directors, managers ,Procedure and time schedule for the allotment and issues of certificate, minimum subscription, etc..) Part three: Explanations of certain terms and expressions used.

Statutory requirements for issue of prospectus •It should be dated.

•Consent of the Experts (Engineers, accountants and valuers etc.)- Express statement- consent is not withdrawn

•Prospectus should be filed with the Registrar of Companies on or before its publication. •Disclosures as per SEBI guidelines to protect the interests of investors

Registrar of Companies - may refuse registration• if not dated •does not comply Schedule II of the Companies Act

Liability for untrue/mis- statement in the Prospectus ( Sec 62-63)

What mis-statement ?

A Statement – Untrue or misleading material facts affecting the privileges and advantages OR An omission calculated to mislead

•Ex. Statement about rate of dividends paid -literally true-•However, dividends not paid out of trading profits but out of realised capital profits-

•false statement - liable for fraud

Remedies

•Prospective shareholders - entitled to all true and honest disclosure

•persons issuing prospectus must state every thing accurately and not to omit material facts

•who subscribe on the faith and if any misrepresentation or •omissions in prospectus is calculated to deceive - are entitled for remedies

•against the company,directors,promoters and the expertsagainst the company,directors,promoters and the experts..

•Civil liability of person who authorized the issue of prospectus Civil liability of person who authorized the issue of prospectus

•Criminal liability of person who authorized the issue of prospectus Criminal liability of person who authorized the issue of prospectus

•Liability of Co. Liability of Co.

Remedies against the Company

• Parties may cancel/refuse the contract to take the shares

• Get back their money with interest

• Claim for damages (Pecuniary compensation )-compensate loss suffered so for as money can do.

• In practice:• claim against company is generally for cancellation of contract

of allotment• claims against director, promoter , expert or other persons are

for damages

Remedies against Directors/Promoters or persons responsible for issue of prospectus

• An allottee of shares can claim damages for fraudulent misrepresentation/ untrue/misleading statement-

1. Liability for damages under the general law

• Contract/tort/civil wrong of deceit/fraud for fraudulent statement with

intention to deceive

• directors not liable if they honestly believed the statement to be true –up to the time of allotment

• Derry V. Peek-(1889 ) Prospectus contained that Co. is authorized to use steam for running the train – in fact it was subject to approval of Board of Trade – no fraud – honestly believed - consent of Board of trade - practically included in the authorization.

Fraud is proved - when false statement is made:

• Knowingly

• without belief in its truth

• recklessly, carelessly it be true or false

• Ex: Prospectus contains statement – object of debenture – to develop trade but in fact was to pay pressing liabilities

Liability of Directors etc. under Company Law

• Compensation for Untrue Statement under (Sec 62)

• Claim can be made for misstatement , whether fraudulent or innocent, if it is misleading or untrue-

• allottee need not to prove the fraud or knowledge on the part of director that statement was untrue.

Liability of Directors etc. under Company Law

• Damages for an omission of material facts ,Sec.56 (4)

• if prospectus does not include the matters in accordance to the provisions of Co. Act

• Immaterial - whether or not -omission made is false or misleading

• Exceptions

• No knowledge of the facts- omitted/not disclosed• Omission to disclose the particulars arose from honest mistake of

fact

Remedies against Expert

•Liable under same principle as a fraudulent statement made by Directors

•But liable only for his own untrue statementBut liable only for his own untrue statement ,Wrong Report Wrong Report /Wrong valuation/Wrong valuation which is the part of prospectus

•Not liable , if withdraws consent before delivery of copy of prospectus for registration

•Expert is not criminally liable for misstatement

Criminal liability for misstatement in Prospectus u/s 63

criminal liability for inducing public to subscribe - by making false statements/Untrue Statement in prospectus

•Directors/Promoters or Others ) responsible for issue of the prospectus is punishable:

•With fine up to Rs. 50,000, or

•With imprisonment up to two years ,or

•With both.

Problem

X Co. Ltd., intended to buy a rubber estate in Peru. Its prospectus contained extracts from an expert report giving the number of rubber trees in the estate. The report was inaccurate.

Will any shareholder buying the shares of the company on the basis of the above representation have any remedy against the company?

Can the persons authorising the issue of the prospectus escape from their liability?

In the event of any mis-statement in a prospectus,

Allottees have certain remedies against the company as well as against those persons responsible for issue of prospectus.

In the present case, the allottee shall have the right to claim compensation from the company for any loss that he might have sustained in terms of the value of shares.

But, his claim against those responsible for issue of prospectus shall not succeed since they made the statement on the basis of report of an expert whom they believed to be competent.See, Section 62(2)

However, the expert can be proceeded against.

Penalty for inducing public to invest money

Besides the liability for misstatement in the prospectus

•Every person fraudulently inducing the public to invest money•is punishable:

•with imprisonment for a term upto 5 years or

•with fine upto Rs.1,00,000 (one lac) or

•with both.(Sec 68)

•LIABILITY FOR INDUCING THE COMPANY TO ALLOT OR TRANSFER SHARES

•The Companies Act prohibits making of an application under a fictitious name for acquiring shares of a company or

otherwise inducing the company to allot or transfer any share to him or to any person in a fictitious name for fraudulent purposes , is liable and

•punishable with imprisonment for a term which may extend up to 5 years.(Sec 68 A)

•The provisions should be reproduced in every prospectus and application forms for share to be issued by the company to any person

What is Share?

Paid -up Capital is divided into a number of indivisible units of a fixed amount known as ‘share’.

A share entitles a shareholder:

• to receive dividends, •to exercise voting rights, •to participate in general body meetings, and

•a share in the surplus assets in the event of winding up of company etc.

•A share represents a ‘bundle of rights and obligations’.

•A shareholder is subjected to the obligations as per the Articles of association

•A share is, not a negotiable instrument

•The certificate of shares in not “shares” it is only a prima facie evidence of title to share;

•it gives the shareholder the facility of dealing in the market

Allotment of shares

Division of share capital into defined shares of a particular value

•It means appropriation (to devote money for special purpose), out of the previously un-appropriated capital of the company of a certain number of shares to a person

•An allotment to be valid should be made by proper authority

•The board of directors or a committee authorised by the Board,

•It should be against application in writing,

• should not be in contravention of The Companies Act, 1956 and any other law,

•It must be made within a very reasonable time and

•It must be communicated to the applicant

Share certificate A share certificate is a prima facie evidence of the title of the members to such shares.

It also serves as estoppels to the paymentIf the certificate states that on each of shares full amount has been paid -the company is estopped , as against the bonafide purchaser- from alleging that they are not fully paid.

•Share certificate must be issued under the common seal of the company affixed in the presence of two directors and the secretary or some other person appointed by the Board for the purpose

Share warrant

• A share warrant is a bearer document of title to shares specified therein

• is issued by the company against fully paid shares.

• A share warrant is treated as a negotiable instrument

•Only a public company limited by shares and authorised by articlesare allowed the facility of conversion of share certificate into share warrants

•Previous approval of the Central Government and the Reserve Bank of India is required

Forfeiture of shares

•Articles usually contain a provision to forfeit shares of a member who fails to pay his calls due -payment of the part of the issue price of the shares which has not been paid

•Forfeiture to be valid must be in accordance with the articles and against a proper notice

•Directors must pass a resolution forfeiting shares bona fide in the interest of company

•A forfeiture has the effect of termination of membership.

•Forfeited member continues to remain liable as a past member in case liquidation takes place within one year of forfeiture

•Normally, forfeited shares are re-issued

•If forfeited shares are not re-issued it may amount to reduction of share capital and normally require the approval of the Court

•The Board of directors may, on a request of a shareholder whose shares have been forfeited, cancel the order of forfeiture

Transfer of shares

• Shares are freely transferable, but subject

•to restrictions contained in Act or any other statute,

•to provisions of Memorandum and Articles of association of the company

•The Depositories Act, 1996 allows shareholders to opt for more convenient and speedy mode of effecting transfers

•A valid transfer must be lodged with the company through the prescribed transfer deed, duly executed and stamped

•It must be lodged with company within prescribed period

•In case a company refuses to register a transfer, an appeal may be made to the CLB

•within two months of the receipt of notice of refusal

•within four months from the date the instrument of transfer was delivered to the company ,where no notice is received

•Transfer of shares- subject to certain restrictions- introduced in the Companies Act vide Sec 108A to 108-I through the MRTP (Amendment) Act, 1991

Transmission of shares

•It is involuntary transfer of shares & it takes place in the event of death or insolvency of a shareholder.

•A simple letter of request •accompanied by proof of succession •entitles the legal representative for registration of the same in his name.

•No stamp duty is accordingly payable on transmission.

BORROWINGS Incidental to Trading Companies

• Trading company has an implied power to borrow- need not authorisation by Memorandum

•Non-trading company must contain an express power to borrow (how and by whom ) in Memorandum

•A public company can exercise borrowing powers bys its directors by means of resolution passed Board of Directors

•Articles provide certain restrictions on Director's powers to borrow

• The restriction on director’s power to borrow does not apply to temporary loans (loan repayable on demand or within 6 months from date of loan ) obtained from the company’s bankers

•Unauthorised Borrowings

Money borrowed without any power to borrowA. Borrowings ultra-vires the Co. A. Borrowings ultra-vires the Co.

•If No borrowing powers, any borrowing will be ultra-vires

•Borrowings beyond the limit fixed by the Memorandum

•Excess Borrowings shall be ultra vires the Co. •Null and void , not enforceable, no legal or equitable right against co. to recover the loan

•Cannot be ratified by a resolution passed by a company in a general meetings.

Borrowings ultra-vires the Company

LENDER’S RIGHTS AGAINST THE COMPANY

1. Injunction- suit for injunction restraining the company- from parting with the money-can get money if not spent and is in actual possession of the company

(Ex. Memo. contains no provision for borrowing-Dir. Borrowed for purchasing machinery- on knowing the fact-if steps are taken- injunction can be obtained against Co. to part with money)

2.Subrogation- substitution of one person to another-

If unauthorised money (ultra vires the Co.) is used in paying off company’s lawful debt-lender will be subrogated to the right of creditor who were paid off -can recover such money paid by Co.

3. Identification and tracinglender can claim property-purchased or money- if in the hands of co.in its original form – or claim proportionate share at winding up .(Ex. a machine purchased from unauhorised money can be taken into possession to realise the money)

4.Recovery of Damages

Suit against the dir. Personally for recovery of damages for exceeding their authority to borrow - but dir. not liable- if ulrta-vires borrowing could be discovered by memo. Or article

•Money borrowed in pursuance of ultra-vires object(If company has power to borrow - but borrowed for ultra-vires object- as power to borrow is always incidental to one of object- borrowing is ultra vires )

•Personal Guarantee by the director- liable to that extent even if loan is ultra-vires- but not liable for illegal loan/ purpose Not in Co.’s object

BORROWING ULTRA VIRES THE DIRECTOR BUT INTRA-VIRESC THE COMPANY

• Director exceeding the limit -If ratified by the company- Co liable to pay

•NOT ratified- general principle of agency will apply & Co liable if used for the benefit of co.- legitimate business use of the company

•Borrowing within the powers of company but Director misappropriate- or apply for unauthorised activities -

•company liable if lender does not know about the intended misuse of money•Lender knows money is borrowed for business – not Co.’s object- loan is ultra vires- invalid

Methods of borrowing

•Company may borrow money in the same manner as a natural person

•It may be loans from financial institutions and banks or by debentures, bonds (fixed amount of debentures ), public deposits•See, Sec 2(12)

•The borrowing may be secured or unsecured(with or without security ) .

•Secured Borrowing creates a charge on the assets of the the company

Creation of charge on the assets of the Company

•If money lender insist on some security

•Company can give by creating a charge on its assets

•Thus, Charge means transfer of an interest (right ) to lender in the assets of the company for the purpose of securing repayment of loan

•Company has power to create charge on its assets

•Lender has a right to enforce if amount of loan is not repaid

•Charges may be :

•Fixed Charge

•( transfer of interest/right in definite and ascertained assets/property -land and buildings, heavy machines fixed with the land etc- )

• Floating Charge is created on

•assets/ property of a company both present and future – • property which is constantly changing- stock in trade , raw materials etc- •company can deal with such property- without the consent of charge holder- until

some steps are taken to enforce the charge )

Crystallisation of floating charges

•conversion of floating charge into fixed charge

•floating charge crystalises:

•when the company ceases to carry on business

•when company goes into liquidation- wound up

•when the charge holder brings a legal action to enforce thesecurity on default to pay interest on due date

•On crystalisation company looses the right to deal with the property and charge holder can enforce the security charged to him