What are the Remedies Open to an Allottee who has Subscribed for the Shares on the Faith of Misleading Prospectus.

Misleading Prospectus: 

A prospectus constitutes the basis of the contract between the company and the shareholders and therefore, it must disclose all material facts which are likely to influence the decision of a prospective investor very accurately. It must not state as fact any matter or thing which is not so. Not only this, it must also not omit any material facts, A person who has subscribed ,to the shares of a company or , one who has been allotted shares on the basis of a mis-statement in its prospectus has got certain remedies against the company as well, as against the person or persons responsible for the issue of such. prospectus.

In order to call a prospectus a ‘misleading prospectus’, there must be misrepresentation of material facts and not of law or opinion. for example if a prospectus states that the company’s shares will be issued at a discount of 10 percent, it is a misrepresentation of law because as per Section 53,
shares can not be issued at a discount, and a person, deceived by it will have no remedy.

Further, opinion given by the directors does not constitute mis – statement. For example, if the directors state that in their opinion, the. ,company
would be able to pay dividend in the very first year of its operations, it would not constitute mis-statement.

Remedies for Mis-statement and Omission in a Prospect: 

The remedies available to a person who has Subscribed for shares on the faith of a misleading prospectus, ,may be grouped into two categories

  1. Remedies against the company.
  2. Remedies against the directors, promoters and experts.

Remedies against the company: 

The following two remedies are available to an injured party against the company for misrepresentation in the prospectus under general law :

Rescission of the contract to take or accept shares: For this, the shareholder has to seek the remedy within a reasonable time and has to
surrender the shares to the company. Further, these conditions must be satisfied:

  • The prospectus was issued by the company or on its behalf by the directors or it was deemed to be a ‘prospectus issued by the company by implication’ under Section 25 or Section 28.
  • The prospectus contained a misrepresentation of facts, and not of law or of opinion.
  • The misrepresentation was material and related to such fads as ate likely to influence the judgement of the prospective investor
  • It must be proved that the subscriber actually relied upon the mis-statement while applying for shares.

Loss of the right of rescission : The right of rescinding the contract however, is lost under the following circumstances.

  • If the allottee does not start the proceedings within a reasonable time after coming to know of the misrepresentation.
  • If he expressly or impliedly affirms his contract after becoming aware of the falsity of the statement e.g., accepts dividend, pays calls money or tries to sell the shares.
  • If the company goes into liquidation before lie has started the proceedings to rescind the contract.
  • If he is a man of such experience that he is not likely to be misled by the mis-statements.

Damages for fraudulent mis-statement or concealment : Any such person induced by such statement or omission is also entitled to sue the company for damages. For this, he has to first rescind his contract and give
up or surrender his shares to the company, as an allottee of the shares cannot claim damages and also, side by side, retain his shares. But to avail this remedy, the subscriber must prove : (i) that the mis-statements were
made fraudulently, and (ii) that he has actually been deceived, in addition to proving other facts necessary to succeed in a suit of rescission.

The usual claim against the company is for rescission of the contract of allotment. Damages are generally claimed from the Directors, Promoters and other persons who had authorized the issue of the prospectus
personally, or from experts who had signed the report referred to in the prospectus.

Remedies against the directors, promoters and experts: 

The liability of the directors, promoters, etc. for a misleading prospectus can be studied under the following heads:

  1. Civil liability
  2. Criminal liability

Civil liability: Where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and every person who

  • Is a director of the company at the time of the issue of the prospectus.
  • 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.
  • Is a promoter of the company;
  • Has authorised the issue of the prospectus; and
  • Is an expert referred tomn Section 26(5) of the Companies Act, 2013 shall be liable to pay compensation to every person who has sustained such  loss or damage. [Section 35 (1)1]

Criminal liability (Section 34): Criminal liability involves a fine or a term of imprisonment or both on the guilty party. Section 34 states that where a prospectus includes an untrue statement,  every person who authorizes the issue of such prospectus she be liable” under Section 447, unless he proves either

  • That the statement or omission was immaterial, or
  • That he had reasonable grounds to believe it to be true.

As per Section 447, any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term ranging from six months to ten years and shall also be liable to fine which shall not be less than the
amount involved in the fraud, but which may extend to three times the amount involved in the fraud. Where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.

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