Regulation of Companies: Raising of Capital Issue of Prospectus

    RAISING OF CAPITAL

    Raising of capital refers to the process of procuring capital funds that are undertaken by companies, governments, etc. Companies may raise capital either by means of a debt instrument or through the issuance of shares. Depending upon the structure of a company, the method of raising capital generally varies. Factors that affect the raising of capital by a corporate include management structure, governance and quality, strategies, and the purpose and funding requirements of the company.

    A public company may issue securities to the public either through a prospectus, or through private placement, or through a rights issue or a bonus issue after complying with the provisions of the Companies Act, 2013.[1]

    Public Offer

    Public offer refers to the issue of securities to the public by a public company for the subscription. A public offer may either be an initial public offer (IPO) or a further public offer (FPO) and must be through the issue of a prospectus. An IPO is when an issuer, who is not listed with any stock exchange, issues securities to the public, whereas a Further Public Offer is when an issuer, who is listed in either of the stock exchanges, issues securities to the public, i.e. the further issue of capital by a company. In addition, a public offer also includes an offer for sale (OFS) of shares by existing shareholders of the company. 

    Every public offer by a public company must be in dematerialized form as required under the Depositories Act, 1996.[2] Chapter III Part I of the Companies Act, 2013 as well as Regulation 4 to 8 and Regulation 26, Companies (Issue of Share Capital and Debentures) Rules, 2014 deal with public offer.

    Further, entry norms[3], i.e. the various available routes by which an issuing company may access the capital market through a public issue, are prescribed so as to protect investors by subjecting a company’s fundraising activities to certain entry requirements.

    An unlisted issuer company, when making a Public Issue,  must satisfy the requirements as specified in the respective entry norm, as applicable:

    1. Entry Norm I: Profitability Route – An Issuer shall have to comply with the following requirements:

      • Net Tangible Assets of at least INR 3 Crore in each of the preceding 3 years, of which not more than 50% are held in monetary assets. This requirement, however, is not applicable in cases where a public offer is made entirely through an OFS.
      • Minimum average pre-tax operating profit of INR 15 Crores in at least 3 of the immediately preceding 5 years.
      •   Net worth of at least INR 1 Crore in each of the preceding 3 years.
      • In case the company’s name has been changed within the preceding year, at least 50% revenue for the preceding 1 year should be from the activity suggested by the new name.
      •   Aggregate of the proposed issue and all previous issues made in a financial year, in terms of issue size, should not be more than 5 times its pre-issue net worth, as reflected in the audited balance sheet of the preceding financial year.

    2. Entry Norm II: QIB Route – Where an issue is made as per the book building route, at least 75% of the net offer made to the public should, mandatory, be allotted to Qualified Institutional Buyers (QIBs). Where the company fails to attain the minimum subscription requirements with regards to QIBs, subscription amount for that issue shall be refunded.  

    A listed issuer making a public issue, i.e. an FPO, is required to satisfy the following requirements:

      •   Where the company has changed its name within the last one year, at least 50% of the revenue for the preceding 1 year should be from the activity suggested by the new name.
      • The aggregate of the proposed issue and all previous issues made in the same financial year, in terms of issue size, should not be more than five times its pre-issue net worth, as reflected in the audited balance sheet of the preceding financial year.

    Further, any listed company failing to fulfil these conditions shall be eligible to make a further public offer by complying with QIB Route, as elaborated above. 

    Private Placement

    Private placement refers to the offer of securities or the invitation to subscribe to securities to a select group of persons by a company through the issue of an offer letter. Section 42, Companies Act, 2013 deals with the offer of securities by means of the private placement. Such an offer or invitation may be made to a maximum of 200 persons in any given financial year, excluding an offer to QIBs and employees of the company receiving securities under employees’ stock options (ESOPs).

    Rights and Bonus Issue

    Issue of Rights refers to the process wherein a company increases its subscribed capital by further issuing shares to such persons who, as on the date of the said offer, hold equity shares in proportion, as far as practicable, to the paid-up share capital of those shares. The process is undertaken by sending offer letters and is subject to Section 62(1)(a) of the Companies Act, 2013. It is, essentially, a means of raising capital from within the company’s existing shareholders. Similar to the process of preferential allotments, Companies Act, 2013 governs rights issue by private as well as unlisted public companies whereas a public listed company has to additionally comply with the ICDR Regulations as well. Further, a bonus share is issued when a company capitalizes its profits by transferring, from its reserves to the nominal capital, an amount equivalent to the face value of the share, a bonus share is issued. 

    PROSPECTUS

    Prospectus refers to any document described or issued by a company as a prospectus. It includes a red herring prospectus and a shelf prospectus as well as any notice, circular, advertisement, or other document inviting offers from the public for subscription or purchase of any securities of a body corporate.[4] It is an offer document which contains pertinent details such as the price and number of shares or convertible securities being offered. A prospectus must be registered with the Registrar of Companies (RoC) before the opening of the issue, in case the issue is fixed price, and after the issue closes, in case of a book built issue. A public company is entitled, by using a prospectus, to invite applications for its shares or debentures.

    Where an advertisement of the company’s prospectus is published, in any manner, the contents of the company’s memorandum with respect to the objects, liability of members, amount of share capital of the company, names of signatories and the number of shares subscribed by the and the company’s capital structure must necessarily be specified in it[5] and it must be in Form PAS-1.

    Kinds

    There are essentially 4 kinds of Prospectus, as described below:

    1. Abridged Prospectus refers to a memorandum containing such salient features of a prospectus, as specified by SEBI.[6] SEBI has provided the revised format for an abridged prospectus under Regulation 58 (1) and Part D of Schedule VIII, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 as Annexure I of its circular dated October 30, 2015.[7] Application forms for securities must be accompanied by an abridged prospectus.[8]
    2. Shelf Prospectus is a prospectus in respect of which the securities or class of securities included therein are issued for subscription in one or more issues, over a certain period, without the issue of a further prospectus. In simple terms, Shelf Prospectus is a single prospectus for multiple public offers. It allows an issuer to offer and sell securities to the public,  without the need of issuing a separate prospectus for each offering, for a certain period. It has to be filed with the RoC at the stage of first offer of securities and must indicate a period, not more than a year, as its validity period commencing from the date of opening of the first offer of securities.[9] Further, a company filing a shelf prospectus must also file an information memorandum containing all material facts with respect to new charges created and changes in the financial position of the company occurring since the first offer, or between two offers. If a company has received applications for allotment along with advance payments before the occurrence of any change, such information must be communicated to them and if such person desires to withdraw, their money must be refunded within 15 days.
    3. Red Herring Prospectus is one that does not include complete particulars of the quantum or price of the securities included therein. It contains most of the information pertaining to the company’s operations and prospects but does not include key details of the issue such as its price and the number of shares offered. A company proposing to make an offer of securities may issue a red herring prospectus. Further, it must be filed at least 3 days prior to the opening of the subscription list and offer.[10] A red herring prospectus carries the same obligations as that of a prospectus. 
    4. Deemed Prospectus refers to any document which contains an offer for sale of securities by the company to the public. All relevant sections relating to matters to be contained in the prospectus, liability for misstatements or omissions in the prospectus are applicable to deemed prospectus also.[11] Where a company makes a rights issue to its existing members with a right to renounce in favor of others, if the number of such others exceeds fifty (Now 200), it also becomes a deemed prospectus.[12]

    Contents

    Every prospectus must comply with the provisions of Section 26, Companies Act, 2013 and Rule 3 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 and must be issued by or under the authority of the company and must be signed and dated. The requirement for signature may be sufficiently met by two directors or at least half of the partners of the firm or company.[13]

    A prospectus must contain the following information:

    1. A fact sheet, containing the required details of the company and of the issue; 
    2. The object of the business and location of Issuer Company;
    3. Details of the corporate office of the company, its compliance officer, and the merchant bankers, co-managers, registrar, bankers, stockbrokers, credit rating agency, etc of the issue, and other persons as specified by SEBI; 
    4. Details of underwriters and the amount has underwritten by them;
    5. Details of directors 
    6. The capital structure of the company;
    7. Date of the opening and closing of the issue along with declaration about the issue of allotment letters and refunds;
    8. Objects of the issue; 
    9. The purpose for which funds would be utilized; 
    10. Funding plan;
    11. Summary of the project appraisal report, if any; 
    12. Project Implementation Schedule; 
    13. Interim use of funds, if any; 
    14. Procedure and schedule with regards to allotment and issue of securities;
    15. Minimum subscription and the amount payable on the premium;
    16. Declaration by the Board or the Committee authorized by the board stating that the allotment letters would be issued within 15 days of payment, failing which, the application money shall be refunded;
    17. Statements of the Board of Directors about separate bank accounts where receipts of issues are to be kept;
    18. Statement of the Board of Directors about the details of utilization and non-utilization of receipts of previous issues;
    19. Consent of the directors, auditors, expert opinions, trustees, solicitors or advocates, etc;
    20. Authority for the issue and details of the resolution passed for it;
    21. Particulars related to management perception of risk factors of the specific project, gestation period of the project, any pending legal action and other important details related to the project;
    22. Disclosures about sources of promoter’s contribution;
    23. Disclosure of details of any litigation or legal action pending or taken by any Ministry or Department of the Government or a statutory authority against any promoter of the issuer company during the last 5 years immediately preceding the year of the issue of the prospectus;
    24. Details of pending litigation involving the company, promoter, director, subsidiaries, group companies or any other person, whose outcome could have a material adverse effect on the position of the issuer; 
    25. Details of pending proceedings against the company for economic offences;
    26. The details of default and non-payment of statutory dues, etc.;
    27. The details of any inquiry, inspections or investigations initiated or conducted under the Companies Act in the last 5 years immediately preceding the year of issue of the prospectus in the case of company and all of its subsidiaries; 
    28. The details of acts of material frauds committed against the company in the last five years, if any, and if so, the action taken by the company.
    29. Reports by auditors of  the company with respect to its profits and losses and assets and liabilities, as specified;
    30. Reports about the business or transaction as to which proceeds are to be applied, directly or indirectly, as provided;
    31. The matters relating to terms and conditions of the term loans including re-scheduling, prepayment, penalty, and default;
    32. Disclosure of the aggregate number of securities of the issuer company and its subsidiaries purchased or sold by the promoter group as well as by the directors of the company which is a promoter of the issuer company and by the directors of the issuer company and their relatives within 6 months immediately preceding the date of filing the prospectus with the Registrar of Companies;
    33. The matters relating to material contracts and details of availability of such contracts and other related documents for inspection. 
    34. The summary of reservations, qualifications or remarks of auditors in the 5 financial years immediately preceding the year of issue of prospectus and of their impact on the financial statements and financial position of the company and the corrective steps taken and proposed to be taken by the company for each of the said reservations or qualifications or adverse remarks.
    35. Related party transactions entered during the 5 financial years immediately preceding the issue of the prospectus; 
    36. Statement regarding the compliance of provisions of the Act and a statement to the effect that nothing in the prospectus is contrary to the Companies Act, Securities Contract (Regulations) Act, and SEBI Act and the rules and regulations made under it.

     

    Process of Issue

     

    Misrepresentations and Misstatements 

    Where a prospectus contains misleading statements or representations, the liability fastened upon the issuer company, its directors, promoters, and all persons involved in the issue, maybe classified into three categories: civil liability, criminal liability and liability under the law of contract.

    Civil Remedies, provided under Section 35 of the Act, includes remedies against the company, such as rescission of contract and damages for fraud as well as against the promoters, directors, and experts under whose authority the prospectus was issued, including damages for misstatements or for non-disclosure of material facts. In order to prove fraudulent misstatement, however, the plaintiff must prove that the false representation was made either knowingly or without belief in its truth or recklessly, carelessly, whether it is true or not. [16] Further, to be entitled to damages for deceit, a plaintiff must prove that there was a fraudulent misrepresentation related to facts, which are material. It is also essential that the plaintiff should have taken the shares directly from the issuing company by means of the process of allotment. [17]

    Marital rape- An Oxymoron?

    Remedies under Criminal Law are provided under Section 34 of the Act,  as per which, where any prospectus contains a false statement, all such persons who authorized the issue will be punishable with either a fine of up to INR 50,000 or with imprisonment of up to 2 years or both. Further, any person making fraudulent misstatements in a prospectus, so as to induce persons to invest,  shall be punishable either with imprisonment of up to 5 years or with a fine of up to INR 1 Lakh, or both.

    Further, Section 447, Companies Act, 2013, entailing liability for fraudulent conduct.[18]. As per the provision, where a prospectus contains any statement which is untrue or misleading, with regards to the form or context of its usage, or where any inclusion or omission of a matter is likely to mislead, everyone authorizing such an issue shall be liable. In cases of fraudulent representations, no burden of proof falls upon the plaintiff and directors cannot escape liability even if such a statement was bona fide and not with the intent to deceive.

    However, directors are not left remedy-less. Section 35 of the Act iterates the following defences:

    1. That the Director withdrew consent to be a director before the prospectus was issued;
    2. That the Prospectus  was issued without the director’s knowledge, even if their name appears on it; 
    3. That the director was ignorant to the untruth of the statement; and 
    4. That the director had a reasonable ground to believe in the truth of the misstatement and believed so up to the time of issue of the prospectus that the statement was true or the inclusion or omission was necessary.[19]

     

    REFERENCES

    [1] Section 23, Companies Act, 2013.

    [2] Section 29(1), Companies Act, 2013. Mukesh Malhotra v. SEBI, (2005) 124 Comp Cas 336 (SAT)

    [3]Available at: https://www.sebi.gov.in/sebi_data/commondocs/subsection1_p.pdf.

    [4] Section 2(70), Companies Act, 2013.

    [5] Section 30, Companies Act, 2013.

    [6] Section 2(1), Companies Act, 2013.

    [7] Available at https://www.bseindia.com/downloads/whtsnew/file/SEBI%20Circular%20dated%2030_10_2015%20on%20Abridged%20Prospectus.pdf

    [8] Section 33, Companies Act, 2013.

    [9] Section 31, Companies Act, 2013.

    [10] Section 32, Companies Act, 2013.

    [11] Section 25(1), Companies Act, 2013.

    [12] SEBI v. Kunnamkulam Paper Mills Ltd, (2013) 178 Comp Cas 371 (Ker).

    [13] Section 25(4), Companies Act, 2013.

    [14] Section 27, Companies Act, 2013.

    [15] Rule 11, Companies (Prospectus and Allotment of Shares) Rules, 2014.

    [16] Derry v. Peek (1889) LR 14 AC 337.

    [17] Peek v. Gurney, (1873) LR 6 HL 377.

    [18] MK Srinivasan v. Emperor, 1944 MWN (Cri) 80.

    [19] TH Chowdary v. Registrar of Companies,(2014) 182 Comp Cas 13 (AP).

    BY- Abhilasha Bhatia | Amity Law School, Delhi

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