Companies Act Section 35

Companies Act Section 35: Civil Liability for Misstatements in Prospectus

1. Liability for Misleading Statements in a Prospectus

Under Section 35 of the Companies Act, civil liability is imposed on certain individuals and entities for any misleading or inaccurate information in a prospectus that leads to financial loss or damage for those who subscribe to a company's securities. 

The provision is designed to safeguard investors from false or incomplete representations made by a company or its agents when issuing securities, ensuring transparency and accountability in capital markets.

General Rule:

When a company issues a prospectus to raise capital, it is expected to present truthful and accurate information regarding its financial status, operations, and the nature of the securities being offered. 

If a person subscribes to the securities of a company based on a misleading statement in the prospectus, or due to an omission that should have been disclosed, and suffers financial loss or damage as a result, then the company and the individuals responsible for issuing the prospectus are held liable for the resulting loss. 

These individuals include:

Directors:  

Every director of the company at the time the prospectus was issued is held accountable for ensuring that the information in the prospectus is accurate and not misleading. 

If a director fails in this duty, they may be liable to compensate affected investors.  

Prospective Directors:  

Any individual who authorized their name to be listed in the prospectus as a future director, or who has agreed to become a director at a later date, may also be held responsible. 

This provision ensures that individuals who are not yet officially directors but are involved in the issuance of the prospectus cannot escape liability.  

Promoters:  

Promoters of the company those involved in the formation and establishment of the company are also liable if they are responsible for any misleading information in the prospectus.  

Persons Authorizing the Prospectus:  

Any person who authorized the issuance of the prospectus is held accountable. This can include individuals involved in creating and disseminating the prospectus, even if they are not company directors or promoters.  

Experts:  

Experts who provided statements, reports, or valuations included in the prospectus, as specified under subsection (5) of Section 26, are also liable for any misleading or incorrect information based on their assessments.

The liability imposed on these individuals is in addition to any other penalties or consequences under Section 36 of the Companies Act, which may involve criminal liability for fraudulent misstatements.

2. Defenses Against Liability

Although the law imposes strict civil liability for misstatements in a prospectus, it also provides certain defenses to protect individuals who were not responsible for the false or misleading information or who acted in good faith. 

These defenses are crucial in distinguishing between those who were actively involved in the misstatement and those who had no knowledge or involvement.

Valid Defenses:

Withdrawal of Consent Before Issuance:  

If a person had initially consented to be a director of the company but later withdrew their consent before the issuance of the prospectus, they can defend themselves against liability. 

However, the individual must prove that the prospectus was issued without their authority or consent. 

This defense is important for individuals who may have had a change of heart or circumstances and did not wish to be associated with the company at the time of the prospectus issuance.  

Unawareness of Prospectus Issuance:  

If a person was entirely unaware of the fact that a prospectus was being issued and upon discovering its issuance, they promptly issued a public notice disclaiming their involvement, they may also avoid liability. 

The key element of this defense is the individual’s quick and reasonable response in issuing the public notice to distance themselves from the prospectus, indicating that they had no role in its issuance.  

Defense for Experts:  

Experts, such as accountants or valuers, who provided reports or valuations used in the prospectus, may not be held liable for misleading information if they can prove that their statements were correct at the time they were made. 

Furthermore, the expert must demonstrate that they had reasonable grounds to believe that the person making the statement in the prospectus was competent and that they consented to the prospectus being issued. 

If they had not withdrawn their consent before the document was filed with the Registrar or before any securities were allotted, they are not liable. 

This defense is critical for professionals who may be relied upon for technical information but are not involved in the overall management or operations of the company.

3. Fraudulent Intent and Unconditional Liability

In situations where it is proven that a prospectus was issued with the intent to defraud applicants or any other person, or for any other fraudulent purpose, the liability of the individuals involved becomes absolute. 

This section provides for unconditional liability when fraud is involved, meaning that all those who participated in issuing the fraudulent prospectus will be personally liable without limitation for all losses or damages suffered by those who subscribed to the securities based on the prospectus.

Unconditional Personal Liability:

If a prospectus is issued with fraudulent intent, the directors, promoters, prospective directors, and other persons involved cannot rely on any defenses to avoid responsibility. 

In such cases, the law imposes severe consequences to deter fraudulent behavior and protect investors from being deliberately misled by false or deceptive information.

Extent of Liability:  

All individuals referred to in subsection (1) including directors, promoters, and those authorizing the prospectus will be held personally liable for all losses or damages incurred by any person who subscribed for securities based on the fraudulent prospectus. 

This personal liability is significant, as it strips away any protections normally afforded by corporate structures, such as limited liability, and holds individuals fully accountable for their actions.