12.5.17 Civil Liability

Where a prospectus is issued inviting persons to subscribe for shares in, or debentures of a company, the following persons shall be liable to pay compensation to every subscriber for loss or damage he may have sustained by reason of any untrue statement included in the prospectus on the faith of which he had applied for the shares or debentures:

            (1) every person who is a director of the company at the time of the issue of the prospectus;

            (2) every person who has authorised himself to be named and is named in the prospectus as a director, or as one having agreed to become a director, either immediately, or after an interval of time;

            (3) every promoter of the company; and

            (4) every person (including an expert) who has authorised the issue of the prospectus. But an expert is liable only in respect of his own untrue statements.

Thus, an allottee of shares, who had applied for shares on the faith of prospectus containing untrue statements has remedies available against the different persons, i.e., the company, directors, promoters and experts.

Remedics against the company. Any person who, relying on mis-statements in or omission of material facts from a prospectus, takes shares from the company may: (1) rescind the contract to take the shares; (2) claim damages. The effect of the rescission of the contract would be that the shareholder would give up the shares and get back his money with interest. He must, however, take action to rescind to contract: (a) within a reasonable time, (b) before proceedings to wind up the company have commenced; and (c) before he does anything (after he comes to know of the mis-statements in the prospectus), which is inconsistent with the right to repudiate, e.g., to accept dividends. The allottee can claim relief only if he can show that the mis-statement or omission was: (i) one of fact and not of law, nor an expression of opinion, (ii) material; and (iii) acted upon by him.

The second right of the allotte against the company is to sue for damages for deceit. In order to succeed, the allottee must, in addition to the three facts mentioned above (in connection with the rescission of contract), prove: (i) that those acting on behalf of the company acted fraudulently; (ii) that those purporting to act on behalf of the company were authorised to act in its behalf; and (iii) that he suffered a loss or damages.

It is important to remember that the allottee cannot both retain the shares and get damages from the company. In actual practice, suit for damages against the company is rarely filed. 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 authorised the issue of the prospectus personally, or from experts who had signed reports referred to in the prospectus.

Remedies against directors or promoters. A shareholder who had been induced to take shares may claim from the directors or promoters or from any one else responsible for untrue statement occurring in the prospectus: (i) damages for fraudulent misrepresentation; (ii) compensation under s.62; (iii) damages for non-compliance with the requirements of s.56 regarding contents of the prospectus.

Damages for fraudulent misrepresentation. An allottee of shares may bring an action for deceit, i.e., fraudulent misrepresentation. There must be an intention to defraud and that is to be proved by him. The directors, etc., will not be liable for the tort of deceit if they honestly believed the statements to be true. The facts in Derry v. Peek

were as follows: The directors of a Tramway Company issued a prospectus stating that they had the right to run tram-cars with steam power instead of with horses as

before. In fact, the Act incorporating the company provided that such power might be used with the sanction of the Board of Trade. But the Board of Trade refused to give permission and the company had to be wound up. P, a shareholder sued the directors for damages for fraud, The House of Lords held that the directors were not liable in fraud because they honestly believed what they said in the prospectus to be true.

Compensation for untrue statement (s.62). Another remedy available to an allottee of

shares for misstatements in a prospectus is to file a suit for compensation under s.62. A claim can be made, whether the statements are fraudulent or innocent. Section 65 provides that a statement is deemed to be untrue if it is misleading in the form and context in which it is issued. It is not necessary for the allottee to prove any fraud or knowledge on the part of the directors that the statement was untrue.

If a director pays damages under s.62, he is entitled to recover contributions from his co-directors, if they, too, are guilty of misstatement, misrepresentation, untrue statement; and on the death of the co-directors, from their estates'

Defences available to avoid civil liability [s.62(2)]. Section 62 names persons who are liable to pay compensation but certain defences are available to them. In a claim for compensation, the director may prove in defence that:

            (i) he withdrew his consent to act as director before the issue of the prospectus

and it was issued without his authority or consent; or

            (ii) the issue was made without his knowledge or consent and on becoming aware of the issue he gave reasonable public notice of that fact; or

            (iii) he withdrew his consent after the issue of the prospectus but before allotment and public notice was given; or

            (iv) he had reasonable ground to believe that the statements were true and believed them to be true; or

            (v) the statement was correct and fair summary or copy of an expert's report; or

            (vi) the statement was made by an official document.

Another remedy available to an allottee of shares is to file a suit for damage in case the prospectus does not include the matters required to be included in accordance with the provisions of the Act.

Remedies against expert. The allottee to the shares who has been induced to take shares on the faith of an untrue statement of an expert in the prospectus is entitled to claim from the expert: (i) damages, (ii) compensation under s.62.

An expert is liable in damages in respect of his own untrue statement, wrong report or valuation made by him and contained in the prospectus and the same principles apply as in the case of a fraudulent or an innocent statement made by the directors. An expert is also liable to pay compensation under s.62. However, he shall not be liable if he proves:

            (i) that having given his consent, he withdrew it in writing before delivery of a copy of the prospectus for registration; or

            (ii) that after delivery of prospectus for registration and before allotment, he became aware of the untrue statement, withdrew his consent in writing and gave reasonable public notice of the withdrawal and his reasons; or

   (iii) that he was competent to make the statement and believed on reasonable grounds that it was true.

Liability under s.56. An omission from a prospectus of a matter required to be stated under s.56 (i.e., as per Sch. II) may give rise to an action for damages at the instance of a subscriber for shares, who has suffered loss thereby, even if the omission does not make the prospectus false or misleading. But, the plaintiff must prove that he has sustained damage by reason of the omission of a matter required to be stated in the prospectus. A director or other person sued under s.56 may escape liability if he proves: (a) that he had no knowledge of the matter not disclosed; or (b) that the contravention arose out of an honest mistake of fact; or (c) in the opinion of the court, non compliance or contravention was not material or that the person sued ought reasonably to be excused, having regard to all the circumstances of the case.