THE COMPANY PROSPECTUS
When the public is asked to subscribe for shares or debentures in a company the invitation involves the issue of documents which set out the advantages to accrue from an investment in the company. This document is called a prospectus and may be issued either the company itself or a promoter. It is only in the case of a public company that a prospectus may be issued.
Under section 2 (1) of the Companies Act, the term prospectus means:
“Any prospectus, notice, circular, advertisement or other invitation offering to the public for subscription or purchase any shares of debentures of a company.”
Any invitation intended to avail company securities for subscription for the public qualifies as a prospectus. Its distinguishing characteristics are the contents and intentions of the issuer.
In Re South of England Natural Gas Co. (1911) 1 Ch. 573 a newly formed company issued 3000 copies of a document stamped “for private circulation only”. The document invited subscription for the company shares and the copies were distributed to members of several gas companies.
Question was whether the document was a prospectus. It was held to be.
The term “offering” used in the definition is used in a non-technical sense as a prospectus invites offers.
The term public in the definition isn’t restricted to the public at large as it includes a section
thereof.
Under section 40 (1) of the Act, a prospectus must ordinarily contain the mattes specified in Part 1 and the reports set out in Part 2 of the Third Schedule to the Act.
Under section 43 (1) a copy of every prospectus issued or on behalf of the company must be delivered to the Registrar for registration on or before the date of publication.
Circumstances in which a company may issue a prospectus
- A newly formed company may issue a prospectus inviting prospectus investors to subscribe for securities.
- An existing public company wishing to raise additional capital from the public may issue a prospectus in relation to the issue.
- Under section 32 (1), if a private company passes a special resolution converting itself into a public company, it ceases to be a private company from the resolution date and must within 14 days thereof deliver to the Registrar for registration either:
- A prospectus containing the particulars of Part 1 and the reports in Part 2 of the 3rd schedule to the Act.
- A statement in lieu of prospectus containing the particulars of Part 1 and the reports in Part 2 of the 3rd schedule to the Act.
CONTENTS OF A PROSPECTUS
Under section 40 (1) every prospectus issued or on behalf of a company or or on behalf of any person who has been engaged or interested in the formation of the company must contain the particulars of Part 1 and the reports in Part 2 of the 3rd schedule to the Act.
Part 1 of the 3rd Schedule to the Act contains the following matters:
a. Particulars of directors and their occupation.
b. Director’s share qualification if any.
c. Director’s remuneration.
d. Director’s interest in promotion of the company.
e. Preliminary expenses.
f. Commission and brokerage.
g. Promoter’s remuneration.
h. Auditors of the company.
i. Minimum subscription. This is an amount, which in the opinion of the BOD must be raised the issue:
- To provide working capital.
- To pay an amount borrowed the company.
- To pay any asset acquired the company.
- To pay any commission payable.
- To meet the preliminary expenses.
j. Particulars of options on shares and debentures.
k. Particulars of shares and debentures issued otherwise than for cash.
l. The time of opening of the subscription lists.
m. The amount payable on application and allotment.
n. Particulars of material contracts.
o. Length of time the company has carried on business if less than 3 years.
p. Particulars of persons who have sold assets to the company.
q. Amount paid to such persons including any sum payable as goodwill.
r. Voting and class rights.
s. Deferred, founders or management shares, if any.
Part 2 of the 3rd Schedule to the Act contains the following 3 reports:
a. Auditors report on:
• Profit and loss of the company in the last 5 years.
• Rate of dividend in the last 5 years.
• Assets and liabilities as at the last date of accounts.
Similar information must be given in relation to subsidiaries if any.
b. If the proceeds of the issue or any part thereof are being used to purchase shares in a
subsidiary, a report a named accountant on the subsidiary’s profit and loss for each of
the last 5 years and assets and liabilities as at the last date of account.
c. If the proceeds of the issue or any part thereof are being used to purchase a business , a profit the named accounts on the business profit and loss in each of the last 5 years and assets and liabilities as at the last date of account.
Other contents of a prospectus:
i. Under section 39 a prospectus issued or on behalf of a company or in relation to an intended company must be dated and unless otherwise provided, this is taken to be the date of publication.
ii. Under section 43 (1) (a) a prospectus must state on its face, any documents annexed thereto or endorsed there on. The objective of the section in relation to the contents of a prospectus is to ensure that the investor has the minimum information necessary to decide whether or not to subscribe for the securities.
iii. Under Capital Markets (Public Offer Listing and Disclosure), Regulations of 2002, the prospectus of a company quoted on the main segment must state:
- The particulars of directors and service managers.
- The bankers and legal advisors of the company.
- The date of incorporation.
- The country of incorporation.
- Whether or not listing has been approved the CMA
- The cautionary statement from the CMA
- The summary of the memorandum and Articles.
- The principal objects of the company.
REGISTRATION OF THE PROSPECTUS
Under section 43 (1) a copy of every prospectus issued or on behalf of company or or on behalf of any person who has been engaged or interested in the formation of a company must be delivered to the Registrar for registration on or before the date of publication.
The copy delivered must be signed every person who is named or proposed as a director either in person or an agent authorized in writing.
Under section 43 (3) the Registrar may reject the prospectus if :
- It is undated
- If it is not signed as required the Act.
- If it does not have the necessary annexures or endorsements.
Under section43 (5) it is a criminal offence:
- To issue a prospectus before a copy thereof is delivered to the Registrar for registration.
- To deliver to the Registrar for registration a copy of the prospectus without the necessary annexures or endorsements.
The company and every person who was knowingly party to the issue and delivery thereof are liable to a fine not exceeding KShs 100 for each day the default subsists.
LIABILITY IN RESPECT OF THE PROSPECTUS
Criminal liability
These are crimes created the provisions of the Companies Act to compel companies to observe the provisions relating to prospectus namely the preparation, the contents and the registration.
Under section 40 (3), it is a criminal offence to issue any form of application for shares or debentures unaccompanied a prospectus of the company. The person in default is liable to a fine not exceeding KShs 10,000.
However an application form need not be accompanied a prospectus if it is issued:
a. In relation to shares or debentures not offered to the public;
b. In relation to shares or debentures similar to those previously issued the company; or
c. In relation to a bonafide invitation to a person to enter into an underwriting agreement on the issue.
Under section 42 (2) it is a criminal offence to issue a prospectus containing a statement purported to have been made an expert without his written consent. Section 42 defines Expert as including “Engineer, Valuer, Accountant or any other person whose profession gives authority to the
statement made him.”
The company and every person who was knowingly party to the issue is liable to a fine not exceeding KShs 10,000.
Under section 43 (5) of the Act, it is a criminal offence to:
a. Issue a prospectus before a copy thereof is delivered to the Registrar for registration.
b. Deliver to the Registrar for registration a copy of a prospectus without the necessary annexure or endorsements.
Under section 46 (1) of the Act, it is a criminal offence to authorize the issue of a prospectus containing any untrue statement. The person in default is liable to imprisonment for a term not exceeding 2 years or a fine not exceeding KShs 10,000 or both.
However the accused escapes liability proving either that:
a. The statement was immaterial; or
b. He had reasonable ground to believe and did believe up to the date of issue that the statement was true.
In R. v. Kylsant (1932) 1 K.B. 442 the accused, who was a chairman of the BOD of the company, was being prosecuted under the provision of the Larceny Act of 1861 for having authorized the issue of a prospectus containing untrue statements. The prospectus had stated between 1911 and 1927, the company had paid an annual dividend of between 5% and 8% except in 1914 where no dividend was paid and 1926, when a dividend of 4% was paid. In actual fact, the company had been paying dividend out of capital and between 1921 and 1926 it had made losses. The accused was found guilty and was sentenced to imprisonment for 12 months.
Civil liability
a. Statutory liability
Under section 45 (1) of the Act, a third party who has suffered loss or damage reason of subscribing for the shares or debentures of a company on the faith of a prospectus containing an untrue statement is entitled to compensation for the loss or damage by:
i. Every person who was a director of the company at the time of issue.
ii. Every person who was a promoter of the company.
iii. Every person who had authorized him to be named in the prospectus as a director and was so named.
iv. Every person who had agreed to become a director of the company either immediately or after an interval of time.
v. Every person who authorized the issue of the prospectus.
Defences
Under section 45 (2) a director sued for compensation may escape liability relying on the defenses prescribed the sub section that:
- He withdraws his consent to act as a director before the issue of the prospectus.
- The prospectus was issued without his knowledge or consent and on becoming aware of the issue, he gave reasonable public notice that it was so issued.
- On becoming aware of the untrue statement, after the issue of the prospectus, but before the allotment of the securities, he withdrew his consent and gave reasonable public notice of the withdrawal and the reasons therefore.
Under section 45 (3) an expert sued for compensation may escape liability relying on the defenses prescribed the sub section that:
- He withdrew his consent in writing before the prospectus was delivered to the register for registration.
- On becoming aware of the untrue statement, after the prospectus was delivered to the register for registration, but before allotment of the securities, he withdrew his consent in writing and gave reasonable public notice of the withdrawal and the reasons therefore.
- He was competent to make the statement and had reasonable grounds to believe and did believe up to the date of allotment that it was true.
b. Common law liability
(Mainly deals with misrepresentation)
A person who has suffered loss or damage reason of subscribing for shares or debentures on the faith of a prospectus containing any untrue statements has a common law action in damages for misrepresentation.
Misrepresentation renders a contract voidable at the option of the innocent party. However for misrepresentation to give rise to liability it must be proved that:
i. The statement was false in a material particular.
ii. The statement was more than mere sales talk, whether a statement amounts to misrepresentation or mere sales talk depends on what a reasonable person will deem it to be.
iii. The statement was one of fact and not opinion. As a general rule opinion does not amount to misrepresentation unless:
• The maker does not honestly hold such opinion.
• The opinion purports to be based on certain facts within the maker’s
knowledge whose truthfulness he does not verify.
iv. The statement was intended to be acted upon the person o persons to whom it was made.
v. The statement was in fact made the other party. As a general rule, silence, non disclosure or does not amount to misrepresentation unless it renders the prospectus misleading. However silence may amount to misrepresentation:
• In contracts of utmost good faith.
• In confidential relationships.
• Where the statement made is half true
• Where disclosure is a statutory requirement.
• Where the statement was true when made, but turns false due to a change in circumstances before the contract was concluded but the maker fails to disclose it falsity.
vi. The false statement influenced the party’s decision to contract. The statement must have been made before or when the contract was being concluded. At common law, the ordinary purpose of a prospectus is to invite persons to subscribe for a company’s shares or debentures. Once the purpose is accomplished, the prospectus becomes exhausted and cannot be relied upon persons who purchased the securities at the stock exchange.
It was so held in Peek v. Gurney (1873) L.R. 377where the company’s shares were allotted between July and October and the plaintiff purchased the shares at the stock exchange in December and purported to rescind the contract as well as sue in damages for fraudulent misrepresentation of the prospectus. It was held that he could not base his action in the prospectus as it had become exhausted the time he purchased the shares.
This case is authority for the proposition that directors are not liable for misrepresentation in a prospectus, after all the shares have been allotted, in respect of transaction concerning them thereafter.
However if it evidenced that the prospectus was intended to influence original and other subscribers, it is not deemed to have been exhausted.
This was the case in Andrews v. Mockford (1896) 1 QB 372 where the plaintiff sued the defendant in damages for conspiracy to defraud him. The defendant had formed a company ostensibly to mine gold in Transvaal South Africa. However very few persons applied for the company shares. The plaintiff, who had a copy of the prospectus, did not subscribe to them. After 8 months, the defendant sent a telegram to the UK that the company had struck gold and the information was printed in the financial news. The plaintiff applied and was allotted 50 shares. The company collapsed thereafter. It was held that the defendant were liable in damages for fraudulent misrepresentation as the prospectus had not become exhausted.
vii. The statement was innocently, fraudulently or negligently made.
a. Innocent misrepresentation: It arises where the make honestly believes in the truth of the statement and has no capacity to ascertain its falsity. The innocent party may apply for rescission of the contract or sue for indemnity for any financial loss occasioned the statement.
b. Fraudulent misrepresentation: This is a situation where the maker of the statement has knowledge that it is false, makes it carelessly and recklessly and without belief in its truth.
This test for fraud was formulated in Derry v. Peek (1889) 14 A.C. 337.
The innocent party may either:
• Apply for rescission of contract; or
• Sue in damages for the tort of deceit as was the case in Andrews V Mockford.
c. Negligent misrepresentation: It exists where the maker of the statement has both the means and capacity of ascertaining its falsity but fails to do so and is thus negligent.
For a party to rely on negligent misrepresentation it must be proved that:
• The maker of the statement owed the recipient a legal duty of care.
• There must have a special relationship between the parties as held in
Hedley Byrne & Co. v. Heller & Partners (1974) A.C. 465
• The loss suffered was of a financial nature.
The innocent party may either:
• Apply for rescission of the contract
• Sue for damages for the tort of negligence.
STATEMENT IN LIEU OF PROSPECTUS
In lieu means instead of / in place of.
The Companies Act does not define the words statement in lieu of prospectus. However this is document prepared and issued public companies in certain circumstances either in place of or in addition to an ordinary prospectus inviting for the public to subscribe for the shares or debentures of the company.
Its contents are prescribed the provisions of the Companies Act.
Contents of a statement in lieu of prospectus
1. Nominal share capital
2. Any preference share capital (redeemable)
3. Names and particulars of directors
4. Voting rights of different share classes
5. Debentures issued
6. Names and particulars of vendors of property
7. Date and particulars of material contracts
8. The accountant’s report on profit & losses and assets.
Circumstances in which a company may issue a statement in lieu of prospectus
a. When a private company goes public
Section 32 (1) provides that if a private company passes a special resolution converting itself to public, it ceases to be a private company on the date of resolution and must within 14 days thereof deliver to the Registrar for registration either a prospectus or a statement in lieu of prospectus.
b. Restriction on allotment
Under section 50 (1) if a company having shares capital has not issued a prospectus with reference to its formation or has issued one and has not proceeded to allot any of the shares or debentures offered to the public, no allotment ought to be made at least 3 days from the date of delivery to the Registrar for registration a statement in lieu of prospectus signed every person who is named or proposed to be director and containing the particulars of part 1 and 2 of the 4th schedule to the Act.
c. Restriction on commencement of business
Under section 111 (2) if a public company having share capital has not issued a prospectus inviting the public to subscribe for its shares or has issued one and failed to raise the minimum subscription, there must be delivered to the Registrar inter alia a statement in lieu of prospectus for the issue of a certificate of trading.
The provisions of the Act do not prescribe the contents of the statement in lieu of prospectus under this section.
ALLOTMENT OF SHARES
Allotment
This is the appropriation of a certain number of shares.
It is the company’s acceptable of an applicant’s offer to take up the shares. It concludes a legally binding agreement between the applicant and the company.
However it doesn’t constitute the applicant as a member of the company as held in Re: Nichols Case (1895) where Wilkinson applied for 100 shares of a company and was allotted the same. The company required him to pay £8 for every share held, his name was not entered in the register of members and he did not pay the amount demanded. Three years later, the BOD cancelled the allotment and issued the shares to third parties. Upon liquidation, Wilkinson’s name was put on the list of contributories. It was held that he was not liable as a contributory as he was not a member of the company.
An allotment, legally, is the company’s acceptance of an offer to buy its shares. It is governed the following common law rules relating to contract:
a. Where a company issues a prospectus, the issue is an invitation to treat but not an offer.
b. The company’s acceptance must be unconditional.
c. The acceptance must be communicated to the applicant.
d. The allotment must be made within a reasonable time
The above common law rules have been modified the following statutory provisions:
RESTRICTIONS ON ALLOTMENT
These are statutory prohibitions prescribed the Companies Act subject to which a company must allot shares, securities and debentures. They are as follows:
i. Minimum subscription
Under section 49 (1) (a) a company must not allot any of its share capital offered to the public for subscriptions before the minimum subscription as prescribed in the prospectus is raised.
Any allotment in contravention thereof is irregular and voidable as the opinion of the applicant within 1 month of allotment or holding of the statutory meeting.
ii. Statement of lieu of prospectus
Under section 50 (1), if a company having a share capital has not issued a prospectus with reference to its formation or has issued but has not proceeded to allot any of the shares or debentures offered to the public, no allotment ought to be made until at least after 3 days from the date of delivery to the Registrar for registration, a statement in lieu of prospectus signed every person who is a named or proposed director and containing the particulars of part 1 and 2 of the 4th schedule to the Act.
Any allotment in contravention thereof if irregular and voidable at the opinion of the applicant within 1 month of allotment or holding of the statutory meeting.
iii. State Corporations
Under section 50 (a) of the Act of a company must not allot any shares to a state corporation without prior written consent of the Treasury.
Any allotment in contravention thereof is irregular and void. In addition, the company and every director who knowingly authorizes and permits the same are liable to a fine not exceeding KShs. 20,000.
iv. Third day rule
Under section 52 (1), a company must not allot any shares pursuant to a prospectus issued generally before the beginning of the third day after that on which it was first issued.
Any allotment in contravention thereof is irregular but valid. However, the company and every officer in default are liable to a fine not exceeding KShs. 10,000.
COMMENCEMENT OF BUSINESS
A private company is entitled to commence business at any time after incorporation (i.e. after issue of the certificate of incorporation.)
Public companies on the other hand require a certificate of trading to commence business or exercise borrowing powers.
Section 111 of the Act entitled “Restrictions on commencement of business” prescribes the
formalities to be complied with public companies to secure the certificate of trading.
Under section 111 (1) if a company having share capital has issued a prospectus inviting the public to subscribe for the shares and:
a. The minimum subscription has been raised.
b. Every director has paid in case the proportions of monies payable on application in respect of the shares held.
c. No money is liable to be paid (repaid) to unsuccessful applicants; then there must be delivered to the Registrar a statutory declaration a Director or the Company Secretary in a prescribed form confirming that the above conditions have been fulfilled (a, b and c).
Under section 111 (3) upon receipt of the declaration, the Registrar issues a certificate of trading therecertifying that the company is entitled to commence business and exercise borrowing powers.
Under section 111 (2) if a company having a share capital has not issued a prospectus in writing to the public, inviting them to subscribe for its shares or has issued one but failed to raise the minimum subscription, there must be delivered to the Registrar:
• A statement in lieu of prospectus; and
• A statutory declaration a director or the company Secretary in the prescribed form confirming that every director has paid the proportion of monies payable as such in cash on application, in respect of the shares held.
Under section 111 (3) upon receipt of the documents, the Registrar issues a certificate of trading.
LEGAL STATUS OF THE CERTIFICATE OF TRADING
Under section 111 (3) a certificate of trading issued the Registrar is conclusive evidence that the public company is duly authorized to commence business and exercise borrowing powers.
EFFECTS OF CONTRAVENTION OF SECTION
The civil effect:
Under section 111(4), contracts entered into a company before it is entitled to commence business are provisional only, i.e. they do not bind the company.
They acquire the force of law when the certificate is granted.
However, a company may allot shares or debentures as per section 111 (5) of the Companies Act.
The criminal Effect:
Under section 111 (6) it is a criminal offence for a company to commence business or exercise borrowing powers before it is entitled to do so.
Every person in default is liable to a fine not exceeding KShs. 1,000 for every day the contravention subsists.
N.B: Under section 219 of the Act a company may be wound up the Court if it fails to commence business within a year of incorporation.