Unit 2

Strategy of
company formation
(COMPANY DOCUMENTS)
We already have seen that because of a corporate form of organization,
collection of large scale capital was possible which further led to mass production.
This form of organization had its own advantages which led the company form to
gain rapid popularity amongst the entrepreneurs. The formation and registration
of company form is a lengthy and a tedious job because it requires various
documents to be registered with the Registrar of the company. Memorandum of
Association, Articles of Association and Prospectus etc are the examples of few
such important documents. Let us study each such document in detail.

 MEMORANDUM OF ASSOCIATION
Memorandum of Association is an important document for formation of a
Company. Every company irrespective of its type needs to prepare its own
Memorandum of Association. It actually forms the constitution of the company
and so has to be drafted very carefully, considering various factors of external and
internal environment of business. It involves drafting of various tables and
schedules in it required by law. It actually lays down the objects and scope of
activities of the business. It defines relationship of the company with that of an
outside world. MOA is a public document and so the general public can have an
access to such documents for reading, understanding and taking their decisions as
to whether deal with the company or not. Its purpose is to enable the
stakeholders to the range of operations and its activities. It contains following
clauses.

Following are the definitions of Memorandum of Association:

“Memorandum means the Memorandum of Association of a company originally

framed or as altered from time to time in pursuance of any previous Companies
Law or of this Act.”

- Under Section 2(28) of Indian Companies Act of 1956.

“The Memorandum contains the fundamental conditions upon which alone the
company is allowed to be incorporated. These conditions are introduced for the
benefit of creditors and outside public as well as for the shareholders.”

- By L.J.Bowen.

Ms. Khushali Katira

Christ College, Rajkot
“The Memorandum of Association of a company is its charter and defines
limitations of the company established under the Act.”

- By Lord Justice Cairns.

-

OBJECTS OF MEMORANDUM OF ASSOCIATIONS

The very reason for preparation of MOA is as follows:

1. To protect the interest of shareholders and creditors by ensuring that the

finance contributed by them are used in the correct manner.
2. It constantly reminds the company its objectives and motives for forming a
company and thereby preventing it from any diversification from its
activities.
3. To inform other parties that a company is now in a legal position to make
contracts.
4. It is mandatory for every company to prepare its MOA. It actually is the
basis for registration.
5. It specifies the liability of the members interested in company and so the
shareholders can take decisions accordingly.
6. To form the very basis of relationship between the company and its
members and other investors.

CONTENTS/ SUBJECT MATTER/ CLAUSES OF

MEMORANDUM OF ASSOCIATION.
Following are the clauses of MOA

1. Name Clause
2. Registered Clause
3. Object Clause
4. Liability Clause
5. Capital Clause
6. Association Clause

Let us study each of such Clauses in detail.

1. Name Clause
The very first clause is Name Clause which states the name of the
company. Company being a legal entity should have a name for
identification. Company can adopt or decide any name for the company but
should keep in mind the following points while doing so:
• The name of the company must end with ‘limited’ if the liability of the
shareholders is limited. If it is a private company with limited liability of
shareholders it must end with the words ‘Pvt Ltd’. Also if it is a foreign
Ms. Khushali Katira
Christ College, Rajkot
 company they must specify (India) in its name.eg Glaxo (India) Pvt Ltd.
Thus through the name of the company stakeholders gets to know
about the kind of the company and liability of the company.
• No company belonging to private sector can make use of nouns like
‘India’, ‘Hindustan’ ‘Bharat’, ‘Government’ etc. Use of such words is
undesirable as it might mislead the shareholders about the involvement
of Government in it.
• Also, a new company is not permitted to adopt a name of an old
company or even similar to existing companies as it creates confusion in
the minds of people.
• It is required to display name of the company on the sign board at every
place where company conducts its business.
• The name chosen shall not be such which is prohibited under Emblems
and Names. The name should also not hurt sentiments and emotions of
people.

2. Registered or Domicile Clause

This Clause states the place or state of registered office of the
company. The full address of the company is to be mentioned here where
1. Any outsider or the member of the company can have an easy
correspondence with company. 2. The place of registered office is also
important because it decides the jurisdiction of the company in case of civil
or criminal charges against them.

3. Object Clause

This Clause actually determines the scope and limitations of the

activities of the company because it states the objectives of the company
in this Clause. The objectives mentioned here in MOA should be very much
lawful and must not contradict against any provision of Companies Act or
any public policy. It is also expected that the objectives should be
specifically and clearly expressed. As MOA is a public document the
creditors and investors can go through the Object Clause so that they
might also ascertain the purpose of their investment or contribution. After
the amendment of Companies Act in 1965, the company should divide its
objectives in three categories namely main object, other objects and the
states to which these objects extend. If companies undertake any such
activity which is not fulfilling the objective of the company, such activities
does not bind the company and it is known as an “Ultra-vires Act”. ‘Ultra’
means beyond and ‘vires’ means power. Thus the activity so undertaken is
beyond the powers of the company.

4. Liability Clause

Ms. Khushali Katira

Christ College, Rajkot
 Here under this Clause the liability of the shareholder is mentioned.
If the liability of the member is limited, the Clause must state that ‘the
shareholder will have liability limited by shares’. So the liability of the
shareholder shall be limited up to the face-value of share. Thus this Clause
is included in MOA to ascertain the liability of the shareholders.

5. Capital Clause
As the name suggests, the company shall mention its total amount of
capital with which it intends to form. This capital is known as registered
capital. It also mentions the maximum amount of capital that a company
can issue through its lifetime, known as authorized capital or nominal
capital. Entire division of capital (which we shall study in next unit) is shown
in such MOA. The Companies Act permits only two classes of share to be
issued; Equity shares or Ordinary shares and Preference shares.

6. Association Clause.
Association Clause is also known as Subscriber’s Declaration Clause. All
the promoters duly sign under this clause stating that they are desirous to
start the company and respectively agree to take so and so number of
shares of the company. Hence each subscriber fills details pertaining to
their name, number of shares to be subscribed by them, their occupation
etc and signs against their name. MOA is then duly signed by at least 7
members in case of a public company and by 2 members in case of a
private company. Each subscriber has to subscribe at least one share.

ALTERATIONS IN THE CLAUSES OF MEMORANDUM

Memorandum of association was earlier known as unalterable charter. But this
added to the hardships of the company and its operations. To make them easier,
we now can make changes in memorandum through following procedure.

I. Alterations in Name clause

Alteration in Name clause means change in the name of a company or
some rectifications in the name of existing company. Following points
should be kept in mind while doing so.
• If a company a wants change in its name, it can do so by passing a
special resolution (obtain the majority of three-fourth members in
favor of motion) and then obtain the approval by Central
Government in writing.
• Many a times, companies convert themselves from private company
to public company or vice-versa; they need to change the name of
the company by deleting or adding the word ‘pvt’ to it. Under such
circumstances, company need not get approval from Central
Government.
Ms. Khushali Katira
Christ College, Rajkot
 • Sometimes if the name of the registered company is similar or too
close to any company already registered the Central Government
may order for change in name. Under such circumstances the
company may pass an ordinary resolution (obtain the majority of half
or more in favor of motion.)
• Also when a company changes its name, the same information has to
be given to the Registrar who will enter the information into his
Register of Companies and in return issue a new certificate with
changed name.

II. Alterations in Registered clause

Alterations in registered clause mean change in place of registered
office of the company. This can take place through…

1. From one place to another, but within same City.

In such a case, directors may pass a resolution amongst
themselves and notify the change to the Registrar of the companies
within 30 days of passing the resolution; and can also issue a public
notice thereby for easy correspondence with stakeholders.

2. From one city to another, but within same State.

In this case a special resolution has to be in shareholders
meeting and the copy of resolution has to be filed with the Registrar
of the companies within 30 days of passing such a resolution along
with a public notice being issued.

3. From one State to another

Changing from one state to another is comparatively a difficult
procedure. Firstly a special resolution has to be passed in general
meeting. Then an application to company law board for the same is
to be made followed by the confirmation from the Company Law
Board. Then a necessary change is to be made in every page of
memorandum wherever necessary.

III. Alterations in Object clause

Alterations in object clause may be permitted only if the changed
objectives helps in carrying the business more economically or to enlarge
the area of operations, attain these objectives by improves or better
means, to amalgamate with any other company, to sell or dispose any part
of company’s undertaking etc. The procedure for alteration is similar to
that of registered clause

Ms. Khushali Katira

Christ College, Rajkot
IV. Alterations in Liability clause

1. Changing from limited liability to unlimited liability of the members

According to sec 38, no member of the company will be bound for such
a liability unless he gives his consent in writing for such unlimited
liability.
2. Changing from limited liability to unlimited liability of the officers may
include Directors, Managers or Secretary or any such employee of the
company. Also if any member is elected in the board his liability too
shall now remain unlimited.
3. Unlimited liability of directors through a special resolution. For this
purpose, the directors may pass a special resolution in its general
meeting and get a written consent of the directors.

V. Alteration of Capital clause.

Alteration in capital clause is permissible for following reasons.

1. To increase share capital by issue of new shares.

2. To consolidate and divide all or any of share capital into shares of
higher denominations.
3. To convert all or any of its fully paid up shares into stock or reconvert
stock into fully paid up shares again.
4. To subdivide the shares of lower denominations
5. To cancel unissued shares to reduce the capital.

Sec 94 provides that a company may alter its capital clause by passing a
special resolution in its general meeting.

DOCTRINE OF ULTRA VIRES

As discussed earlier, ultra-vires means any act or transaction done by
company, although not unlawful or against the public policy yet the act consists
beyond the powers of the company. The act of ultra-vires does not bind the
company and is not valid unless consented by every member of the company.

Issuing an unauthorized capital, reduction or repay of capital without

following its statutory provisions, to make payments for the benefit of a particular
section of shareholders only, etc are the examples of such ultra-vires acts.

Definitions

“An ultra-vires contract is void and cannot be ratified even by the unanimous
consents of share holders”

- By Justice Cairns

Ms. Khushali Katira

Christ College, Rajkot
“An act beyond the objects mentioned in memorandum is ultra vires, void and
cannot be ratified.”

- By Supreme Court of India

EFFECTS OF ULTRA VIRES ACTS/TRANSACTIONS

1. Injunction by any member

Injunction means a court’s order to the company not to perform an
ultra-vires act and any member can get an injunction to prevent or restrain
the company from doing so.

2. Personal liability of directors

If it is found that directors of company engage themselves in any
ultra-vires act, they are personally responsible to replace the funds.

3. Breach of warranty of authority

As discussed earlier, directors are personally liable for any ultra vires act.
Similarly, if director of the company stimulates an outsider to contract with
the company however innocently, they (third party) will be personally liable
for loss suffered by the third party for breach of warranty of authority on
account of ultra vires act.
- In ultra-viresly acquired property, the rights of such property shall be
secured with company.
- If any property is purchased ultra- viresly, the right of possession and
its ownership remains with company because it was purchased from
company’s capital ultimately.

4. Ultra-vires act cannot be ratified

As said earlier, an ultra-vires act is ab-initio. That means void since its
beginning. Its validity cannot be justified ever by any act and can never
become intra-vires (within the scope of the company) again.

5. Ultra-vires contract is null and void.

An ultra-vires act contracts are also null and void and cannot be ever
ratified even by unanimous decisions of the company’s members or
shareholders.

6. Loans cannot be recovered.

In case of an ultra-vires borrowing, the lender has no right of action in

respect of loan against the company.

Ms. Khushali Katira

Christ College, Rajkot
  ARTICLES OF ASSOCIATION.
Articles of Associaction is another important document necessary for the
formation of the company. It states the internal rules and regulations of the
company. It is actually meant for easy functioning and internal management of
the company. Articles of association is also a public document, though meant for
internal management. The articles of the company are actually subordinate of
Memorandum.

Also, a public company limited by shares, have an alternative document to

present. Instead of preparing Articles of Association, they can directly follow
Table-A. Table-A is an ideal format of an Articles of Association. A company can
follow Table-A completely or in part also. The advantage of following Table-A over
own Articles of Association is that its provisions are completely legal and free
from any sort of disagreements or doubt.

Definitions of Articles of Association.

“Articles means Articles of Association of a company as originally framed or as
altered from time to time in pursuance of any previous Company Laws or of the
Act.”

- Companies Act, Sec 2(2).

“The Articles of Association is a document regulating the rights of members of the

company among themselves and the manner in which the business of the
company shall be conducted.”

- By Justice Charlesworth.

“The articles proceeds to define the duties, the rights, and the power of the
governing body as between themselves and the company at large and the mode
and form in which the business of the company is to be carried on, and the mode
and form in which changes in internal regulations of the company may, from time
to time be made.”

SUBJECT MATTER/ CONTENTS OF ARTICLES OF ASSOCIATION

Following things can be mentioned in articles of association.

• Provision of share capital and its division.

• Rules regarding allotment of shares, giving calls, forfeituring of shares,
transfer and transmission of shares etc.
• Rules regarding meetings, notices, quorums, proxy, votings, resolutions etc.
• Preliminary contracts if any.
• Definition and clarification of some important and technical terms so as to
avoid any ambiguity over it.
Ms. Khushali Katira
Christ College, Rajkot
 • A statement as to whether Table-A is followed or own Articles is prepared.
If Table-A is followed, whether it is followed completely or partly and if
partly what sections from it are followed should be mentioned.
• Actual borrowing powers of the company
• Rules regarding alteration of share capital
• Payment of dividends and retaining reserves
• Rights, duties and liabilities of directors
• Rules for issuance share certificates and share warrants
• Procedure for winding up etc.

ALTERATIONS IN ARTICLES OF ASSOCIATION.

The Articles of the company may be altered from time to time as
convenient for the company. It is the right granted to company by Indian
Companies Act. But the altered Articles shall bind all members as it used to bind
earlier. Certain insignificant changes can be made by directors themselves but for
certain changes can be applied only after passing special resolutions or ordinary
resolutions depending upon the criticality of the issue.

Also there are certain restrictions laid down by the Act in order to prevent
the management to manipulate and change Articles according to their changing
needs. They are as follows:

1. Statutory restrictions
2. Judicial restrictions.

1. Statutory restrictions are as follows

7. The alteration made should not ever go against the provisions of
Companies Act.
8. Also, it should not be in contrast with the Memorandum of
Association of the company.
9. If any alteration made increases the liability of shareholders it shoud
not be accepted unless the consent is given in writing.
10.For following alteration approval of central government is important
- Converting the public company into private company
- Increase in remuneration of Director, Managing Director or a
Whole-time Director.
- Appointment or re-appointment of Director, Managing
Director or a Whole-time Director not retiring by rotation.
2. Judicial restrictions are as follows.
• The alterations so made in articles of association should not
constitute breach of contract.
• The alterations should be authenticated and should always be done
in the interest of the company.

Ms. Khushali Katira

Christ College, Rajkot
 • The alterations in the articles should be done in good faith and not
for cheating any concerned party or to get the work done in their
favour.
• Alterations should not be done that supports company to conduct
any sort of illegal business.
• The alteration should not be done to favor any group.
• Also an alteration should not constitute a fraud on the minority.

DOCTRINE OF INDOOR MANAGEMENT

Doctrine means an assumption. Doctrine of Indoor Management of any party
dealing with company or an officer or director that they have necessary powers
and have followed all the rules and regulations and have obtained necessary
powers from concerned parties to do so and act accordingly. This is known as
doctrine of Indoor Management.

The doctrine of Indoor Management is a perception of outside party that the

officer dealing with him/her is an authentic person. Most importantly the outsider
assumes that the officer has attained a prior approval of shareholders to deal with
other parties.

The Doctrine of Indoor Management indicates that outsider can just assume that
only authorized person has right to enter the transaction. Any party is not
required to ask for evidence or proof that whether the officer is empowered for
the deal or not.

Exceptions to Doctrine of Indoor Management.

1. Knowledge of Irregularities ( a clarification is already done prior hand)

2.Negligence on the part of outsider ( basic research has to be done by an

outsider)

3. Forgery case

4. No knowledge of Articles

Difference between Memorandum and Articles

Basis of Memorandum of
Articles of Association
difference Association
It is actually the
It is meant for internal
constitution of the
management that defines the
Meaning company and defines the
rules & regulations of the
scope and powers of the
company
company
It defines legal relationship It defines legal relationship
Relationship
between the company and between company and its
Ms. Khushali Katira
Christ College, Rajkot
 the external parties members
It is a
supplementary/complementary
It is a fundamental
document. A company can
document and every
Importance prepare its own AOA or can
company has to prepare its
directly follow Table – A in case
own MOA
if they do not wish to prepare
their own AOA
To define the internal rules &
To define the scope and
Objects regulations for smooth
limitations of the company
functioning of the company
Any act committed by the
Any act committed beyond the
company which goes
provisions of AOA can be easily
beyond their powers
Ultravires ratified by shareholders if it lies
cannot be ratified even if all
within the scope of the
the shareholders
company
unanimously agree to it.
MOA is prepared AOA is prepared keeping in
Dependence
independently mind the content of MOA
Articles can be altered easily
It is extremely difficult and
from time to time according to
Alteration tedious task to make any
the convenience of the
changes in MOA
company.

Ms. Khushali Katira

Christ College, Rajkot
  PROSPECTUS
The company form of organization conducts its business on huge scale
because it is able to collect its capital from public through instruments called
shares and debentures. Investors need to give proper thought for their hard
earned savings being invested in company. They need some information that
would aid in their decision making process. This information is provided in a
document called ‘Prospectus’.

Definition of Prospectus

“Prospectus means any document described or issued as prospectus and includes

any notice, circular, advertisement or other document inviting deposits from the
public for subscription or purchase of any shares in or debenture of any corporate
body.”

- Sec 2(36), Companies Act.

CONTENTS OF PROSPECTUS
The prospectus may contain following information:

• The main objectives of the company

• Names, address of directors or proposed directors or promoters, details
pertaining to managing directors, auditors etc.
• Contents of Memorandum of association and Articles of Association which
are directly concerned with shareholders.
• The day of opening of subscription list for allotment of shares
• Amount payable on different initial calls like application, allotment etc
• Names of underwriters, if any
• Details pertaining to preliminary expenses, if any.
• Different classes of shares and debentures and their benefit associated
with.
• If the company is already into existence and issue is for additional capital
their past profit figures, balance sheets etc can be given to show the
efficiency of the company.
Companies should not show unnecessary rosy picture of their business and
thereby cheat shareholders. Actual and real facts of the business should be
highlighted. There are various laws that would protect the interest of
shareholders in such situations.

Ms. Khushali Katira

Christ College, Rajkot
CONSEQUENCES OF OMISSION OR MISSTATEMENTS IN
PROSPECTUS.
As mentioned above, in order to collect more capital, directors try to create
a superior image of the company which might not be true. Much incorrect, fake
and exaggerated information might be given to create such rosy pictures and
thereby cheat such innocent shareholders or investors. Sometimes important
information may be omitted in prospectus which shareholders ought to know and
affect their subscription decision.

But there are serious consequences for omission or mis-statement in prospectus.

They are as follows:

1. Effects of omission in prospectus

According to sec 56 any company which is found to hide or omit
some important material information or relevant facts is liable to be
punished. The aggrieved shareholder has right to claim for damages from
the directors, any officer or concerned person thereby. But the aggrieved
shareholder cannot get his investment money back. Also, the shareholder
should prove that the information omitted was important and if the
aggrieved shareholder had known about the concealed information, s/he
would not have invested in the company‘s shares.
2. Effects of mis-statement or untrue statement in prospectus
I. Liabilities of the company or rights against the company
II. Liabilities of directors and promoters.

I. Liabilities of the company or rights against the company

The company undertakes following remedies for aggrieved
shareholder for mis-statement in a prospectus
• Rescission of the contract
When a mis-statement or an untrue statement is proved in
prospectus whether innocently or fraudulently, the company is
liable to reimburse the amount of such plaintiff that he had
paid to the company for shares. The shareholder has to
surrender all his shares to the company.
• Damages to the aggrieved shareholder for fraud
When such a fraud is proved in prospectus with a view to
attract maximum investors, the complainant is entitled to claim
for full compensation against loss borne by him directly for such
a fraud. Such a right can also be claimed once the winding up
process of the company begins.

II. Liabilities of directors and deceit.

Ms. Khushali Katira

Christ College, Rajkot
 Under this provision any person is liable to be punished who is a
director, promoter, the then director or whose name and signature is
found in prospectus.
Their liabilities is of following nature
I. Civil liability
II. Criminal liability

I. Civil liability:
Under this section, all the persons mentioned above are liable
to be punished and the complainant can file a civil suit to recover
damages.
Exemption to directors can be given under following situations:
• That s/he had consented to become director of the company
but before the prospectus was issued he withdrew his consent
and the same was issued without his/her consent or authority.
• That the prospectus was issued without his consent and on
becoming aware of such a mis-statement he gave a reasonable
public notice thereof clarifying the facts.
• That after issue of prospectus but before allotment of shares,
on becoming aware of such untrue statements s/he gave a
reasonable public notice thereof.
• That he had reasonable grounds to believe the information to
be correct and did believe up to the time of allotment of share.
• That the statement made in prospectus was correct as it was
represented by expert and the expert was competent enough
to do so.
• That the information was directly absorbed from some official
public document and therefore was assumed to be correct.

II. Criminal liability:

Sec 63 of the Act provides that every person found guilty for
such mis-statement or mis-representation shall be liable for
imprisonment for two years or fine of Rs 5000 or both. However, a
director can defend himself or can exempt on following grounds.
• That the statement contained in prospectus was immaterial.
• That he had reasonable grounds to believe and did believe up
to the time of issue of the prospectus that the statement was
true.

Ms. Khushali Katira

Christ College, Rajkot
STATEMENT IN LIEU OF PROSPECTUS.
Public companies limited by shares generally issues prospectus so that they
can attract as many as applicants they can because prospectus acts as an
advertisement for the company. But sometimes directors are sure that they will
be able to collect capital through internal management or sources. So under
such circumstances the company will not waste its efforts and resources on issue
of prospectus. Instead they issue ‘Statement in lieu of Prospectus’. Such a
statement should be registered with the Registrar for registration. The
consequences for omission or misrepresentation are similar to that of prospectus.
Further if any alteration is to be done the statement, it could be done only after
passing a resolution in annual general meeting.

ABRIDGED PROSPECTUS
As amended by the company’s Act of 1988 states that no application form
can be issued for shares or debentures of the company unless it is accompanied
by an abridged prospectus which complies the requirements of the Act. However,
full prospectus is to be furnished on a request being made by any person before
the closing of the subscription list

The Abridged prospectus contains information very much similar to a

prospectus but in a concise and a compact manner so that the cost of public
issue of capital be reduced.

Abridged prospectus and the share application form should bear the same
printed number. The investors may detach the share application form along the
perforated line after the shareholder had an opportunity to study the content of
the abridged prospectus, before submitting the same to the company or its
designated bankers. The same procedure may be also followed while making
available copies of the prospectus.

Ms. Khushali Katira

Christ College, Rajkot
Red – Herring Prospectus (Section 32)

Introduction

The Companies Act, 2013 has legally recognized the issue of securities through
‘Book Building Process’ by introducing the concept of ‘Red-Herring
Prospectus’. The Red-herring is a rough draft of the company’s prospectus and
it includes most of the description of the company’s business, financial
conditions, strategy, management, litigation and risk factors. But it does not
include details of the issue, such as number of shares and price per share. It is a
preliminary prospectus filed by a company with the SEBI in connection with the
company’s initial public offerings.

Meaning

When the company wants to offer its securities on the basis of market
perception, instead of at fixed price, it can issue a ‘Red-Herring Prospectus’.
Dictionary meaning is a ‘thing that draws attention away from something
important’. Let us define red-herring prospectus:

A red-herring prospectus, as a first or preliminary prospectus, is a document

submitted by a company (issuer) as part of public offering of securities (either
stocks or bonds).

Red-herring prospectus means a prospectus which does not include complete

particulars of the quantum of price of the securities included therein. In the
red-herring prospectus price of shares, number of shares to be issued and issue
size are kept blank and mostly look like this – [*]. These blanks are filled in the
final prospectus.

Provisions relating to Red-herring prospectus

Section 32 (1 to 4) of the companies Act, 2013 makes following provisions:

 A company proposing to make an offer of securities may issue a red-

herring prospectus prior to the issue of a prospectus.
 A company proposing to issue a red-herring prospectus under sub-
section (I) shall file it with the Registrar at least three days prior to
the opening of the subscription list and the offer.
 A red-herring prospectus shall carry the same obligations as are
applicable to a prospectus and any variation between the red-herring
prospectus and a prospectus shall be highlighted as variations in the
prospectus.
 Upon the closing of the offer of securities under this section, the
prospectus stating therein the total capital raised, whether by way of
debt or share capital, and the closing price of the securities and any

Ms. Khushali Katira

Christ College, Rajkot
 other details as are not included in the red-herring prospectus shall
be filed with the Registrar and the Securities and Exchange Board.

Purpose

Red-herring prospectus is drafted and registered with the regulator (SEBI) when
a company ought to discover the price of securities through ‘Book Building
Process’. The book building route helps the company to realize the true value
for its equity or intrinsic value of the company. It also gives the company insight
into its credibility factor among the investors. The credibility can be gauged by
the demand for the purchase of equity offered for sales. The book building
system is suitable only if the issuer companies are fundamentally strong and
well known to the investors. It works efficiently when market conditions are
matured and investors are smart and aware of the various parameters affecting
the market price of securities.

Ms. Khushali Katira

Christ College, Rajkot
 Contents of Red-herring prospectus

Red-herring prospectus contains details about the company to help the

potential investors to judge worth of company and its securities. This
prospectus includes everything, except issue size (or amount), number of
shares, and price per share. Normally, red-herring prospectus contains:

1. Risk factors
2. Use of proceeds (where the funds will be invested)
3. Industry description
4. Business description
5. Strategy
6. Management (detail about managing body)
7. Litigation and risk factors
8. Price range of securities to be offered
9. Financial condition
10.Other information

Shelf Prospectus

As per section 31, the expression ‘Shelf prospectus’ means 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.

Rationale or purpose behind the concept of ‘Shelf Prospectus’

Sometimes, a company may make frequent issues of securities during a specified

period. A public company is required to issue a prospectus for raising finance
through issue of securities. It is costly and time-consuming to issue a fresh
prospectus at every issue. In order to minimize such burden, the concept of ‘shelf
prospectus’ has been introduced. As per the provision of the Act, a self
prospectus is valid for a period of one year. Any subsequent offer within the valid
period, only an information memorandum for updating the information under the
specified heads is required to be filed. There is no need to issue a fresh
prospectus, a shelf prospectus deems to be a prospectus at the time of a new
issue. This provision is a special significance in case of developmental financial
institutions, like IDBI and ICICI, who raise money from public through issue of
bonds in a series.

A shelf prospectus is useful to only those companies who want to collect finance
through frequent issues during a defined period to time.

Ms. Khushali Katira

Christ College, Rajkot
Provisions in respect of Shelf prospectus

In regard to ‘shelf prospectus’ section 31 of the Act makes following provisions:

1. As per the SEBI regulation, any class of or classes of companies may file a
shelf- prospectus with the Registrar of company at the stage of the first
offer of securities included therein. The shelf – prospectus will be valid for
one year from the date of opening the first offer of securities under that
prospectus.
2. At the time of subsequent offer of securities within the valid period of shelf
prospectus, the company has to file an information memorandum
containing all material facts relating to new changes created.
3. An updated information memorandum filed every time an offer of
securities is made together with shelf prospectus shall deem to be a
prospectus. There is no need to issue of further prospectus.

Public Offer and Private Placements

Generally, any sale of securities to more than 200 people is deemed to be a public
offering, and thus requires the filing of registration statements with the
appropriate regulatory authorities. The offering price is predetermined and
established by the issuing company and the investment bankers handling the
transaction. The term Public Offering is equally applicable to a company's initial
public offerings, as well as subsequent offerings. Not all public offerings are IPOs.
An IPO occurs only when a company offers its shares for the first time for public
ownership and trading, an act making it a public company.

Conditions

If a listed or unlisted company (1) makes an offer or invite subscription, or (2)

allots or enter into agreement to allot securities to more than 200 persons in a
financial year, it shall be deemed to be an offer to the public. However, aforesaid
200 persons, following are not taken into account:

1. Qualified institutional buyers

2. Employees, who are offered securities under a scheme of Employees Stock
Option as per provisions of Section 62 (1) (b)
This offer must comply with norms of public issue, any violation of which money
collected from public is to be refunded.

A private placement is the sale of securities to a relatively small number of

selected inventors as a way of raising capital. Investors involved in private
placement are usually large banks, mutual funds, insurance companies and

Ms. Khushali Katira

Christ College, Rajkot
pension fund. A private placement is different form a public offer, in which
securities are made available for sale on the open market to any type of investors.

Private placement (or non-public offering) is a funding round or securities which

are sold not through a public offering, but rather through a private offering,
mostly to a small number of chosen investors.

Provisions of Section 42

Private placement is opposite to public offer. Private placement refers to any

offer of securities or invitation to subscribe securities to a selected group of
persons by a company through issue of a private placement offer letter in Form
PAS – 4, and which satisfies the following conditions:

1. The company shall issue securities through private placement offer letter
provided that proposed offer of securities has been previously approved by
a special resolution of shareholders.
2. The offer of securities or invitation to subscribe securities shall be made to
not more than 200 persons in a financial year.
3. If a company make an offer to allot or invite subscription, allots or enters
into an agreement to allot, securities to more than the prescribed limit of
persons, the same shall be deemed to be an offer to public and shall be
accordingly be governed by the provision applicable to a prospectus.
4. All money payable toward subscription of securities under this section shall
be paid through cheque or demand draft or other banking channel but not
by cash.
5. Securities shall be allocated within 60 days from the date of receipt of the
application money.
6. The application money received shall be kept in a separate bank account in
a scheduled bank and shall be utilized for any purpose other than (1) for
adjustment against allotment of securities; or (2) for repayment of money
whether the company is unable to allot securities.
7. A company making private placement shall not release any advertisements
and shall not utilize any media, marketing and distribution channels or
agents to inform the public at large about such offer.
8. The company shall file with the Registrar a return of allotment in prescribed
manner giving full names and addresses of the allotees and number of securities
allotted.

Ms. Khushali Katira

Christ College, Rajkot