Chapter III of the Companies Act, 2013 — Sections 23 to 42 — is the law of how a company raises money from the outside world. It governs the public offer, the prospectus that must accompany it, the liability that attaches to what the prospectus says and omits, and the allotment of the securities that follows. The chapter rests on a single regulatory intuition: a company asking strangers to part with their savings must tell them the truth, the whole truth, and must be held to it. The prospectus is the instrument of disclosure; allotment is the moment the company accepts the investor's offer and the shares come into existence. Between them sit the deemed prospectus, the shelf and red herring variants, the golden rule of disclosure, and the dual civil and criminal liability for misstatement that gives the disclosure regime its teeth.
This chapter sets out the architecture of Chapter III for the judiciary and CLAT-PG aspirant: the Section 23 menu of fund-raising routes, the definition of a prospectus and the threshold question of what counts as an offer "to the public," the deemed prospectus under Section 25, the contents mandated by Section 26, the golden rule of New Brunswick v. Muggeridge and Rex v. Kylsant, the liability provisions of Sections 34 to 36, the allotment regime under Sections 39 and 40, and the private placement carve-out in Section 42. For the foundations that precede it, see our chapters on the introduction to company law, the definitions of company, director and member, and the incorporation of a company.
The statutory scheme of Chapter III
Chapter III of the Act is divided into two Parts. Part I, comprising Sections 23 to 41, deals with the public offer of securities and the prospectus. Part II, which is Section 42, deals with private placement. The architecture is deliberate. A company that wishes to solicit the savings of the general public submits to the full disclosure-and-liability discipline of Part I and, if listed or seeking listing, to the parallel regime of the Securities and Exchange Board of India Act, 1992. A company that wishes to raise money quietly from a handful of identified investors takes the Part II route and escapes the public-offer machinery, but is fenced in by the numerical and procedural limits of Section 42.
The whole chapter is animated by the principle that capital-raising from the public is a privilege conditioned on candour. The memorandum and articles tell the world what the company is and how it is governed — covered in our chapters on the memorandum of association and the articles of association — but the prospectus tells the investing public why it should hand over its money. The greater the reach of the solicitation, the heavier the disclosure burden. That sliding scale is the organising idea behind the entire chapter, and it explains why almost every section in it is paired with a liability or a penalty.
Section 23 — public offer and private placement
Section 23 is the gateway. It tells us the permissible ways a company may issue securities. A public company may issue securities by three routes: to the public through a prospectus, which the section calls a "public offer," in compliance with Part I of Chapter III; or by private placement under Part II; or by a rights issue or bonus issue under the Act, and — for a listed company or one intending to list — in compliance with the SEBI Act and the regulations made under it. A private company has a narrower menu: it may issue securities only by way of rights issue, bonus issue, or private placement. It cannot make a public offer at all, which is the statutory expression of the defining feature of a private company — the prohibition on inviting the public to subscribe.
The Explanation to Section 23 defines "public offer" expansively to include an initial public offer or further public offer of securities to the public by a company, and an offer for sale of securities to the public by an existing shareholder, in each case through the issue of a prospectus. The 2017 amendment added sub-section (3), permitting companies to issue Global Depository Receipts in a foreign country in the prescribed manner. Section 23 thus performs two functions at once: it lists the lawful fund-raising channels and, by confining the public-offer channel to public companies, it polices the public-private divide. For the judiciary aspirant the high-yield point is the three-route structure for public companies and the contrast with the two-route structure for private companies.
What is a prospectus — Section 2(70)
A prospectus is the document through which a company invites the public to subscribe for or purchase its securities. Section 2(70) of the Companies Act, 2013 defines it as any document described or issued as a prospectus and includes a red herring prospectus referred to in Section 32, a shelf prospectus referred to in Section 31, or any notice, circular, advertisement, or other document inviting offers from the public for the subscription or purchase of any securities of a body corporate. The definition is functional rather than formal: it is not the label "prospectus" but the act of inviting public subscription that brings a document within the section. A circular, an advertisement, or a notice that solicits the public is a prospectus whatever it calls itself.
Two ideas are embedded in the definition. First, a prospectus is an invitation to offer, not an offer. The company that issues a prospectus is not making an offer capable of acceptance; it is inviting members of the public to make offers (applications) which the company may then accept by allotment or reject. Second, the document must invite offers from "the public." A communication that does not reach or address the public is not a prospectus, however detailed its contents. Both ideas are tested repeatedly, and the second is the subject of the leading authority discussed next.
Issued to the public — the Nash v. Lynde test
The provisions of the Act are attracted only when a prospectus is issued to the public. The leading authority is Nash v. Lynde, 1929 AC 158. A document headed "strictly private and confidential," containing particulars of a proposed issue, was handed by the managing director to a few persons — a relation, a co-director, and a solicitor — without any general circulation. The House of Lords held that there had been no issue to the public and that the document was therefore not a prospectus. Viscount Sumner observed that "the public" is a general word with no fixed lower limit; the test is whether the offer is open to anyone who brings his money and applies in due form. A private and confidential communication to a closed circle is not such an offer.
The principle is that the word "public" is elastic and is to be read in opposition to a private, domestic, or personal communication. A single member of the public may constitute "the public" if the invitation is, in substance, a general one that happens to reach him. Conversely, an invitation to a defined and limited circle, with no element of general solicitation, falls outside the section. This threshold question — public or private — is the hinge on which prospectus liability turns, because if the document is not a prospectus, the disclosure and liability provisions of Sections 26, 34, and 35 simply do not engage. The same line is now policed on the private-placement side by the numerical caps in Section 42.
Section 25 — the deemed prospectus
Section 25 closes an obvious avenue of evasion. A company could, in theory, allot its entire issue to an intermediary — an issuing house — which would then sell the securities on to the public, the company thereby avoiding the obligation of issuing a prospectus itself. Section 25 defeats this device. Where a company allots or agrees to allot any securities with a view to all or any of those securities being offered for sale to the public, any document by which the offer for sale to the public is made is deemed to be a prospectus issued by the company, and all the enactments and rules as to the contents of a prospectus and as to liability in respect of misstatements apply to it as if it were a prospectus issued by the company.
Section 25(2) supplies two evidential presumptions that an allotment or agreement to allot was made with a view to the securities being offered to the public. It is presumed, unless the contrary is shown, that the offer for sale was so intended if the offer was made within six months after the allotment or agreement to allot, or if, at the date of the offer, the whole of the consideration to be received by the company in respect of the securities had not yet been received. The deemed prospectus must additionally state the net amount of the consideration received by the company in respect of the securities and the place and time at which the underlying contract may be inspected. The provision ensures that the substance of a public offer cannot be defeated by interposing a middleman; the disclosure travels with the securities to the public.
Section 26 — matters to be stated in a prospectus
Section 26 is the disclosure code. Every prospectus issued by or on behalf of a public company must be dated and signed and must state the information and set out the reports on financial information specified by SEBI, together with the matters enumerated in the section — among them the names and addresses of the registered office, directors, auditors, and bankers; the dates of opening and closing of the issue; particulars of the underwriting; the objects of the issue and the utilisation of proceeds; the capital structure; and the consents of experts named in it. Section 26(4) requires that a copy of the prospectus, signed by every named director or proposed director, be delivered to the Registrar for filing on or before the date of its publication. Section 26(8) renders a prospectus invalid if it is issued more than ninety days after that copy is delivered to the Registrar.
The penalty provision, Section 26(9), is the enforcement backstop. Where a prospectus is issued in contravention of Section 26, the company is punishable with a fine of not less than fifty thousand rupees extending to three lakh rupees, and every person who is knowingly a party to the issue is punishable with imprisonment up to three years, or with a like fine, or both. The section thus combines a positive disclosure mandate, a filing requirement, a validity time-limit, and a penal sanction. It is the statutory embodiment of the disclosure philosophy: the investor is entitled to a complete, dated, signed, and registered statement of the facts material to his decision before he is invited to subscribe.
The golden rule of disclosure
Behind the statutory list of Section 26 lies a common-law standard of candour known as the golden rule for framing a prospectus, laid down in New Brunswick and Canada Railway Co. v. Muggeridge, (1860) 1 Dr & Sm 363. Kindersley V.C. held that those who issue a prospectus hold out to the public great advantages that will accrue from the enterprise, and the public is invited to take shares on the faith of the representations contained in the prospectus. A person taking shares on the strength of the prospectus has a right not only not to be misled by any positively false statement, but to be informed of every material fact the knowledge of which might reasonably affect his decision to subscribe. The prospectus must, in short, make a full and honest disclosure of all material facts without concealment.
The corollary — that a statement may be true in the letter yet false in the impression it conveys — was driven home in Rex v. Kylsant, (1932) 1 KB 442, the Royal Mail case. The prospectus stated, accurately, that the company had paid dividends over a number of years. The statement was literally true. But it omitted that, in the relevant years, the dividends had been paid not out of trading profits — the company was in fact trading at a loss — but out of accumulated capital reserves built up in earlier prosperous years. The court held the prospectus false and misleading: the true statement was rendered deceptive by what it left unsaid. A half-truth that creates a false overall impression is, for the purposes of prospectus liability, a misstatement. This is why Section 26 and the liability sections speak not only of untrue statements but of misleading inclusions and omissions.
Variations, shelf and red herring prospectus
Sections 27, 31, and 32 supply the variations on the standard prospectus. Section 27 governs variation in the terms of a contract or the objects stated in the prospectus: such a variation requires the authority of the company in general meeting by special resolution, and dissenting shareholders must be given an exit in the manner SEBI specifies. The company cannot use the money raised through the prospectus to buy or trade in the shares of any other body corporate. Section 27 protects the investor who subscribed on the faith of the stated objects from a unilateral post-issue change of purpose.
Section 31 introduces the shelf prospectus — a prospectus in respect of which the securities included in it are issued for subscription in one or more issues over a certain period without the issue of a further prospectus. The Explanation defines it accordingly, and the validity period is one year from the opening of the first offer. For subsequent offers within that period, the company need only file an information memorandum updating any material change, sparing it the cost and delay of a fresh prospectus for each tranche. Section 32 introduces the red herring prospectus — a prospectus which does not include complete particulars of the quantum or price of the securities. It is the instrument of the book-building process, where the price is discovered from investor demand rather than fixed in advance. It must be filed with the Registrar at least three days before the subscription list opens, it carries the same obligations as a prospectus, and on the closing of the offer it is followed by the final prospectus stating the total capital raised and the closing price. The shelf prospectus addresses repeat issuance; the red herring addresses price discovery.
Civil liability for misstatements — Section 35
Section 35 is the civil-liability provision and the one most heavily tested. Where a person has subscribed for securities of a company acting on any statement included, or on the inclusion or omission of any matter, in the prospectus which is misleading, and has sustained loss or damage in consequence, the company and certain named persons are liable to pay compensation. The persons made liable are: every person who is a director of the company at the time of the issue of the prospectus; every person who has authorised himself to be named, and is named, in the prospectus as a director or as having agreed to become one; every promoter of the company; every person who has authorised the issue of the prospectus; and every expert referred to in Section 26(5). Their liability is to compensate every subscriber who has sustained loss or damage by reason of the misleading statement, inclusion, or omission.
Section 35(2) supplies the statutory defences. No person is liable if he proves that, having consented to become a director, he withdrew his consent before the issue of the prospectus and that it was issued without his authority or consent; or that the prospectus was issued without his knowledge or consent and that, on becoming aware of its issue, he forthwith gave reasonable public notice to that effect; or that, as regards every misleading statement, he had reasonable grounds to believe, and did up to the time of allotment believe, that the statement was true, or that the statement was a correct copy of, or extract from, an expert's report or a public official document. The common-law backdrop is Derry v. Peek, (1889) 14 App Cas 337, which held that to found an action in deceit the misrepresentation must be fraudulent — made knowingly, or without belief in its truth, or recklessly careless whether it be true or false — and that an honest belief, however unreasonable, is a defence to deceit. Section 35, by imposing liability for misleading statements without requiring proof of fraud and casting the burden of the reasonable-belief defence on the defendant, deliberately goes beyond the rigour of Derry v. Peek, which Parliament had already corrected for company prospectuses by statute.
Criminal liability — Sections 34 and 36
Criminal liability runs along two tracks. Section 34 deals with criminal liability for misstatements in the prospectus itself: where a prospectus issued, circulated, or distributed includes any statement which is untrue or misleading in form or context, or where any inclusion or omission is likely to mislead, every person who authorises the issue of such prospectus is liable for fraud under Section 447. The proviso supplies a defence: a person escapes liability if he proves that the statement or omission was immaterial, or that he had reasonable grounds to believe, and did up to the time of issue of the prospectus believe, that the statement was true or the inclusion or omission was necessary. Section 34 thus criminalises the misleading prospectus and routes the punishment through the general fraud provision.
Section 36 deals with a different wrong — fraudulently inducing persons to invest money. Any person who, knowingly or recklessly, makes any statement, promise, or forecast which is false, deceptive, or misleading, or deliberately conceals any material fact, in order to induce another person to enter into an agreement to acquire, dispose of, subscribe for, or underwrite securities, or an agreement to obtain credit facilities from a bank or financial institution, is liable for action under Section 447. Section 36 is not confined to prospectuses; it reaches any fraudulent inducement to invest, however made. Section 447 itself prescribes the punishment for fraud — imprisonment of not less than six months extending to ten years and a fine of not less than the amount involved in the fraud extending to three times that amount; where the fraud involves public interest, the minimum imprisonment is three years. The distinction to remember is that Section 34 attaches to authorising a misleading prospectus, while Section 36 attaches to fraudulently inducing investment by any false statement; both lead to Section 447.
Allotment — the contract and Section 39
Allotment is the company's acceptance of the investor's offer. When the company invites offers through a prospectus, the applicant who applies makes an offer; the company, by allotting the shares, accepts it, and a binding contract results. The Supreme Court in Sri Gopal Jalan and Co. v. Calcutta Stock Exchange Association Ltd., (1963) 33 Comp Cas 862 (SC), held that allotment of shares means the appropriation, out of the previously unappropriated capital of the company, of a certain number of shares to a person. It is on allotment that the shares come into existence. It follows that the re-issue of forfeited shares is not an "allotment" in this sense — those shares already exist — but a sale; only a fresh appropriation of unappropriated capital is an allotment. For an allotment to be valid it must be made by proper authority, within a reasonable time, and be absolute and unconditional and duly communicated to the applicant.
Section 39 imposes the minimum-subscription condition on a public allotment. No allotment of securities offered to the public for subscription may be made unless the amount stated in the prospectus as the minimum amount has been subscribed, and the sums payable on application for that amount have been paid to and received by the company by cheque or other instrument. The amount payable on application on every security must be at least five per cent of the nominal amount of the security, or such other percentage or amount as SEBI may specify. If the stated minimum subscription has not been received within thirty days of the issue of the prospectus, or such other period as SEBI prescribes, the application money must be repaid within the prescribed period, failing which the company and its officers in default attract a penalty. A company having a share capital must file a return of allotment with the Registrar. Minimum subscription protects the public investor from being locked into a venture that the market has declined to fund.
Section 40 — listing and the escrow of application money
Section 40 ties the public offer to the stock exchange. Every company making a public offer must, before making the offer, apply to one or more recognised stock exchanges and obtain permission for its securities to be dealt in on the exchange or exchanges, and must state in the prospectus the name of each exchange to which the application has been made. All monies received on application from the public must be kept in a separate bank account with a scheduled bank and may not be used for any purpose other than adjustment against allotment where permission to deal has been obtained, or repayment of monies to applicants where permission has not been obtained or the offer has otherwise failed.
Default attracts a substantial penalty: the company is punishable with a fine of not less than five lakh rupees extending to fifty lakh rupees, and every officer in default with imprisonment up to one year or a fine of not less than fifty thousand rupees extending to three lakh rupees, or both. Section 40(6) permits the company to pay a commission to any person subscribing or agreeing to subscribe for securities, subject to the prescribed conditions. The section's escrow mechanism is the practical safeguard that the public's application money is ring-fenced until either the securities are allotted and listed or the money is returned — the financial counterpart to the disclosure safeguards in Section 26.
Section 42 — private placement
Section 42 is Part II of the chapter — the private placement regime, the alternative to a public offer. A company may make a private placement of securities to a select group of identified persons through a private placement offer-cum-application letter in Form PAS-4. The offer may be made to not more than two hundred persons in the aggregate in a financial year, excluding qualified institutional buyers and employees offered securities under a scheme of employees' stock options. The two-hundred-person ceiling is computed separately for each kind of security. If an offer or allotment exceeds this limit, it is deemed to be a public offer and all the provisions of the Act and of the SEBI and Securities Contracts (Regulation) Acts apply — the statutory recognition that a private placement which spills over its numerical banks becomes, in substance, a public solicitation.
The procedural discipline of Section 42 is tight. The application money must be received only by cheque, demand draft, or other banking channel, never in cash. Monies received must be kept in a separate bank account and may be used only for allotment or repayment. The company must allot the securities within sixty days of receipt of the application money, failing which it must repay the money within fifteen days, and thereafter with interest. A company making an offer under Section 42 may not make a fresh offer of the same kind of security while a previous offer is pending or has not been withdrawn or abandoned. The company must file a return of allotment with the Registrar within the prescribed period, and contravention attracts a penalty that may extend to the amount raised through the private placement or two crore rupees, whichever is lower, together with refund to subscribers. Section 42 is, in short, the controlled private channel: it spares the company the public-offer machinery but holds it to numerical, procedural, and timing limits designed to keep a private placement genuinely private.
MCQ angle — the recurring distinctions
Several distinctions recur in objective papers. First, the three fund-raising routes for a public company under Section 23 (public offer, private placement, rights or bonus issue) versus the two for a private company (no public offer). Second, the deemed prospectus under Section 25 and its two presumptions — the six-month window and the unreceived consideration. Third, Nash v. Lynde as authority for the proposition that a privately circulated, confidential document is not a prospectus. Fourth, the golden rule of New Brunswick v. Muggeridge and the half-truth doctrine of Rex v. Kylsant. Fifth, the precise allocation of the liability sections — Section 34 (criminal liability for misstatements in the prospectus), Section 35 (civil liability and the list of liable persons: directors, those named as directors, promoters, those who authorised the issue, and experts under Section 26(5)), and Section 36 (fraudulently inducing persons to invest) — all of which feed into Section 447.
Sixth, the shelf prospectus (Section 31, repeat issuance, one-year validity, information memorandum for subsequent offers) versus the red herring prospectus (Section 32, incomplete price or quantum, filed three days before the subscription list opens, book-building). Seventh, the minimum-subscription rule of Section 39 and the five-per-cent application-money floor. Eighth, the two-hundred-person ceiling under Section 42 and the consequence of breach — deemed public offer. And ninth, the Sri Gopal Jalan proposition that allotment is appropriation of unappropriated capital, so that re-issue of forfeited shares is a sale and not an allotment. These distinctions are the staple of the prospectus-and-allotment question; mastering them and the cases that anchor them — alongside the foundational chapters on company, director and member and incorporation — covers the bulk of what is asked. For the full subject map, return to the Companies Act, 2013 hub.
Frequently asked questions
What is the difference between a public offer and a private placement under Section 23?
Section 23 of the Companies Act, 2013, sets out the permissible routes by which a public company may issue securities: a public offer, a private placement, or a rights or bonus issue. A public offer — defined in the Explanation to include an initial public offer, a further public offer, or an offer for sale by an existing shareholder — is made to the public at large through a prospectus and must comply with Part I of Chapter III and the SEBI regime. A private placement under Section 42 is an offer or invitation to a select group of identified persons (not more than 200 in a financial year, excluding qualified institutional buyers and ESOP holders) made through a private placement offer-cum-application letter in Form PAS-4, and carries no public solicitation. A private company may issue securities only by private placement or rights or bonus issue, never by public offer.
When is a document deemed to be a prospectus under Section 25?
Section 25 creates the 'deemed prospectus' to prevent companies from evading prospectus liability by routing an issue through an intermediary. Where a company allots or agrees to allot securities with a view to those securities being offered for sale to the public, the offer-for-sale document issued by the intermediary is deemed to be a prospectus issued by the company. Section 25(2) supplies two presumptions of an intention to offer to the public: that the offer for sale was made within six months after the allotment or agreement to allot, or that, at the date of the offer, the company had not received the whole consideration for the securities. The same threshold question of what counts as an offer to the public was settled in Nash v. Lynde, 1929 AC 158, where a privately circulated, confidential document was held not to be a prospectus.
What is the golden rule for framing a prospectus?
The golden rule was laid down in New Brunswick and Canada Railway Co. v. Muggeridge, (1860) 1 Dr & Sm 363, by Kindersley V.C. A person inviting the public to take shares has a right not only not to be misled by any positively false statement, but to be informed of every material fact the knowledge of which might reasonably deter him from subscribing. The prospectus must make a full, frank, and honest disclosure; there must be nothing concealed and no half-truths. The rule is reinforced by Rex v. Kylsant, (1932) 1 KB 442, where a prospectus that was literally true — it disclosed that dividends had been paid over a period of years — was held false and misleading because it omitted that those dividends had been paid not from trading profits but from accumulated capital reserves. A literal truth that creates a false overall impression is a misstatement.
What is the distinction between civil and criminal liability for misstatements in a prospectus?
Civil liability arises under Section 35: where a person subscribes for securities acting on a misleading statement or a misleading inclusion or omission in the prospectus and sustains loss, the company, every director at the time of issue, every promoter, every person who authorised the issue, and every expert named under Section 26(5) are jointly and severally liable to pay compensation. Section 35(2) supplies the statutory defences — chiefly withdrawal of consent before issue, issue without knowledge or consent followed by prompt public notice, or reasonable belief in the truth of the statement. Criminal liability arises under Section 34: where the prospectus contains an untrue or misleading statement, every person who authorises its issue is liable for fraud under Section 447, unless he proves the statement was immaterial or that he had reasonable grounds to believe it true. Section 36 separately punishes any person who fraudulently induces another to invest money, also under Section 447.
What is minimum subscription, and what happens if it is not received under Section 39?
Under Section 39 of the Companies Act, 2013, no allotment of securities offered to the public may be made unless the minimum amount stated in the prospectus has been subscribed and the application money has actually been received by cheque or other instrument. The application money must be at least five per cent of the nominal amount of the security, or such other percentage as SEBI may specify. If the stated minimum subscription is not received within thirty days of the issue of the prospectus (or such period as SEBI prescribes), the application money must be repaid within the prescribed period; failure to repay attracts a penalty on the company and its officers in default. Allotment in contravention of Section 39 is irregular, and a company having a share capital must file a return of allotment with the Registrar.
What is the difference between a shelf prospectus and a red herring prospectus?
A shelf prospectus under Section 31 is a prospectus in respect of which the securities are issued for subscription in one or more issues over a certain period — up to one year — without the issue of a further prospectus; for subsequent offers within that validity period the company files only an information memorandum updating material changes, sparing it the cost of a fresh prospectus each time. A red herring prospectus under Section 32 is a prospectus issued prior to the main prospectus that does not contain complete particulars of the quantum or price of the securities; it is filed with the Registrar at least three days before the subscription list opens, carries the same obligations as a prospectus, and on closing of the offer is followed by the final prospectus stating the total capital raised and the closing price. The shelf prospectus addresses repeat issuance; the red herring addresses book-building where price and quantum are fixed only after demand is gauged.