“Section 25 of Companies Act-Document containing offer of securities for sale to be deemed prospectus.

 (1) Where a company allots or agrees to allot any securities of the company 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 shall, for all purposes, be deemed to be a prospectus issued by the company; and all enactments and rules of law as to the contents of prospectus and as to liability in respect of mis-statements, in and omissions from, prospectus, or otherwise relating to prospectus, shall apply with the modifications specified in subsections (3) and (4) and shall have effect accordingly, as if the securities had been offered to the public for subscription and as if persons accepting the offer in respect of any securities were subscribers for those securities, but without prejudice to the liability, if any, of the persons by whom the offer is made in respect of mis-statements contained in the document or otherwise in respect thereof. 

(2) For the purposes of this Act, it shall, unless the contrary is proved, be evidence that an allotment of, or an agreement to allot, securities was made with a view to the securities being offered for sale to the public if it is shown—

 (a) that an offer of the securities or of any of them for sale to the public was made within six months after the allotment or agreement to allot; or

 (b) that at the date when the offer was made, the whole consideration to be received by the company in respect of the securities had not been received by it.

 (3) Section 26 as applied by this section shall have effect as if — (i) it required a prospectus to state in addition to the matters required by that section to be stated in a prospectus— (a) the net amount of the consideration received or to be received by the company in respect of the securities to which the offer relates; and (b) the time and place at which the contract where under the said securities have been or are to be allotted may be inspected; (ii) the persons making the offer were persons named in a prospectus as directors of a company.

 (4) Where a person making an offer to which this section relates is a company or a firm, it shall be sufficient if the document referred to in sub-section (1) is signed on behalf of the company or firm by two directors of the company or by not less than one-half of the partners in the firm, as the case may be”.

Broad Scope of term “Securities” under Section 25 of Companies Act 2013

A security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

“As per Section 2 (b) of The Securities Contracts (Regulation)Act, 1956, “Government security” means a security created and issued, whether before or after the commencement of this Act, by the Central Government or a State Government for the purpose of raising a public loan and having one of the forms specified in clause (2) of section 2 of the Public Debt Act, 1944”.

1. Deemed Prospectus: 

Though not the final prospectus, any document used by a company to publicly offer its securities gains the legal standing of a prospectus under Section 25(1) of the Companies Act 2013. This “deemed prospectus” acts as an initial public offer but without fulfilling the complete requirements of a formal prospectus. This elevated status subjects the document to the same rigorous disclosure obligations, filing procedures, and potential legal liabilities as a regular prospectus under Section 26. In essence, by encompassing even informal offering materials, this concept ensures market fairness and investor protection through mandated transparency and accountability in public offerings. Companies and their directors must remember these implications when publicly seeking investments, as non-compliance with the stringent regulations can lead to significant legal consequences. 

2. Triggering Mechanism:

Triggering action determines when a company action activates the strict disclosure and regulatory framework associated with a public offering through prospectus. Triggering action involves allotting  or agreeing to allot any securities including formal allocation and preliminary agreements as long as ultimate goal is a public offering.  Even if a company hasn’t formally allocated shares, their public call for subscriptions which would ultimately lead to a public offering if successful, triggers the strict rules of a deemed prospectus.

Let’s discuss the example, If  Company “ XYZ”  is a Tech start-up and  it announces on social media and tech blogs that they are “ opening up investment opportunities” and invites people to “get on board with the next big thing.” They haven’t formally allocated shares yet, but they clearly intend to sell them to the public if enough people express interest.

As per Sectio 25, this public solicitation, even without actual allotments, automatically makes the announcement document a deemed prospectus, requiring them to follow the same strict disclosure and liability rules as a regular public offering.

3. Deemed prospectus Effect:

Deemed prospectus has several significant effects in terms of:

• Information disclosure: Disclosure of information about finances, reports relating to profit and loss, present business plan including projects and deadline to complete the projects, future risk involved in business, etc.
• Legal compliance: It  leads the document enters the regulatory framework for prospectuses legally which is also subject to scrutiny and filing procedures.
• Potential liabilities like misstatements or omissions, or any litigation or legal action pending or taken by a Government Department or a statutory body.

4. Exemptions and Exceptions:

Section 25 of Companies Act 2013 outlines the provisions related to exemptions and exceptions. These provisions allow companies to be exempted from certain requirements or obligations under the Act in certain situations. For example, companies can be exempted from complying with certain provisions related to capital structure, valuation, and mutual fund investment. Exemptions and exceptions are subject to various conditions, and companies must satisfy these conditions to avail of the benefits of these provisions.

5. Content and Disclosure Requirements:

If deemed prospectuses skip some of the details like financial and company information demanded by Section 26. The modifications in subsections (3) and (4)

streamline certain disclosures, focusing on the net sale proceeds, intended use of funds, and risk factors. This can be seen as a concession for smaller offerings or less complex structures.

6. Practical Implications of Section 25 of the Companies Act, 2013

Section 25 of Companies Act 2013, has significant practical implications for companies considering public offers of securities in India. Here’s a breakdown of its key impacts:

6.1  Deemed Prospectus:

“Deemed prospectus” is the document that is considered a prospectus under the provision of Section 25 of Companies Act 2013 and Security Law to offer securities to investors. As the name says, this document is just deemed to be a prospectus and when a company offers to sell its IPOs, shares, rights issues, bonus issues, and private placements it shall comply with the comprehensive disclosure requirements specified in the Acts, and SEBI regulations.

6.2. Streamlined Disclosure:

Section 26, Section 25 of Companies Act 2013 allows for certain modifications in disclosure mainly on focusing on key information including: 

• Net sale of the company’;
• Intended use of funds;
• Risk factor;
• Omission of detailed financial statements;
• Historical performance data;
• Management profile including information 

6.3 Information Asymmetry:

• The streamlined disclosure in deemed prospectuses might raise concerns about information asymmetry, where investors lack crucial details.
• Companies must be mindful of providing sufficient information to make informed investment decisions.
• Investors and intermediaries must conduct stronger due diligence to compensate for potential information gaps.

6.4  Impact on Offering Process:

• Deemed prospectuses offer a faster and potentially cheaper route to market compared to regular prospectuses.
• However, the simplified disclosure might deter some investors seeking more comprehensive information.
• Companies must carefully consider the trade-off between speed and information richness when choosing between a deemed and regular prospectus.

6.5  Additional Compliance Burden:

• Companies using deemed prospectuses must still comply with various regulations, including filing requirements with SEBI and maintaining proper records.
• This adds to the overall compliance burden compared to private placements without public offers.

In the case of  Financial Planning Supervisory vs SEBI on 30th September 2015 before the Security Appellate Tribunal

An appeal was filed to challenge the communication of the SEBI. Financial Planning Supervisory Board (FPSB) and the Investment Management Association of India (IMFI), on the matter of who should be recognized as the Self Regulatory Organization (SRO) for distributors of mutual funds in India.

In the said matter, FPSB argues that they were registered under Section 25 of Companies Act 2013 before IMFI, So they shall be SRO AND IMFI weren’t registered at the time so their application shall be deemed to be invalid.

Further, they argued that SEBI didn’t follow the proper procedure in selecting IMFI as per prescribed rules, so they did not give an opportunity to FPSB for a hearing before rejecting their application.

IMFI argues that their application was valid because they were granted a license under Section 25(1) of the Companies Act, which is sufficient to meet the eligibility criteria for submitting an application under the SRO regulations. They also argue that SEBI doesn’t need to give a hearing to all applicants when selecting an SRO, only to the one who is ultimately chosen.

The court ruled in favor of FPSB. They found that SEBI did not follow the proper procedure in selecting an SRO for distributors of mutual fund products. Regulation 10 of the SRO Regulations requires SEBI to give a hearing to unsuccessful applicants at the time of selecting and granting in-principle approval. SEBI failed to do this, so the court quashed their decision and ordered them to select an SRO afresh. This means that FPSB could still be chosen as the SRO, even though they lost the case on the first issue.

Conclusion

Section 25 of Companies Act 2013 interests of potential investors offering  deemed prospectus  through an allotment of securities, or an agreement to allot securities, securities was made with a view to the securities being offered for sale to the public.

Furthermore, it focuses on transparency by providing all required details to the investor’s confident and informed investment decisions through a public offering. 

All provisions mentioned in Section 25 of Companies Act 2013 help to create a healthy capital market in India  for Investors. It also leads to safeguarding the company’s goodwill and status by disclosing the all information through a deemed prospectus which helps to attract  investors at large.

FAQs

1. What happens if I offer securities to the public without using a deemed prospectus under Section 25?

Offering without a Deemed Prospectus may be a serious offense under the Companies Act. You could face penalties like fines, imprisonment, or both. Additionally, the offer itself might be declared invalid, leaving investors and intermediaries in a precarious situation.

2. Are there any exemptions from using a deemed prospectus under Section 25? If so, what are they?

Exemptions from Deemed Prospectus are as below:

1. Offers solely to institutional investors (defined by SEBI regulations).
2. Offers through recognized stock exchanges.
3. Certain types of private placements with limited investor numbers.
4. Issuance of bonus shares to existing shareholders within certain limits.

3. What specific information do I need to disclose in a deemed prospectus compared to a regular prospectus under Section 26?

Deemed prospectuses require disclosure of key information like net sale proceeds, intended fund use, risk factors, etc. Compared to Section 26, they might omit detailed financial statements, historical data, and extensive management profiles.

4. How can I ensure I’m fulfilling my due diligence obligations when investing in a company that uses a deemed prospectus?

There are different ways:

1. Scrutinize the disclosed information critically, looking for any missing details or red flags.
2. Conduct independent research on the company’s financial health, track record, and management.
3. Consider seeking professional advice from financial advisors or legal counsel.

5. What are the potential risks of information asymmetry for investors when it comes to deemed prospectuses?

          There is potential risk involved for investors in the following ways:

1. Streamlined disclosure may leave investors with less comprehensive information to make informed decisions.
2. This makes due diligence even more crucial to mitigate potential information gaps and investment risks.

6. Does using a deemed prospectus under Section 25 always mean a faster and cheaper public offering process compared to a regular prospectus?

Deemed prospectuses can offer a potentially faster and cheaper option than regular ones due to simplified filings and disclosure requirements. However, this depends on factors like offer size, complexity, and investor demands for detailed information.