Section 37 of Companies Act. Action by affected persons

“A suit may be filed or any other action may be taken under section 34 or section 35 or section 36 by any person, group of persons or any association of persons affected by any misleading statement or the inclusion or omission of any matter in the prospectus.“

Scope of Section 37 of Companies Act

We talk about shareholder democracy and rights. The law Companies Act intends to protect the interests relating to majority powers and minority protection. Generally, Companies offer their securities through prospectus to generate capital for their businesses and the Companies Act provides statutory actions to the investors or persons who have subscribed for such securities, and any untrue, misleading statement or the inclusion or omission of the matter contained in the prospectus shall be liable to civil or criminal or both against the company.

The corporate disputes involved the power of the Security Exchange Board of India when a company or persons involved in it failed to act. A dispute can arise between the board and the company or the board and its shareholders. Section 37 allows to take action against such acts of failure. 

“Section 37 says that Action by affected person suit may be filed or any other action may be taken under section 34 or section 35 or section 36 by any person, group of persons or any association of persons affected by any misleading statement or the inclusion or omission of any matter in the prospectus.”

Who are “Affected Persons” in Section 37 of Companies Act? 

Affected persons can be individual shareholders, or shareholder groups who take action for misstatements or omissions in a prospectus under Section 37 of the Companies Act.

The provisions under Section 34, section 35, and Section 36 of the Companies Act which prescribed the provisions for taking action by affected persons include civil liabilities, criminal liabilities, Punishment, and procedure against the offenses of untrue information or fraudulent practices against the interest of the shareholders.

What all “actions” are referred to?

Let us assume that a company, ABC Ltd, has been issued a prospectus to generate capital for new projects and attract investors for it. The prospectus stated the information that the company has got a major tender from another country which will have great financial growth for the company. A person “X” who wants to invest his money analyse the offer issued and invests his money.  Later, it was said that the tender mentioned in the prospectus did not belong to another country it was just to mislead the investors to attract them, and due to this company’s revenue projections were highly inflated. A Person “X”, has suffered a loss due to the misleading information in the prospectus. So “x” can file the case against ABC under Section 37 of The Companies Act, for the losses he suffered due to the false misleading statements made in their prospectus.

Section 34 and Criminal liability for misstatements in prospectus

Any company issues, distributes, or circulates a prospectus that contains information that is not true, misleading statements, or omission of material information may lead to criminal liability under Section 447 of the Companies Act, 2013. Anyone responsible for violating the said provisions can be punished with imprisonment for up to 5 years or a fine or both.

Provided if it is proved that,

The misstatement or omission in the prospectus was immaterial and it has not affected the Investors.

It shall prove that on the ground of reasonable belief, the statement in the prospectus was true and omission in it was necessary which was done with complete due diligence.

Section 35, says civil liability for misstatements in the prospectus arises towards its director, authorised director, and promoter of the company. Section 26 subsection (5) prescribed the punishment of paying compensation to the aggrieved party who has sustained such loss or damages.  As per subsection (2) it is Provided that if the alleged party proves that he issued his consent before issuing a prospectus or a prospectus issued without his consent, or his knowledge or after issuing such prospectus he gave a reasonable public notice that it was issued without his knowledge or consent.

Every person shall be liable for compensation personally without any limitation of liability if it is proved that the prospectus was issued with the intent of fraud or deceiving investors.

CrPC and Section 37 of the Companies Act

Fraud under Companies Act and Indian Penal Code (IPC), Cr. Pc.: Fraud is an act of deceiving someone intentionally for wrongful gain. When we talk about fraud in the context of Section 447 of the said Act, it is about untrue information in the prospectus to offer securities to the investor with the intent of wrongful gain. The Criminal procedure laid down in the Cr. Pc. against the fraud.

Other authorities: The detailed adjudication procedure related to inspection, Inquiry, and Investigation has been empowered by Ministry of Corporate Affairs (MCA), Security Exchange Board of India (SEBI), NCLT (National Company Law Tribunal), Registrar of the Company (ROC), NALAT (National Company Law Appellate Tribunal), etc.

Landmark Precedent under Section 37 of Companies Act

In the matter of Balram Garg Vs. Security Exchange Board of India (SEBI) allegation made for insider trading by relatives of a company’s executives by Security Exchange Board of India (SEBI).  One of the relatives had been selling the company’s shares before the announcement of the buy-back at a lower price. SEBI claimed that the executives leaked “Unpublished Price Sensitive Information” (UPSI) to their relatives. There was a fraudulent intent to trade profitably.

Key Findings

SEBI held responsible to the executives for the violation of inside trading rules by sharing UPSI. Also, SEBI was held responsible for violation by acting on leaked information for their profit. The court focused on the burden of proof for wrongful acts that they have been a possession of shares before they traded shall established by SEBI.

Conclusion

Section 37 provides intent to ensure better corporate compliance under the Companies Act with the enactment of different civil liabilities, and criminal liabilities by taking action by affected persons. However, it ensures certain procedural and technical non-compliances for the default or violation of the securities laws. It also provides the mechanism for adjudication with the different authorities along with other provisions given by the Acts.

FAQs

1. On which grounds can someone be held liable under Section 36 of the Companies Act?

Fraudulent intention to mislead someone for wrongful gain, someone induced to invest by using verbal, written, or other means, and as a result, if someone has suffered financial losses can be held liable under Section 36 of the Companies Act.

2. Who can take action against someone accused of violating Section 36?

On the violation of Section 36 the parties responsible for legal action are

1. Individual Investor or group of Investors
2. Regulatory authorities like SEBI, ROC, MCA 
3.  Companies authorised shareholders who hold the voting rights
4. Other parties like the government, financial stakeholders

3. Which Companies are covered under Section 36? or are there any exemptions?

Section 36 has jurisdiction over public companies (listed and unlisted), One Person Companies (OPCs), Private companies, and Companies (as defined under the Act).  Companies that can be exempted are Government companies owned by the central or state government, foreign companies, and Charitable Companies. 

4. Which penalties are prescribed for individuals found guilty under section 36?

Both imprisonment of fines can be imposed at the discretion of the court on the grounds of the severity of the offence and financial losses.