Section 32: Red Herring Prospectus

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Section 32 of Companies Act, 2013, part of chapter III lays down the provision for red herring prospectus. This section was enforced vide notification on 12th September 2013. This section helps one understand the concept and obligations with respect to issue of a red herring prospectus, which is one of the types of prospectus, by a company proposing to make an offer of securities. It is basically a prospectus which is used in the public issue to attract different investors and acts as a disclosure document, providing investors all the necessary details. A prospectus as defined by the act, 2013 is basically a document inviting deposits from the public or a document-inviting offer from the public for the subscription of shares or debentures of the company [1]. A red herring prospectus is one, which is issued prior to prospectus by a company offering securities for raising money. This analysis will give a better understanding of this concept along with laying down judicial view as well as its situation under the old act, if any. 

Purpose of Section 32

This section under the act, 2013 is quite brief and lays down following:

  • This section permits a company to issue red-herring prospectus prior to issue of a prospectus.
  • The expression “red herring prospectus” is a prospectus according to this section one which does not include complete particulars of the quantum or price of the securities. In simple terms a red herring prospectus contains most of the information pertaining to the company’s operations and prospects, thus enabling the investors to have the necessary information to make an informed decision.
  • Three days prior to the offer and opening of subscription list, the company who wants to issue a red herring prospectus must inform the registrar of their intention to issue the same.
  • Any variations between the red herring prospectus and the prospectus shall be highlighted as variations in the prospectus. Further The red herring prospectus must carry the same obligations as a prospectus.
  • When the offer of the securities is closed, then a company must provide the registrar as well as SEBI, a prospectus stating the total capital raised, and the closing price of the securities and any other details which were not included in the red herring prospectus issued prior to the issue of securities. Here price means the actual price to be issued per share in the initial public offering and quantum means the quantity or the total number of shares to be offered in the initial public offering.

During a book-building process, a red herring prospectus by a company is usually issued. It is important to understand that building is a process used in initial public offer for efficient price discovery by any company, to get a feel of the market. In this process, during the period for which the IPO is open, investors bid at a variety of prices according to their estimates, which are above or equal to the floor price. Red herring prospectus contains either the floor price of securities offered or a price band along with the range within which the bids can move. The applicants bid for the shares quoting the price and the quantity that they would like to bid at. Merchant bankers use a red herring prospectus to test the demand and price for the securities proposed to be offered and thereby use it to determine the final size and prize for the public offer, giving the company a better picture of the market.

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All the implications that come with concealment, misstatement and inaccuracies as well as all the requirements to exercise due care and diligence while drafting a prospectus are also required to be followed and borne in mind while drafting a RHP as well, it is a duty on every company.

SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2009 prescribe certain disclosures to be made in the red-herring prospectus that must be followed by every company. SEBI has made it mandatory for companies to file a draft red herring prospectus with SEBI, before going to the registrar, so that SEBI can review its documents, check the disclosures and make variations and give recommendation, before a final red herring prospectus is filed[2]. After making the changes the final document is filed with SEBI, registrar and stock exchanges and after its reviewed and approved the document becomes a red herring prospectus.

Situation Before Enactment of Section 32

This section is similar to Section 60B of the Act of 1956, which was included in 1956 act by 2000, companies act amendment. There are more than a few changes between the old and the new act, with respect to this section as follows:

  • The option of filing information memorandum prior to red herring prospectus has been dispensed with under the new act.
  • Procedure with respect to receiving subscription money through post-dated cheque or stock investment do not find mention in the new act of 2013.
  • The new act does not cast an obligation to individually intimate the prospective investors about the variations during the interregnum period between issue of red herring prospectus and the prospectus.
  • The new act does not grant an option to withdraw applications available to prospective investors, who have given advance monies before the date of issue, without being aware of the variations during the interregnum period between issue of red herring prospectus and the prospectus.

Application of Section 32

This section basically comes into application, when a company is issuing shares to the public for raising money. This section provides a possible method that can be used by the company for delivering important and relevant information to the investors and also is useful for merchant bankers to find if the initial public offering will be successful in the market or not and gauze the price of the same in the market.

Cases at a Glance

Following are the cases pertaining to this section:

  • Indowind Energy Limited v. Wescare (India) Ltd. & Ors. Subuthi Pvt. Ltd.[3] was the second respondent in this case, and a promoter of the appellant’s company. Subhuthi entered into an agreement of sale with respondent 1, agreeing to transfer some business assets for a consideration of Rs. 98.19 crores of which Rs. 24.19 crores which was payable in cash and Rs. 74 crores by issue of shares. The agreement provided arbitration as a dispute settlement mechanism in case a dispute arose. The agreement, however, could only be enforced after approval from all three companies, but the appellant never approved it. The companies went forward to perform their obligations under the contract. In between a dispute arose and respondent filed for an arbitration proceeding and asked for an interim relief to prohibit appellants to proceed with an IPO by issuing red herring prospectus. The court stated that the appellant was bound by the sale agreement as their issue of red herring prospectus for issue of equity shares clearly indicates their intention to be bound by the agreement. The red herring prospectus issued by applicant states that the appellant entered into agreement for sale with respondent.
  • Appeal by Mr. S.V. Khandekar[4] : This was an appeal against the order of SEBI in its appellate tribunal. Here the appellant filed an application under right to information act seeking a copy of red herring prospectus of a company with respect to its acquisition of another company. This case shows how if the prospectus is not available in any public platform, one can file an RTI application to seek the same from the issuing company. Further this case differentiates between a red herring prospectus with respect to acquisition of a private company by a public company and with respect to IPO.
  • Palco Recycle Industries Limited [5]: Here the company in question filed a draft red herring prospectus with the SEBI for its recommendations and approval as per regulation 6 of SEBI (Issue of capital and Disclosure requirements) Regulation, 2009. The company complied with all the queries of the SEBI but did not receive approval and hence this case was filed. There was a huge delay by the board in giving its approval. This case exemplifies that the board takes cognizance of situations that may cause delays in getting approvals. The board directed the respondents to take actions within two weeks.
  • Casa Paradiso, Owner Welfare Association v. M/s Sanathnagar Enterprises Limited[6]:  Bookings were made in respondent’s building but later on respondent made unilateral changes in his oral assurances to the petitioner and thus because of these inconsistencies, the aggrieved petitioner filed this case before the commission. The aggrieved approached the commission claiming that the enterprise was abusing its dominant position and this fact could be proved based on its red herring prospectus. This case is important as here the commission held that self-acclaims by enterprises in their own documents like red herring prospectus cannot be taken as evidence of dominance per se by respondent to show that its major real estate developer in India.
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Concluding Summary

This section is very important as any company which wants to issue its securities to the public, must adhere to requirements that it has to provide some basic relevant information to the investors. One such form of providing the information is by way of issuing a red herring prospectus. It is an important requirement that needs to be followed by the companies. The member and the company would suffer great loss and penalties for misstatement and providing wrong information in a red herring prospectus. The primary motive behind having such a document is ensuring welfare of investors and misappropriation of funds raised by companies through sale of securities does not happen and the interest and rights of investors are protected.

[1] Companies Act, 2013, No. 18, Acts of Parliament, § 2(70) (2013). 

[2] Dia Rekhi, Why Red herring prospectus is important?. Economic Times (May 20, 2016 03:08 am)

[3] Indowind Energy Limited v. Wescare (India) Ltd. & Ors Civil Appeal No. 3874 of 2010.

[4] Appeal no. 1206 of 2011 by Mr. S.V. Khandekar (SEBI).

[5] Palco Recycle Industries Limited Securities Appellant Tribunal 12th September 2012.

[6] Casa Paradiso, Owner Welfare Association v. M/s Sanathnagar Enterprises Limited Competition Commission of India 2nd September 2013.

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