3 Important Liabilities of the Directors, Promoters and Others of a Company (Indian Companies Act, 1956)

The person sued for damages can escape liability for damages by successfully pleading any of the following defences. [Sec. 62 (2)].

(a) Authority of an expert:

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He made the statement on the authority of an expert whom he believed to be competent and that the expert had given his consent required by Section 58 and had not withdrawn it.

(b) Reasonable ground for belief:

He had reasonable grounds for believing the statement to be true and that he did believe it to be true up to the time of allotment.

(c) Correct copy of an extract:

The statement was a correct copy of some extract from an official document and that he had in fact believed it to be true.

(d) Consent withdrawn:

He withdrew his consent to become a director before the issue of the prospectus and the prospectus was issued without his authority.

(e) Issued without knowledge:

The prospectus was issued without his knowledge and that on knowing the fact he gave reasonable public notice that it was issued without his knowledge.

(f) Public notice:

After the issue of prospectus but before the allotment there under, he, on knowing that the statement is untrue, withdrew his consent and gave reasonable public notice of the withdrawal and the reason thereof.

A director, who has been asked to pay damages to a shareholder, is entitled to a pro rata contribution from other directors who would have been liable to damages had the proceedings been instituted against them. [Sec. 62 (5)].

Further, an expert or a person who has given his consent to his name being mentioned in the prospectus in the capacity of an auditor, legal adviser etc., is liable only to the extent of any untrue statement, if any, purporting to have been made by him as an expert.

(ii) Criminal liability:

According to Section 63(1) of the Companies Act, a person responsible for the issue of prospectus containing untrue statements relating to material facts may also be held criminally liable and may be punished with imprisonment up to two years and/or with fine up to Rs. 50,000 except when in the opinion of the court (1) the statement in question was immaterial, or (2) that he had reasonable ground to believe and he did believe in the truth of the statement till the issue of the prospectus. Even mere negligence in the absence of reasonable grounds for belief that the statement was true will entail criminal liability.

Under section 68 a person who fraudulently induces or attempts to induce any person to invest money in a company or to enter into any agreement for, or with a view to acquire, dispose of, subscribe or underwrite shares or debentures or to enter into any agreement the purpose of which is to secure a profit to any of the parties from the yield of shares or from the fluctuations in the value of shares or debentures, shall be liable to imprisonment upto 5 years or fine upto Rs. 100,000 or both.

(iii) Liability under general law:

Persons responsible for the issue of prospectus can also be held liable in an action for deceit, under general law as provided by section 19 of the Indian Contract Act. This remedy shall be available even where the remedy by way of rescission as against the company is lost either through latches or negligence or even if the company goes into liquidation. But the plaintiff will have to prove the following:

(a) There was a fraudulent mis-statement:

A fraud is said to have been committed if a false representation is made knowingly or without belief in its truth or recklessly, whether it be true or false. From this it follows that there is no fraud if the person making a false statement honestly believes it to be a true one.

(b) Representation related to some existing material facts:

Material facts mean facts which are important for the contract.

(c) He had seen the prospectus and is the original allottee:

A person who had not purchased the shares on the basic of the prospectus, which contained false and misleading statements, shall not be entitled to any remedy, either that of rescinding the contract or that of claiming the damages. A person cannot be said to have purchased on the basis of the prospectus when he has purchased those shares from an existing shareholder.

Similarly, a purchaser of shares from the share market cannot be looked upon as one to whom the prospectus is addressed and is precluded from bringing an action of deceit because “the object of a prospectus is to invite persons to become allottees and the allotment having been completed, such object is exhausted and the liabilities to allottees do not follow the shares into the hands of subsequent transferees.

Directors cannot be made liable infinitum for all the subsequent dealings which may take place with regard to those shares upon the stock exchange.” The leading case is that of Peek v Gurney:

Gurney issued a fraudulent prospectus on behalf of a company. No shares were purchased by Peek at that time. Several months afterwards, Peek purchased 2,000 shares of the company from the stock exchange. He brought an action against the directors for deceit. Held, the directors were not liable.

(d) He has been actually Deceived:

There can be no action unless the shareholder has actually been deceived. A deceit which does not deceive is no fraud. Besides mere misreading of a prospectus cannot form the basis of an action for deceit.