The integrity of financial markets and investor confidence depend largely on transparency and truthfulness in the communication of company information. Section 36 of the Companies Act, 2013, aims to prevent fraud in securities transactions by penalizing fraudulent inducement in investments. This section applies to misleading statements or deceptive practices that persuade individuals to invest in a company, ensuring that investors are not misled by false promises, misstatements, or material omissions.
This provision corresponds directly to Section 68 of the Companies Act, 1956, and, therefore, judicial precedents interpreting Section 68 of the 1956 Act serve as important references for understanding the scope and application of Section 36 of the 2013 Act. The intent behind this provision is to act as a deterrent against unscrupulous promoters and entities that attempt to defraud investors by providing misleading information.
Scope of Section 36
Section 36 is applicable not only to company prospectuses but also to any proposal or offer for the sale of shares made by any entity. Moreover, under the 2013 Act, its scope extends further to the availing of credit facilities from banks and financial institutions. This means that fraudulent inducement in securing loans or credit arrangements also falls within the ambit of this provision.
The Company Law Committee Report highlights that this section, along with Section 63, serves as a sufficient deterrent against those who attempt to defraud the public by making deceptive statements to raise capital. An important case that illustrates the application of these provisions is M.K. Sreenivasan, Re (1944) 14 Com Cases 193, where individuals were convicted for criminal conspiracy to cheat the public by selling shares through a prospectus that suppressed critical information about the company.
Reckless Misstatements and Fraudulent Inducement
One of the key aspects of fraudulent inducement under Section 36 is the concept of recklessness. Fraudulent conduct does not always require intent; recklessness can also establish liability. If a person deliberately ignores risks or fails to consider them when any reasonable person would have, they can be held accountable under this provision.
The English case law R. v Cunningham (1957) 2 QB 396 defines recklessness as either:
- Knowing there is a risk and still proceeding with the action, or
- Failing to even consider a risk that a reasonable person would recognize.
The Indian courts have followed similar reasoning, a where recklessness was equated with a high degree of negligence.
Misstatement in a Prospectus
A company’s prospectus serves as an essential document for potential investors. It provides details about the company’s financial health, future plans, and risk factors. However, if a prospectus presents a false or overly optimistic picture, it may mislead investors into making financial commitments based on incorrect information.
In Hemendera Prasad Nag Chowdhary v ROC (2010) 99 CLA 60 (AP), a company was accused of misleading the public by painting an excessively rosy picture in its prospectus and Letter of Offer. The court observed that as long as no definite promise or guarantee of performance was made, and as long as all material risks were disclosed, it would not amount to fraudulent inducement.
This distinction is important because future projections and expectations do not always amount to misrepresentation. However, if a company knowingly hides adverse information or fabricates financial data, it can be held liable under Section 36 of the 2013 Act.
Penalties for Fraudulent Inducement
Fraudulent inducement under Section 36 carries severe penalties, as it directly affects investor trust in the market. The punishment for those found guilty includes:
- Imprisonment for up to 10 years
- A fine of up to three times the amount involved in the fraud
These stringent penalties demonstrate the seriousness of offenses under this section and act as a strong deterrent against corporate fraud.
Comparison with Section 628 of the 1956 Act
A key legal discussion arises regarding the relationship between Section 36 of the 2013 Act and Section 628 of the 1956 Act (which dealt with false statements in documents). While both sections address fraudulent misrepresentation, Section 36 is broader in scope.
The Company Law Committee Report clarified that offenses under Section 68 (now Section 36) are wider than those under Section 628. Section 628 deals specifically with false statements in company documents, while Section 36 covers all forms of fraudulent inducement, including deceptive offers, reckless misstatements, and misleading prospectuses.
Courts have also recognized this distinction. In Dilip Dahanukar v Padam Kumar Khaitan (1996 Cr LJ 1569 Raj), a complaint under Section 68 of the 1956 Act was dismissed because fraudulent inducement could not be proven, the individual had not been deceived into purchasing shares due to any false representation. This highlights the high burden of proof required to establish liability under this section.
Conclusion
Section 36 of the Companies Act, 2013, plays a crucial role in protecting investors from fraudulent inducement and ensuring market integrity. By penalizing false representations, reckless misstatements, and deceptive practices, it strengthens investor confidence in financial markets.
With stringent penalties including imprisonment and heavy fines, Section 36 serves as a powerful deterrent against corporate fraud. For investors, it ensures a more transparent and trustworthy investment environment. For companies, it underscores the importance of ethical business practices and the need for accurate financial reporting.
By enforcing strict legal standards, Section 36 contributes to the overall stability and credibility of India’s financial markets, ensuring that investors can make informed decisions based on truthful and complete information.
Related Resources
- Section 36, The Companies Act, 2013
- Section 68 of the Companies Act, 1956
- v Cunningham (1957) 2 QB 396
- K. Sreenivasan, Re (1944) 14 Com Cases 193
- Dilip Dahanukar v Padam Kumar Khaitan (1996 Cr LJ 1569 Raj)
This article is presented by CA B K Goyal & Co LLP Chartered Accountants, your trusted partner in audit and compliance solutions. For expert assistance, feel free to contact us.
About the Author
This article is written by Advocate Shruti Goyal. Advocate Shruti Goyal has done her LLB from Dr Bhim Rao Ambedkar Law University and a Law graduate currently practicing as an Advocate in High Court and Supreme Court of India.