Amendment in Share capital and Debentures Rules

Ministry of Corporate Affairs came with yet another amendment to the Companies (Share Capital and Debentures) Rules, 2014, a third amendment this year to the rules. These rules has been published in official gazette on 19^th July 2016 and came into force on that date. In this post, we will discuss these amendments.

Regaining power to issue equity share with differential voting rights

Before present amendment, sub – rule (1) of rule 4 restricts a company to issue equity shares with differential voting rights in case of certain cases. Clause (g) of sub – rule (1) of rule 4 restricts companies to issue these differential rights equity shares in case of certain defaults. Before present amendment as discussed earlier here, the clause read as under –

“No company limited by shares shall issue equity shares with differential rights as to dividend, voting or otherwise, unless it complies with the following conditions, namely –

…

• the company has not defaulted in payment of the dividend on preference shares or repayment of any term loan from a public financial institution or State level financial institution or scheduled Bank that has become repayable or interest payable thereon or dues with respect to statutory payments relating to its employees to any authority or default in crediting the amount in Investor Education and Protection Fund to the Central Government;

….”

Before present amendment, it seems a default committed once put this restriction for an unlimited period on the company. To correct this position and making it to more logical, present amendment insert following proviso after clause (g) to sub – rule (1) of rule 4. Newly inserted proviso read as under –

“Provided that a company may issue equity shares with differential rights upon expiry of five years from the end of the financial year in which such default was made good.”

Now, a company may issue equity share with differential voting rights even after committing default on following conditions –

• Default was made good; and
• Five years has expired form financial year in which default was made good.

Once, default was made good by the company, there is no need related to compounding of offence, payment of related penalties or pending prosecutions.

Sweat equity shares by startups

Before present amendment, law restrict a company from issuing sweating more than fifteen percent  of existing paid up capital in a year  or twenty five percent of existing paid up capital at any time. We have originally discussed it here.

Sub – rule (4) of rule 8 read as under –

“The company shall not issue sweat equity shares for more than fifteen percent of the existing paid up equity share capital in a year or shares of the issue value of rupees five crores, whichever is higher:

Provided that the issuance of sweat equity shares in the Company shall not exceed twenty five percent, of the paid up equity capital of the Company at any time.”

Now, present amendment rules insert following proviso after above mentioned proviso –

“Provided further that a startup company, as defined in notification number GSR 180(E) dated 17th February, 2016 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India, may issue sweat equity shares not exceeding fifty per cent of its paid up capital upto five years from the date of its incorporation or registration.”

Now, a startup company may issue sweat equity share upto fifty percent of paid up capital up to five year form date of incorporation or registration under the companies Act, 2013.

This is clear that after completion of five year from date of incorporation, such startup companies may issue not more than fifteen percent of the existing paid up equity share capital in a year or shares of the issue value of rupees five crores, whichever is higher. First proviso of this sub rule shall not be effective in such case until sweat equity issued by the company falls below twenty five percent of paid up capital anytime after these five years.

Employee stock options by startup companies

As we have experience with Ministry of corporate affairs to have some drafting error in its rules, we have yet another example in these amendment rules also. These Rules wish to insert a proviso in rule 12, in sub – rule (1), in clause (c), after sub-clause (ii). However, intention is to insert proviso to explanation of sub – rule (1) as clause (c) and sub – clause (ii) belongs to an explanation here.

We have discussed original provision earlier here. Before present amendment, this explanation read as under –

“Explanation: For the purposes of clause (b) of sub-section (1) of section 62 and this rule ‘‘Employee’’ means –

(a) a permanent employee of the company who has been working in India or outside India; or

(b) a director of the company, whether a whole time director or not but excluding an independent director; or

(c) an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company or of an associate company but does not include-

(i) an employee who is a promoter or a person belonging to the promoter group; or

(ii) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.”

Now present amendment rules insert a proviso to the explanation to rule 12(1) read as under –

“Provided that in case of a startup company, as defined in notification number GSR 180(E) dated 17th February, 2016 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry Government of India, Government of India, the conditions mentioned in sub-clause (i) and (ii) shall not apply upto five years from the date of its incorporation or registration.”.

Accordingly, following persons shall also be treated as employees in case of startup companies for the purpose of employee stock option –

(i) an employee who is a promoter or a person belonging to the promoter group; or

(ii) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

This will help tech – startups where person behind idea have no money to invest but brain. Now such person, who became employees in their own dream startup, may get appropriate recognition in share capital and voting powers of their company.

Partly paid securities in preferential allotment

Before present amendment, rules do not permit a company to issue partly paid shares and convertible securities at the time by way of preferential allotment. We have discussed rule 13 earlier here.

Requirement under rule 13(2)(c) is as under –

“The securities allotted by way of preferential offer shall be made fully paid up at the time of their allotment.”

This clause has been omitted by this amendment. There was and is certain thinking on part of regulators for introducing and omitting this clause regarding investor protection.

Valuation report

Before present amendment, in case of convertible securities, a valuation report beforehand to determine the resultant shares is required. We have discussed rule 13 earlier here. Clause (h) of rule 13(h) presently, read as under-

“where convertible securities are offered on a preferential basis with an option to apply for and get equity shares allotted, the price of the resultant shares shall be determined beforehand on the basis of a valuation report of a registered valuer and also complied with the provisions of section 62 of the Act.”

Now this amendment rules propose to substitute this clause with new one –

“(h) where convertible securities are offered on a preferential basis with an option to apply for and get equity shares allotted, the price of the resultant shares pursuant to conversion shall be determined –

(i) either upfront at the time when the offer of convertible securities is made, on the basis of valuation report of the registered valuer given at the stage of such offer, or

(ii) at the time, which shall not be earlier than thirty days to the date when the holder of convertible security becomes entitled to apply for shares, on the basis of valuation report of the registered valuer given not earlier than sixty days of the date when the holder of convertible security becomes entitled to apply for shares:

Provided that the company shall take a decision on sub-clauses (i) or (ii) at the time of offer of convertible security itself and make such disclosure under sub-clause (v) of clause (d) of sub-rule (2) of this rule.”.

This is amendment rule does not done away this requirement of valuation report but just give relief to companies that they may opt for valuation at the time of conversion. This option should be exercised beforehand at the time of offer of such convertible securities.

Alteration of number of members

All readers of present set of company law, including this blog, have raised their voice that whole framework has forgot about companies not having share capital; guarantee companies and unlimited companies. At present, there was no procedure to alter number of member in case of companies not having share capital. Present amendment seeks to correct this position. We have discussed rule 15 earlier here.

Before present amendment, rule 15 dealing with notice to registrar for alteration of share capital read as under –

“Where a company alters its share capital in any manner specified in sub-section (1) of section 61, or an order is passed by the Government increasing the authorized capital of the company in pursuance of sub-section (4) read with sub-section (6) of section 62 or a company redeems any redeemable preference shares, the notice of such alteration, increase or redemption shall be filed by the company with the Registrar in Form No SH -7 along with the fee.”

After inserting few words this rule will read as under –

“Where a company alters its share capital in any manner specified in sub-section (1) of section 61, or an order is passed by the Government increasing the authorized capital of the company in pursuance of sub-section (4) read with sub-section (6) of section 62 or a company redeems any redeemable preference shares or a company not having share capital increases number of its members, the notice of such alteration, increase or redemption shall be filed by the company with the Registrar in Form No SH -7 along with the fee.”

Interestingly, title of the rule remain same, which should have been amended to reflect true position.

Debenture to be secured by property of holding – subsidiary or associates companies

We discussed rule 18 earlier here. Before present amendment, clause (b) of sub rule (1) of rule 18, presently read as under –

“Such an issue of debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon.”

After this amendment, this clause read as under –

“Such an issue of debentures shall be secured by the creation of a charge on the properties or assets of the company or its subsidiaries or its holding company or its associates companies, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon.”;

Further, presently sub – clause (i) of clause (d) of rule 18(1), as earlier amended, read as under –

“Any specific movable property of the company;”

After present amendment, this clause read as under –

“Any specific movable property of the company or its holding company or subsidiaries or associate companies or otherwise;”

There term otherwise is of wide interpretation and give meaning that debenture may be secured by any specific movable property of any person related to company.

Debenture redemption reserve

Before present amendment, clause (b) of sub – rule (7) of rule 18, has following requirement regarding debenture redemption reserve –

“the company shall create Debenture Redemption Reserve (DRR) in accordance with following conditions:-

(i) No DRR is required for debentures issued by All India Financial Institutions (AIFIs) regulated by Reserve Bank of India and Banking Companies for both public as well as privately placed debentures. For other Financial Institutions (FIs) within the meaning of clause (72) of section 2 of the Companies Act, 2013, DRR will be as applicable to NBFCs registered with RBI.

(ii) For NBFCs registered with the RBI under Section 45-IA of the RBI (Amendment) Act, 1997, ‘the adequacy’ of DRR will be 25% of the value of debentures issued through public issue as per present SEBI (Issue and Listing of Debt Securities) Regulations, 2008, and no DRR is required in the case of privately placed debentures.

(iii) For other companies including manufacturing and infrastructure companies, the adequacy of DRR will be 25% of the value of debentures issued through public issue as per present SEBI (Issue and Listing of Debt Securities), Regulations 2008 and also 25% DRR is required in the case of privately placed debentures by listed companies. For unlisted companies issuing debentures on private placement basis, the DRR will be 25% of the value of debentures.”

Now after present amendment this clause shall read as under –

“the company shall create Debenture Redemption Reserve (DRR) in accordance with following conditions:-

(i) No DRR is required for debentures issued by All India Financial Institutions (AIFIs) regulated by Reserve Bank of India and Banking Companies for both public as well as privately placed debentures. For other Financial Institutions (FIs) within the meaning of clause (72) of section 2 of the Companies Act, 2013, DRR will be as applicable to NBFCs registered with RBI.

(ii) For NBFCs registered with the RBI under Section 45-IA of the RBI (Amendment) Act, 1997, ‘the adequacy’ of DRR will be 25% of the value of outstanding debentures issued through public issue as per present SEBI (Issue and Listing of Debt Securities) Regulations, 2008, and no DRR is required in the case of privately placed debentures.

(iii) For other companies including manufacturing and infrastructure companies, the adequacy of DRR will be 25% of the value of outstanding debentures issued through public issue as per present SEBI (Issue and Listing of Debt Securities), Regulations 2008 and also 25% DRR is required in the case of privately placed debentures by listed companies. For unlisted companies issuing debentures on private placement basis, the DRR will be 25% of the value of debentures.”

Following proviso to this clause also inserted –

“Provided that where a company intends to redeem its debentures prematurely, it may provide for transfer of such amount in Debenture Redemption Reserve as is necessary for redemption of such debentures even if it exceeds the limits specified in this sub-rule.”

This amendment clarify the doubt regarding debenture redemption reserve and its relation with outstanding debentures.

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