India: Amendments In Companies (Share Capital And Debentures) Rules: Ease Of Raising Fund For Corporate And Start -Ups

Last Updated: 9 September 2016
Article by Kumar Deep

Introduction:

The Ministry of Corporate Affairs ("MCA") vide Notification1 dated 19.07.2016 amended the Companies (Share Capital and Debentures) Rules, 2014 (hereinafter referred as "Principal Rules") vide Companies (Share Capital and Debentures) Third Amendment Rules, 2016 (hereinafter referred as "Amendment Rule") to carry on major changes with respect to issuance of equity shares with differential voting rights, privileges to Startups, issuance of partly-paid up securities, conversion price for convertible securities, creation of security for secured debentures, premature redemption of transfer of amount to debenture redemption reserve etc. The major changes and impacts thereof as provided by the Amendment Rules have been summarized in this Article in the manner listed herein below.

Defaulter Companies may issue equity shares with differential voting rights

Pursuant to the provisions of section 43 of the Companies Act, 2013 ("Act"), a company can issue equity shares with differential voting rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed. Further, Rule 4 of the Principal Rules provides certain conditions to be complied by the company for issuing equity shares with differential voting rights. One of the other conditions is that the company had not defaulted in any of the following:

  • 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;
  • Payment of dues with respect to statutory payments relating to its employees to any authority; or
  • Crediting the amount in Investor Education and Protection Fund to the Central Government.

Therefore, as per Principal Rules, a company which has defaulted in any of the above mentioned payment is not eligible to issue equity shares with differential voting rights as to dividend, voting or otherwise. Now, the present Amendment Rules has inserted a Proviso after sub clause (g) of sub-rule (1) of Rule 4 of the Principal Rules which provides that such companies may issue equity shares with differential voting rights as to dividend, voting or otherwise upon expiry of 5 years from which such default was made good.

Benefits to Start ups

The Amendment Rules provide certain benefits and privileges with respect to issue of sweat equity shares and ESOPs to Startups which would not otherwise available to other companies. It may be noted here that startup has been defined as per Notification2 number G.S.R. 180(E), dated 17th February, 2016 issued by the Department of Industrial Policy and Promotion ("DIPP"), Ministry of Commerce and Industry, Government of India.

As per the said Notification of DIPP dated February 17, 2016 an entity is considered as a 'startup' if it is incorporated or registered in India not prior to five years, with an annual turnover not exceeding Rs. 25 Crore in any preceding financial year and at the same time, it should be working towards development, deployment or commercialization of new products, processes or services driven by technology or intellectual property. Further, Startups would need to get a certificate from the Inter-ministerial Board of Certification to get the status of startup.

The benefits which are available to Startups under the Amendment Rules are as under:

Limit enhanced for issue of sweat equity shares by Start –ups

Pursuant to Rule 8(4) of the Principal Rules, a company shall not issue sweat equity shares for more than 15% of the existing paid up equity share capital in a year or shares of the issue value of Rs. 5 Crore, whichever is higher. Further, the issuance of sweat equity shares in the company shall not exceed 25% of the total paid up equity capital of the company at any time.

Now, with the objective of promoting Start-ups, a proviso has been inserted in the Amendment Rules which allows a startup company to issue sweat equity shares not exceeding 50% of its paid-up share capital upto 5 years from the date of its incorporation or registration.

Broader category of 'employees' for ESOPs for Start -ups for an initial period of 5 years

Rule 12 (1) of the Principal Rules provides certain conditions for issue of Employees Stock Option Scheme (ESOP) and accordingly certain category of persons are not eligible for ESOP. Such categories of persons are:

  1. An employee who is a promoter or a person belonging to the promoter group; or
  2. A director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.

The Amendment Rule, in order to promote startups, vide insertion of Proviso to the clause (c) of the sub rule (1) of Rule 12 in the Principal Rules, provides that, in case of Startups, the above mentioned category of persons would also be eligible for ESOPs upto 5 years from the date of incorporation or registration of such Startups.

Amendments in provisions relatin g to Issues of Shares on Preferential basis

a) Partly-paid up Securities may now be issued

There was a prohibition on issue of partly paid up securities on preferential issues basis as under Rule 13(2) (c) of the Principal Rules, the securities allotted by way of preferential offer shall be made fully paid up at the time of their allotment. Now, the Amendment Rules provides omission of the said clause (c) which prohibited issue of partly-paid up shares on preferential basis. Accordingly company may issue shares on preferential basis as partly paid up at the time of allotment.

b) Relaxation in disclosure of upfront conversion price for issuance of Convertible Securities

As per Rule 13(2) (h) of the Principal Rules, in case of issue of convertible securities 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 and on the basis of a valuation report of a registered valuer. In order to simplify the procedure for determining conversion price in case of prrefential allotment of convertible shares, the Amendment Rules provide that the conversion price for convertible securities can be determined in following manner, provided the company discloses such manner upfront at the time of offer of such securities:

  1. The price can be determined 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 time of making such offer; or
  2. The price can be determined at the time, which shall not be earlier than 30 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 60 days of the date when the holder of convertible security becomes entitled to apply for shares.

Therefore, the requirement of upfront disclosure of conversion price in case of convertible securities on preferential basis has been done away with the amended provision which provide an option to choose any one of the above mentioned manner to determine the conversion price. However, the company has to take decision to take up either of the above mentioned method at the time of making offer of such convertible securities and to disclose the same in the explanatory statement to be annexed to the notice of general meeting in which such offer is proposed to be considered in accordance with the provisions of the Act and Amendment Rules.

Notice to be filed with ROC for increase of number of members

The Amendment Rules provide that a company which does not have share capital is now required to disclose the increase in number of its members in Form SH-7 to the ROC. This is an additional requirement which has been provided by the Amendment Rules by insertion of the words "or a company not having share capital increases number of its members" in the existing Rule 15 of the Principal Rules.

Widening the scope of creation of security on issue of secured Debentures

Rule 18 of the Principal Rules provides certain conditions for issue of secured debentures, such conditions inter alia includes that 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. This means for issue of secured debentures, companies are required to secure such an issue with a charge on their own assets and properties only.

Now, the Amendment Rules provide that the issue of secured debentures can 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. The Amendment Rules further provide that such security can be created on any specific movable property of the company or its holding company or subsidiaries or associate companies or otherwise.

Provisions relating to creation of Debenture Redemption Reserve and premature redemption of debentures

Under sub rule 7 of the Rule 18 of the Principal Rules, the provision for creation of Debenture Redemption Reserve (DRR) is required to be created for the purpose of redemption of debentures in accordance with the conditions provided under the said rule itself. The conditions inter alia provided that the adequacy of the DRR should be 25% of the value of debentures issued. The Amendment Rules provide clarification that the adequacy of DRR should be 25% of the value of the outstanding debentures rather than the value of debentures issued.

Further, the Amendment Rules vide insertion of proviso in clause (b) after sub-clause (iii) of Rule 18(7) provide that, a company intending to redeem debentures prematurely i.e. before time may transfer such amount in DRR as is necessary for redemption of such debentures even if it exceeds the limit specified in this rule.

Conclusion

The notification of Amendment Rules is a step forward for making provisions of the Companies Act, 2013 simpler so far it is relating to issue of securities and to promote the Start-ups. The Amendment Rules provide certain relaxations to the Start-ups which are otherwise not available to other companies. The Start-ups are in very need of funds during its initial period of operation and thus, such relaxations as provided by the Amendment Rules undoubtedly help them. The fund raising will become less complicated for the corporate facing fund related problems in India. By providing more options to raise funds and allowing the assets belonging to their subsidiaries, holding and associate companies for securing debentures, the Amendment Rules provide flexibilities in raising funds.

Footnotes

1 http://mca.gov.in/Ministry/pdf/Rules_19072016.pdf

2 http://dipp.nic.in/English/Investor/startupindia/Definition_Startup_GazetteNotification.pdf

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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