The Central Government has issued a notification on 27 October 2023 amending the Companies (Prospectus and Allotment of Securities) Rules, 2014 called the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (Rules). Currently, public companies are required to maintain their securities in dematerialized form. The Rules now mandate dematerialization of securities of private companies as well. The amendment is aimed to increase transparency and facilitate digital oversight on transactions of large private companies. The Rules are effective from 27 October 2023. In this article, we provide a short update on the applicability, key requirements, and impact of the Rules, on various stakeholders.

Dematerialization of securities of private companies:

Applicability: The Rules are applicable to all private companies other than government companies1 and small companies2 except small companies that are: (i) holding companies; (ii) subsidiary companies; (iii) companies formed for promoting charitable objects; (iv) companies governed under any special legislation (Private Company).

When to comply: A Private Company, as on 31 March 2023, must comply with the Rules within 18 months of 31 March 2023 i.e., by 30 September 2024. A company which is no longer a small company on or after 31 March 2023 will be required to comply with the Rules within 18 months of the closure of the relevant financial year in which it ceases to be a small company (Effective Date).

For instance, X Pvt. Ltd. is a small company as on 31 March 2023. If X Pvt. Ltd. ceases to be a small company in December 2023, then X Pvt. Ltd. will be required to comply with the Rules by 30 September 2025.

Conditions: The Rules require that:

(i) all Private Companies must assist in dematerialization of all its securities, and issue securities only in dematerialized form within the Effective Date; and

(ii) all Private Companies must ensure the dematerialization of securities held by promoters, directors, and key managerial personnel before any offer for issue of any securities, buyback of securities, issuance of bonus shares or rights offer, after the Effective Date.

Further, the Rules also require that on or after the Effective Date:

(i) holders of securities of a Private Company must dematerialize their securities before undertaking any transfers; and

(ii) persons who subscribe to securities of a private company must ensure that the securities are in dematerialized form before subscription.

Our thoughts:

Currently, ~95% of the companies registered in India are private companies (Business Standard, 2023). Accordingly, this step will require the depositary participants and associated intermediaries to scale up operations and infrastructure.

The process to convert and maintain shares in dematerialized form will be time consuming and increase compliance costs for Private Companies. However, this will also increase corporate governance standards as it may reduce activities such as benami transactions and back dated issuance of securities. Digital securities provide additional benefits over physical share certificates such as protection from loss, theft, fraud and timely payment of stamp duty. Mandatory dematerialization of securities will also mean that foreign investors will be required to have a demat account, permanent account number and adhere to KYC (know your customer) norms.

Footnotes

1. Government company is a company in which 51% of the paid-up share capital is held by the Central and / or the State Government, and it includes a company which is a subsidiary of a government company.

2. Small companies are companies whose: (i) paid up share capital does not exceed INR 4,00,00,000; and (ii) turnover for the preceding financial year does not exceed INR 40,00,00,000.

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.