On 19 July 2016, the Ministry of Corporate Affairs notified the Companies (Share Capital and Debentures) Third Amendment Rules 2016 (Amendment) to amend certain provisions of the Companies (Share Capital and Debentures) Rules 2014 (Rules). The Rules, inter alia, set out the procedure for issuance of shares and debentures, disclosure and filing requirements, and other compliances. The Amendment modifies rules relating to the issue of shares (including by start-ups), pricing, and creation of security for secured debentures. The key changes introduced by the Amendment are summarised below.

KEY ASPECTS OF THE AMENDMENT

Relaxation of preferential allotment process:

  • The Rules previously stipulated that securities allotted on a preferential basis should be fully paid-up at the time of their allotment. The Amendment has removed this stipulation and provides much needed clarity on the issuance of partly-paid shares. Companies could previously issue partly-paid shares on a rights basis only, which denied companies access to third party capital (unless existing shareholders waived or renounced their entitlements in favour of a third party investor).
  • The Amendment modifies the controversial requirement of an upfront determination of the conversion price of convertible securities based on valuation of a registered valuer. Now, companies may either determine the conversion price (a) upfront at the time of offering the convertible securities, or (b) within a 30-day period ending on the date the holder of convertible securities becomes entitled to convert such convertible securities, based on a valuation report of a registered valuer issued within a 60-day period ending on such date. Companies are also required to choose one of the above methods at the time of issuing convertible securities. The Rules, as amended, offer more flexibility to determine the conversion price of convertible securities. Parties will now have the option to fix the conversion price at the time of issuance or wait until shortly before conversion. One could potentially argue that the language in the Amendment clarifies the prior ambiguity on the requirement to specify a conversion price upfront or simply state a conversion methodology or formula for arriving at the conversion price. In the context of foreign direct investment (FDI), conversion formulae and price are subject to a floor valuation as determined at the time of issuance of convertible securities. The interplay of the Amendment and FDI laws is presently unclear. Absent an amendment to FDI laws, it is unlikely that foreign investors will be permitted to utilise the Amendment to their benefit.

Issue of secured debentures:

  • The Rules previously required companies to secure an issue of secured debentures with a charge on their own assets and properties. The Amendment extends the ability of companies to secure an issue of secured debentures by permitting the creation of a charge on the assets and properties of their subsidiaries, holding company, or associate companies. This relaxation is limited to creation of charge on specific movable properties, as the Rules already permit companies to secure debentures with any specific immovable property.
  • The Amendment also expressly permits companies intending to redeem their debentures prematurely to transfer such amounts in excess of the limits specified under the Rules as may be necessary to the Debenture Redemption Reserve.

Issue of equity shares with differential rights:

Earlier, companies could not issue equity shares with differential rights if they defaulted in (a) the payment of dividends on preference shares, (b) the repayment of a term loan (or interest thereon) from specified institutions, (c) the payment of statutory dues relating to employees, or (d) crediting prescribed amounts in the Investor Education and Protection Fund. The Amendment allows such defaulting companies to issue equity shares with differential rights after 5 years from the end of the financial year in which they make good the default.

Sweat equity shares by start-ups:

Start-ups (as recognised by the Department of Industrial Policy and Promotion) are now permitted to issue sweat equity shares up to 50% of their paid-up capital for the first 5 years from the date of their incorporation. For other companies, this limit continues to be 25%.

Stock options to promoters and shareholder-directors of start-ups:

Start-ups are also permitted to issue stock options to their promoters and to directors who hold more than 10% of the start-up's equity shares for the first 5 years from the date of their incorporation. The restriction on issuing stock options to promoters and such directors continues for all other companies.

Form SH-7 by companies not having share capital:

The Amendment requires that Form SH-7, for intimating any alteration of a company's authorised share capital, be filed by companies that do not have share capital in case of an increase in the number of members.

Comments

The Amendment is a welcome change, especially for start-ups. It offers more flexibility to raise both debt and equity capital. However, amendments to rules pertaining to the determination of conversion price appear to add more ambiguity to an already ambiguous provision, especially when applied in the context of FDI. We are nonetheless hopeful that the Amendment is a precursor to more such changes that would follow in Companies (Amendment) Bill, 2016.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com