[The following is a guest post
from Vinod Kothari of Vinod Kothari
& Co. He can be contacted at vinod@vinodkothari.com]
from Vinod Kothari of Vinod Kothari
& Co. He can be contacted at vinod@vinodkothari.com]
Closer
to the gradual implementation of the 2013 Act, one gets an ever firmer feeling
that the drafting of the law became highly superficial, and the twin
Parliamentary committees merely went on the basis of innate assurances that MCA
would do what is required to resolve all the problems in law-making. If the law
has problems, rule-making can do nothing to resolve the same. And let us face
it – the law has problems. In fact,
it has big-time problems.
to the gradual implementation of the 2013 Act, one gets an ever firmer feeling
that the drafting of the law became highly superficial, and the twin
Parliamentary committees merely went on the basis of innate assurances that MCA
would do what is required to resolve all the problems in law-making. If the law
has problems, rule-making can do nothing to resolve the same. And let us face
it – the law has problems. In fact,
it has big-time problems.
What
is more important for companies than the liberty in capital-raising. There are
plenty of restraints on capital raising in the new law, one, obviously being
the intricate set of requirements in section 42 dealing with private
placements. However, this article is about section 62, which apparently will
have massive applicability, to all companies, and on all types of issuances,
except in case of rights or bonus issuances. This article explains the dire
consequences of sec 62.
is more important for companies than the liberty in capital-raising. There are
plenty of restraints on capital raising in the new law, one, obviously being
the intricate set of requirements in section 42 dealing with private
placements. However, this article is about section 62, which apparently will
have massive applicability, to all companies, and on all types of issuances,
except in case of rights or bonus issuances. This article explains the dire
consequences of sec 62.
1. What
is the main purport of section 62?
is the main purport of section 62?
The section corresponds to section 81 of the 1956 Act. Section 81
contained the right of pre-emption, which is a valuable right of shareholders
of a company. They should be able to preserve the value of their shareholding,
as well as their control over the company, by ensuring that any issue of shares
is made to the existing equity shareholders, in proportion to their
shareholding in the company. Otherwise, the shareholders will have to approve
the proposal by a special resolution.
contained the right of pre-emption, which is a valuable right of shareholders
of a company. They should be able to preserve the value of their shareholding,
as well as their control over the company, by ensuring that any issue of shares
is made to the existing equity shareholders, in proportion to their
shareholding in the company. Otherwise, the shareholders will have to approve
the proposal by a special resolution.
Even a special majority may try to bulldoze the minority, but for
that, the Act has always had minority protection rights such as relief against
oppression.
that, the Act has always had minority protection rights such as relief against
oppression.
The section is not applicable to private companies. However, Supreme
Court has, on several occasions (Kilpest
is an example), held that the principles of sec. 81 are applicable to private
companies as well.
Court has, on several occasions (Kilpest
is an example), held that the principles of sec. 81 are applicable to private
companies as well.
2. Apart
from sec 81, what other important provisions are applicable in case of capital
raising by companies?
from sec 81, what other important provisions are applicable in case of capital
raising by companies?
In case of private companies, the section did not apply at all. In
case of public companies, if it is unlisted, the 2003 Rules called Unlisted
Public Companies (Preferential Issue of Securities) Rules would apply. Read
them with the substantial additions made in 2011.
case of public companies, if it is unlisted, the 2003 Rules called Unlisted
Public Companies (Preferential Issue of Securities) Rules would apply. Read
them with the substantial additions made in 2011.
In case of listed companies, SEBI’s ICDR Regulations contain separate
set of provisions for preferential allotments and public offers.
set of provisions for preferential allotments and public offers.
3. Were
there any notable examples of misuse/abuse of shareholding powers, where Sec.
81 failed to do justice?
there any notable examples of misuse/abuse of shareholding powers, where Sec.
81 failed to do justice?
Frankly, with some 30 years into the study of corporate laws, and
about 25 years into its active practice, the author cannot find one flaw in the
basic provisions of Sec 81. The additions about convertible loans, etc that
were made over a period of time might have become redundant, but otherwise, the
section was working perfectly fine.
about 25 years into its active practice, the author cannot find one flaw in the
basic provisions of Sec 81. The additions about convertible loans, etc that
were made over a period of time might have become redundant, but otherwise, the
section was working perfectly fine.
4. What
are the major differences between sec 62 and section 81 of the 1956 Act?
are the major differences between sec 62 and section 81 of the 1956 Act?
Several
differences:
i. First,
as usual with the rest of the provisions of the Act, the section applies to all
companies. So it applies to private companies too. Now, one will keep waiting
with all humility for the Central Government to “grant” exemption from what
should never have applied in the first place to a private company. And who
knows, like in case of sec 185, the enforcement may come like flashflood, and
the exemption may come like rain in Sahara.
as usual with the rest of the provisions of the Act, the section applies to all
companies. So it applies to private companies too. Now, one will keep waiting
with all humility for the Central Government to “grant” exemption from what
should never have applied in the first place to a private company. And who
knows, like in case of sec 185, the enforcement may come like flashflood, and
the exemption may come like rain in Sahara.
ii. Second,
there was an initial capital raising exemption period of 2 years from
incorporation or 1 year from first allotment, whichever is earlier. During this
period, any capital raising did not require the section to be complied with. If
the draftsmen of the new law chose to remove this initial capital raising
exemption, they have only evidenced the gross failure to understand the
essence. How could there be an anti-dilution provision even while the company
is still ramping up the capital base? That is, when the company is populating its
shareholders during the start-up period, there is no question of anti-dilution
at that stage.
there was an initial capital raising exemption period of 2 years from
incorporation or 1 year from first allotment, whichever is earlier. During this
period, any capital raising did not require the section to be complied with. If
the draftsmen of the new law chose to remove this initial capital raising
exemption, they have only evidenced the gross failure to understand the
essence. How could there be an anti-dilution provision even while the company
is still ramping up the capital base? That is, when the company is populating its
shareholders during the start-up period, there is no question of anti-dilution
at that stage.
iii. Third,
all one needed to do, to get away from the section, was a special resolution.
There obviously was no regulation in the section about pricing. In SEBI’s preferential issue norms, in all
fitness, there is elaborate pricing protection also. In Unlisted Public
Companies Rules also, there was a requirement to state the manner of computing
the price, but there was no absolute price protection. This section, in
sub-section (1) (c), has legislated the fair-value pricing rule – that is, not
only does one need to get a super majority vote, but also, ensure the issuance
is at fair value.
all one needed to do, to get away from the section, was a special resolution.
There obviously was no regulation in the section about pricing. In SEBI’s preferential issue norms, in all
fitness, there is elaborate pricing protection also. In Unlisted Public
Companies Rules also, there was a requirement to state the manner of computing
the price, but there was no absolute price protection. This section, in
sub-section (1) (c), has legislated the fair-value pricing rule – that is, not
only does one need to get a super majority vote, but also, ensure the issuance
is at fair value.
Scope
of applicability
5. Is
the section applicable to a listed company?
the section applicable to a listed company?
There is no exemption in the section in case of a listed company. SEBI
ICDR Regulations do not override the Companies Act, rather, the two are to be
read in consonance.
ICDR Regulations do not override the Companies Act, rather, the two are to be
read in consonance.
6. Is
the section applicable to public offers also?
the section applicable to public offers also?
Ridiculous as it may seem, the section has been made applicable to
public offers as well. Sec 81 of the 1956 Act also applies to public offers, in
as much as approval u/s 81 (1A) has to be taken. However, sec 62 has elaborate
controls – pricing included. Draft Rules seem to be giving exception in case of
public offers by creating a new definition of “Preferential Offer”. However,
there is no scope for such a definition in the Act.
public offers as well. Sec 81 of the 1956 Act also applies to public offers, in
as much as approval u/s 81 (1A) has to be taken. However, sec 62 has elaborate
controls – pricing included. Draft Rules seem to be giving exception in case of
public offers by creating a new definition of “Preferential Offer”. However,
there is no scope for such a definition in the Act.
7. Is
the section applicable to a private company?
the section applicable to a private company?
As mentioned before, there is no exemption in the section for a
private company.
private company.
8. Is
the section applicable in case of issue of shares by a subsidiary company to
its holding company?
the section applicable in case of issue of shares by a subsidiary company to
its holding company?
In case of issue to wholly owning holding companies, there is no
question of the section applying, as it is not other than rights offer.
question of the section applying, as it is not other than rights offer.
In case of less than 100% holding companies, if the issuance is other
than in proportion of existing holding, the section will be applicable.
than in proportion of existing holding, the section will be applicable.
9. The section is applicable in case of
“increase of subscribed capital”. From the incorporation of the company, when
does one start capturing “increase”? Is there an initial capital-raising period
where the company is free to take capital contribution from just anyone?
“increase of subscribed capital”. From the incorporation of the company, when
does one start capturing “increase”? Is there an initial capital-raising period
where the company is free to take capital contribution from just anyone?
There is no initial period exemption at all. Now, it is anyone’s guess
as to when does one start applying the section. Shares agreed to be taken up by
the subscribers to memorandum are deemed allotted upon incorporation.
Therefore, that capital becomes “subscribed capital”. Hence, technically, any
issue of shares, from day 1, amounts to an increase in subscribed capital. If
this view is too narrow, in fact, any other view will not be keeping in line
with the language of the section.
as to when does one start applying the section. Shares agreed to be taken up by
the subscribers to memorandum are deemed allotted upon incorporation.
Therefore, that capital becomes “subscribed capital”. Hence, technically, any
issue of shares, from day 1, amounts to an increase in subscribed capital. If
this view is too narrow, in fact, any other view will not be keeping in line
with the language of the section.
Pricing
of the issue
10. What
is the anti-dilutive pricing mechanism provided by the law?
is the anti-dilutive pricing mechanism provided by the law?
As mentioned above, the section stipulates pricing of any new issues
to be at a fair value determined by a valuer. This ensures that there is no
dilutive impact of the capital on the existing shareholders’ value of shares.
Assuming that the valuer uses “earnings capitalisation method” as the basis for
valuation, the EPS post-issue will hopefully be the same as the one before the
issue. Hence, there will be no dilutive impact of capital issues on earnings
per share.
to be at a fair value determined by a valuer. This ensures that there is no
dilutive impact of the capital on the existing shareholders’ value of shares.
Assuming that the valuer uses “earnings capitalisation method” as the basis for
valuation, the EPS post-issue will hopefully be the same as the one before the
issue. Hence, there will be no dilutive impact of capital issues on earnings
per share.
11. Since
the essential intent of right of pre-emption is to provide anti-dilution
protection, how is that the section provide for both of (a) a special
resolution and (b) anti-dilutive pricing?
the essential intent of right of pre-emption is to provide anti-dilution
protection, how is that the section provide for both of (a) a special
resolution and (b) anti-dilutive pricing?
The contention is correct. Anti-dilutive pricing itself is all there
is right of pre-emption, except, of course, maintenance of shareholding
control. However, maintenance of shareholding control is for the shareholders
to fix up may be by articles and/or shareholders’ agreements. Having mandated
anti-dilutive pricing, supermajority consent seems superfluous. Or, to put it
differently, supermajority consent is needed if the company were to divert from
an essential rule. If the company is deviating from the anti-dilutive pricing,
insistence on special resolution seemed apt. But insisting on both the pricing
rule and super-majority consent seem superfluous combination.
is right of pre-emption, except, of course, maintenance of shareholding
control. However, maintenance of shareholding control is for the shareholders
to fix up may be by articles and/or shareholders’ agreements. Having mandated
anti-dilutive pricing, supermajority consent seems superfluous. Or, to put it
differently, supermajority consent is needed if the company were to divert from
an essential rule. If the company is deviating from the anti-dilutive pricing,
insistence on special resolution seemed apt. But insisting on both the pricing
rule and super-majority consent seem superfluous combination.
12. Is
the anti dilutive pricing applicable in case of conversion of debentures or
loans?
the anti dilutive pricing applicable in case of conversion of debentures or
loans?
Section 62 (3) provides for an exception in case of conversion of
debentures into shares. This is, however, only in case of “conversion”. It is
said to be a conversion only where, to the extent of value of equity shares
issues, debt gets converted into equity. There is a cessation of one, and birth
of another. Typical “mezzanine debt” instruments which contain an option to
subscribe to equity, and not conversion, are not exempted from the section.
debentures into shares. This is, however, only in case of “conversion”. It is
said to be a conversion only where, to the extent of value of equity shares
issues, debt gets converted into equity. There is a cessation of one, and birth
of another. Typical “mezzanine debt” instruments which contain an option to
subscribe to equity, and not conversion, are not exempted from the section.
13. Is
the section applicable in case of conversion of warrants or other rights to
subscribe to shares?
the section applicable in case of conversion of warrants or other rights to
subscribe to shares?
Yes.
14. Is
the section applicable in case of conversion of preference shares into equity?
the section applicable in case of conversion of preference shares into equity?
No. The section does not apply in case of conversion of preference
shares into equity, as there is no “increase” in subscribed capital. It is
merely moving from one type of capital to another.
shares into equity, as there is no “increase” in subscribed capital. It is
merely moving from one type of capital to another.
15. The
section says “price determined by the valuation report”. Does the issue have to
be made at the price determined by
the valuation report? There is obviously no dilution if the price is higher
than the valuation.
section says “price determined by the valuation report”. Does the issue have to
be made at the price determined by
the valuation report? There is obviously no dilution if the price is higher
than the valuation.
The section says “if the price for such shares is determined by
valuation report of a registered valuer”. This clearly means at the price, neither less nor more.
valuation report of a registered valuer”. This clearly means at the price, neither less nor more.
Draft Rules seem to be trying to insert some sense by saying “price
shall be determined on the basis of valuation report of a registered valuer”.
It will remain arguable whether this tendency to pass the law with bunch of
wrong expressions, missed exemptions, flawed concepts, and so on, and with the
rules trying to do sawing, machining, polishing, fitting, filling, etc., would
do a good to the democratic system that we pride ourselves in.
shall be determined on the basis of valuation report of a registered valuer”.
It will remain arguable whether this tendency to pass the law with bunch of
wrong expressions, missed exemptions, flawed concepts, and so on, and with the
rules trying to do sawing, machining, polishing, fitting, filling, etc., would
do a good to the democratic system that we pride ourselves in.
16. Does
the section necessarily mandate uniform pricing in case of all capital offers?
the section necessarily mandate uniform pricing in case of all capital offers?
There is no scope in the section for any preferential or differential
pricing to anyone. The only exception is employee’s stock options. The draft
Rules have laid bunch for rules for ESOPs.
pricing to anyone. The only exception is employee’s stock options. The draft
Rules have laid bunch for rules for ESOPs.
17. Does
the valuer have substantial discretion in valuing shares?
the valuer have substantial discretion in valuing shares?
Valuer may use various valuation methods. Yes, the valuer has to
exercise professional discretion, of course, in context of accepted valuation
standards. Note that valuer is also subject to class action suits if his report
causes a loss to the company or a class.
exercise professional discretion, of course, in context of accepted valuation
standards. Note that valuer is also subject to class action suits if his report
causes a loss to the company or a class.
Rule-making
18. Are
the Rules relaxing the requirements of the section?
the Rules relaxing the requirements of the section?
Importantly, the Draft rules say that the valuation
requirement shall not apply in case of listed companies.
requirement shall not apply in case of listed companies.
19. Are
the Rules adding any new requirements?
the Rules adding any new requirements?
Importantly, Draft Rules provide that in case of
any warrants, rights attached for subscription of any shares in future, the
pricing shall have to be determined beforehand.
This seems highly detached from reality – how is it possible to fix tomorrow’s
value today? In several securities, that tomorrow may be deep into future. It
will be fatal for both the shareholder and the company to fix the price today.
What may be fixed is the methodology or formula for arriving at the price, but
surely enough, the price cannot be fixed upfront.
any warrants, rights attached for subscription of any shares in future, the
pricing shall have to be determined beforehand.
This seems highly detached from reality – how is it possible to fix tomorrow’s
value today? In several securities, that tomorrow may be deep into future. It
will be fatal for both the shareholder and the company to fix the price today.
What may be fixed is the methodology or formula for arriving at the price, but
surely enough, the price cannot be fixed upfront.
Non
compliance of the section
20. What
is the impact of non-compliance of the section?
is the impact of non-compliance of the section?
This is a very important question. The section is essentially not a
breach of law but breach of shareholders’ right. The section is a mandatory
provision, and not a compliance provision. Any issue of shares in breach of the
section will be illegal, and therefore, may be quashed. Rectification of
register of members, oppression, etc. may follow if the company issues any such
securities violating the section.
breach of law but breach of shareholders’ right. The section is a mandatory
provision, and not a compliance provision. Any issue of shares in breach of the
section will be illegal, and therefore, may be quashed. Rectification of
register of members, oppression, etc. may follow if the company issues any such
securities violating the section.
21. Can
members by unanimous resolution approve an issue at a price which is dilutive?
members by unanimous resolution approve an issue at a price which is dilutive?
The author will strongly argue – yes. If the law requires
super-majority, and still comply with the pricing norms, after all, who could
be prejudiced if the company brings additional capital, albeit with dilutive
pricing, if all shareholders consent to it? It is not a breach of public
policy. It is not an offence of any regulatory requirement of the government. No
one would claim to be prejudiced except the shareholders.
super-majority, and still comply with the pricing norms, after all, who could
be prejudiced if the company brings additional capital, albeit with dilutive
pricing, if all shareholders consent to it? It is not a breach of public
policy. It is not an offence of any regulatory requirement of the government. No
one would claim to be prejudiced except the shareholders.
Clash
with SEBI law
22. Are
the provisions of the section clashing with SEBI’s ICDR regulations?
the provisions of the section clashing with SEBI’s ICDR regulations?
Since the provisions apply to listed companies as well, they are
clearly clashing /overlapping with ICDR.
clearly clashing /overlapping with ICDR.
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– Vinod Kothari
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