from Vinod Kothari of Vinod Kothari
& Co. He can be contacted at [email protected]]
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.
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 the main purport of section 62?
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.
that, the Act has always had minority protection rights such as relief against
Court has, on several occasions (Kilpest
is an example), held that the principles of sec. 81 are applicable to private
companies as well.
from sec 81, what other important provisions are applicable in case of capital
raising by companies?
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.
set of provisions for preferential allotments and public offers.
there any notable examples of misuse/abuse of shareholding powers, where Sec.
81 failed to do justice?
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.
are the major differences between sec 62 and section 81 of the 1956 Act?
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.
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.
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.
the section applicable to a listed company?
ICDR Regulations do not override the Companies Act, rather, the two are to be
read in consonance.
the section applicable to public offers also?
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.
the section applicable to a private company?
the section applicable in case of issue of shares by a subsidiary company to
its holding company?
question of the section applying, as it is not other than rights offer.
than in proportion of existing holding, the section will be applicable.
“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?
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.
of the issue
is the anti-dilutive pricing mechanism provided by the law?
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
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?
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.
the anti dilutive pricing applicable in case of conversion of debentures or
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.
the section applicable in case of conversion of warrants or other rights to
subscribe to shares?
the section applicable in case of conversion of preference shares into equity?
shares into equity, as there is no “increase” in subscribed capital. It is
merely moving from one type of capital to another.
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.
valuation report of a registered valuer”. This clearly means at the price, neither less nor more.
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.
the section necessarily mandate uniform pricing in case of all capital offers?
pricing to anyone. The only exception is employee’s stock options. The draft
Rules have laid bunch for rules for ESOPs.
the valuer have substantial discretion in valuing shares?
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.
the Rules relaxing the requirements of the section?
requirement shall not apply in case of listed companies.
the Rules adding any new requirements?
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.
compliance of the section
is the impact of non-compliance of 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.
members by unanimous resolution approve an issue at a price which is dilutive?
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.
with SEBI law
the provisions of the section clashing with SEBI’s ICDR regulations?
clearly clashing /overlapping with ICDR.
– Vinod Kothari