Dematerialization Mandate for Private Companies: Navigating Transparency & Challenges

[Bhabesh Satapathy and Harsh Mittal are third year B.B.A. LL.B. (Hons.) students at National Law University, Odisha]

On October 27, 2023, the Ministry of Corporate Affairs (“MCA”) ushered in a significant change with the introduction of rule 9B through the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (“PAS Rules”) The amendment is in harmony with the overarching trend of digital transformation within the corporate domain, underscoring the MCA’s commitment to augmenting transparency and efficiency in the securities market.

The amendment to the PAS Rules incorporates two fundamental modifications. Firstly, it extends the reach of section 29 of the Companies Act, 2013 by mandating the issuance of securities exclusively in dematerialized form by private companies, excluding small companies, along with the facilitation of the dematerialization process for all existing securities. Secondly, it provides for the relinquishment of share warrants previously issued by public companies prior to the inception of the Act, with a concomitant shift to the dematerialized mode for shares. While the amendment is notable, it carries several specific implications for the legal landscape and industry.

In this post, the authors embark on a critical analysis of the amendment, aiming to illuminate various concerns associated with it.

The Advent of Dematerialisation

Dematerialization is the process of converting physical securities into electronic records held in a centralised depository. The journey towards dematerialization in India began with the enactment of the Depositories Act, 1996. It laid the foundation for the establishment of two national depositories: the National Securities Depository Limited (“NSDL”) and the Central Depositories Services Limited (“CSDL”). Notably, the Depositories Act provided that all securities held by these depositories must be in dematerialized form, marking a significant shift from the traditional system of physical certificates. Building upon this foundation, the Government in 2000 further implemented an amendment to the Companies Act, 1956. This amendment introduced section 68B of that legislation stipulated that any listed company making a public offer of INR 10 crores or more must issue shares solely in dematerialized form. 

The Securities and Exchange Board of India (“SEBI”), through its committee report in 2004, highlighted the inherent risks associated with physical share certificates. These risks included the high cost of printing and handling, vulnerability to theft and damage, and delays in transfer and settlement. Recognizing the limitations of the physical system, the report advocated for a shift towards dematerialization.

The Companies Act, 1956 marked the initial foray into the dematerialization of securities in India. However, its scope was limited, requiring only listed companies to make public offers exceeding INR 10 crores, but the Companies Act, 2013went a step further and, through section 29, made it mandatory for all public offers of securities by listed companies and any other entities as may be prescribed to be in dematerialized form only. Moreover, the PAS Rules solidified the framework for public offer dematerialization. Initially, only listed companies were subject to this mandate. However, in 2018, the MCA broadened its reach through rule 9A of the PAS Rules, bringing unlisted public companies under the umbrella of compulsory dematerialization.

Crux of the Current Notification

The Companies Act, 2013 underwent a substantial amendment with the incorporation of sub-section (1A) under section 29 of the Act, granting the Central Government authority to specify classes of unlisted companies mandating the exclusive holding and transfer of securities in dematerialized form. In alignment with this statutory empowerment, rule 9b was introduced via the PAS Amendment Rules.

Rule 9B mandates that every private company, as defined in section 2(68)  of the Act, issue securities exclusively in dematerialized form and facilitate the dematerialization of all its securities, adhering to the provisions of the Depositories Act. Notably, two specific exemptions from rule 9B exist. Firstly, small companies, characterized by a paid-up share capital of INR 4 crores or below and turnover of INR 40 crores or below, are excluded. Secondly, government companies are exempt, recognizing their unique regulatory framework.

Private companies involved in activities such as issuing securities, buybacks, or offering bonus shares or rights must ensure dematerialization of securities held by their promoters, directors, and key managerial personnel (KMPs) before making such offers, in accordance with the amended section 29 of the 2013 companies legislation.

Rationale Behind the Move

The Government’s decision to make dematerialization mandatory for private companies marks a significant step forward in the development of the country’s financial sector. This move aims to enhance efficiency, transparency, and security within the private sector, ultimately benefiting both companies and investors. The intention behind bringing this change is multi-fold.

It will help in addressing the critical issue of shell companies and impersonation of shareholders, which prevalent in this sector as compared to public companies. As a recent example, a massive GST fraud involving 3,000 shell companies and amounting to INR 10,000 crores highlights the urgency of addressing this issue. Dematerialization makes it much easier to track the ownership of securities. This is because all transactions are recorded electronically, thereby creating a clear and auditable trail. This makes it much more difficult for individuals to hide their ownership through shell companies or benami transactions.

Further, it will act as a pivotal mechanism for government authorities to enhance the identification of beneficial ownership. This transition facilitates seamless correlation of permanent account numbers and Aadhaar details, empowering regulators to monitor and authenticate genuine ownership, mitigating potential misuse and ensuring market transparency.

Moreover, the dematerialization of securities of private companies will revolutionise the foreclosure process as dematerialized shares exist electronically, eliminating the need for physical certificates. This simplifies the foreclosure process by removing the need to locate and retrieve certificates, which can be time-consuming and cumbersome, especially if the shares are pledged by multiple individuals or entities.

Critical Analysis: Possible Repercussions of the Amendment 

The process of dematerialization offers a compelling prospect for enhancing efficiency, transparency, and security within the Indian financial market. Nevertheless, the ensuing discussion underscores specific issues and concerns that warrant attention for the purpose of achieving a more effective implementation.

Firstly, with the advent of dematerialization, the efficacy of traditional restrictions on share transfers in private limited companies, which often require board approval, is under scrutiny. This is because depositories hold shares electronically, enabling direct transfer even when the articles of association (“AoA”) of the company may not permit it. Striking a balance between the benefits of dematerialization (efficiency and transparency) and the need for control over ownership structure and shareholder protection is crucial.

Secondly, transitioning to dematerialized instruments requires adherence to strict regulations, demanding additional compliance efforts and incurring costs related to technology and infrastructure upgrades. To navigate this evolving financial landscape, private enterprises may need to allocate substantial resources to ensure seamless compliance with regulatory standards and to effectively manage the financial implications arising from the dematerialization process.

Thirdly, no exemption is granted to wholly owned subsidiaries (“WoS”) of private companies under the amended PAS Rules, in contrast to the WoS of unlisted public companies exempted by the 2018 amendment to the PAS Rules. Consequently, private company subsidiaries of other private entities must comply with dematerialization requirements. If a subsidiary is under a public company, maintaining deemed public company status, the exemption from the 2018 amendment of the Rules persists.

Lastly, it is necessary to consider the control over nominee shareholding under depository system. In case of a WoS or otherwise, it is common that the registered owner and the beneficial owner of securities may be different. For instance, section187 (1) of the Companies Act, 2013 provides for a company to hold any shares in its subsidiary company through a nominee in order to meet the minimum of shareholders requirement under the Act. Further, section 89  of the 2013 legislation requires declaration of beneficial interest held in shares with the Registrar of Companies where the registered and beneficial owners are different.

These principles apply to the securities held in dematerialized form as well. According to section 10 of the Depositories Act, the depository shall remain the registered owner, but it will not have voting rights. It is the beneficial owner who is entitled to all the rights and benefits attached to securities. Further, all the shareholders are treated as beneficial owners under the depository system, although a particular shareholder may be acting just as a nominee. This legal position may impose practical challenges for the holding company to control the actions of nominee shareholders.


In all, the mandatory dematerialization for private companies, as introduced by rule 9B, signifies a pivotal shift in the Indian financial landscape, aligning with global trends towards enhanced efficiency and transparency. While aimed at addressing issues like shell companies and improving market integrity, the amendment raises critical considerations. Striking a balance between the advantages of dematerialization and the need for control over share transfers and ownership structures is paramount. Additionally, the financial burden and compliance challenges for private enterprises demand strategic resource allocation.  As India embraces this transformative step, careful navigation of legal nuances and industry implications will be essential for a successful implementation.

Bhabesh Satapathy & Harsh Mittal

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