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Companies Act 2013 and impact on investment and financing transactions

There are two ways to raise money – one is to approach the public (for example, through an initial public offer (IPO) or a follow-on public offer (FPO) and the other is to specifically identify a set of investors who are willing to fund the company. Note that under Indian law, any company which makes a public offer must also get its securities listed on a stock exchange, which increases compliance and governance requirements significantly.

In the pre-1990 era (even before SEBI had been constituted), Reliance Industries had extensively accessed vast amounts of capital from the public and popularized raising public money as a source of finance. Today, Indian capital markets have matured significantly from that stage, with ‘capital markets’ becoming a very strong practice area for law firms, investment banks, Chartered Accountants and consultants.

While huge amounts of money can be mobilized through IPOs and FPOs, sourcing finance through privately identified investors (called private placement) is still the simplest method to raise money and is widely used by both public and private companies alike. Both unlisted and listed public companies can raise money through private placements – listed companies will additionally be governed by the Listing Agreement of the stock exchange (which is made on the lines of standardized model suggested by SEBI) and the ICDR Regulations.

Private companies can only raise capital through a private placement (through equity or debentures / bonds), or by issuing shares to existing shareholders through a rights issue, since they are prohibited from issuing securities to the public.
In this chapter, we will discuss how investment and financing transactions must be undertaken in light of the new Companies Act provisions governing private placements.

What is a private placement?
A company can raise investment either through equity financing, that is, issuance of shares/securities or through debt financing.  Issuance of securities can be made through public offer (applicable only for a public company) or through private placement or by a way of right or bonus. As private equity investment, venture capital and angel investment is the most important source of raising investment for startups and growing companies, it is quite essential to understand how a company can raise investment through public placement of shares or its securities. While under the Companies Act, 1956 the rules related to private placements were applicable only on the public companies; the Companies Act, 2013 has extended certain rules related to private placement which will be applicable on both the public and private companies.

Under the old Companies Act, the directors of a private company automatically had the authority (through the Articles of the Company) to issue shares to any person or entity (without shareholder approval), unless the articles were modified to introduce restrictions on this power. Many companies which were not funded by professional investors did not restrict this power of directors, as a matter of practice.
However, under the new Companies Act, private companies need to comply with several provisions of the law, including obtaining shareholder approval, under the Act.

Companies Act 2013 and private placements
The Companies Act 2013 has made the process of undertaking a private placement far more elaborate (see below). Under the earlier Companies Act, 1956, there was no requirement to obtain a special resolution from shareholders, unless their articles of association required them. Unless they were professionally funded by financial investors, most companies did not have this requirement incorporated in their articles and their board was free to issue shares to select investors. There were no requirements for preparation of offer letters, conducting valuations and no requirement to purchase a minimum amount of shares – an investor could purchase 100 shares of face value INR 10 by paying INR 100 per share (that is, a total investment of INR 10,000). Now, there are restrictions on this.

The only relaxation appears to be that a limit of 49 investors per private placement has been relaxed to 200.
The upper limit is capped individually for each kind of securities. Equity shares, optionally convertible debentures, compulsorily convertible preference shares will each qualify as a kind of securities.

The act also states that any issuance of securities which is non-compliant with the provisions related to private placement will be considered as a public issue – implying that the issue must comply with the provisions of Securities Contracts (Regulation) Act, 1956 (SEBI Act) Securities and Exchange Board of India Act, 1992 (SCRA) and Companies Act provisions pertaining to public issue. Moreover, private companies are not permitted to make a public issue.

Therefore, all companies issuing securities privately must ensure they are compliant with the private placement provisions, to avoid penalties. These provisions will apply to any investment transaction such as venture capital investment, private equity funding, joint ventures, acquisitions by strategic investors and debenture issues.

Restrictions governing issuance of securities through private placement
Since this is a private placement, no public advertisement can be issued or media, marketing or distribution channels or agents can be used to publicise about the offer. Apart from this, there are several other conditions on private placements, as follows:
  • A “Private placement Offer Letter” (PPOL) must be prepared. (Click here to download sample PPOL)
  • The offer cannot be made to more than 200 people in one financial year. Naturally, the number of subscribers cannot exceed 200, if the invitation itself cannot be made to more than 200 people.
  • One kind of securities can be issued at a time: A company must complete the issuance of one kind of securities before offering or inviting for another kind of securities.
  • Amount of subscription: The value of the offer per person shall not be less than INR 20,000 of face value of securities. Any person intended to be offered any securities must pay at least INR 20,000 as consideration (unless the issuance is of sweat equity or ESOPs).
  • Valuation of securities:  A company must get the security issuance valued from a registered valuer, a registered merchant or a Chartered Accountant who has been practising for at least 10 years.
Exception: Offer made to qualified institutional buyers (QIBs) and shares allotted to the employees under a stock option scheme will not be taken into account while calculating the limit. The exclusion of Qualified Institutional Buyers (QIB)s from the cap of 200 members for private placements in a financial year, will allow the companies to raise fund through Qualified Institutions Placement route (called QIPs), without having to worry about the cap of 50 members under the 1956 Act. Unlisted companies can also issue shares privately to QIBs.

What are the consequences of non-compliance of these provisions?
If a company fails to comply with the provisions related to private placements, the company, its directors and the promoters of the company may be fined with an amount equal to the amount involved in the offer or invitation or INR 2 crores, whichever is higher. Apart from the fine, the company will be liable to return all the monies accepted from the subscribers.

Issuance of convertible instruments
The new regulations have a special bearing on the issuance of convertible instruments. The most important question is whether shareholder approval is required at the time of issuance of convertible instruments, especially (warrants are neither shares nor debentures, but at a future date they give a right to purchase shares at a discount to the holder). At a practical level, issuance of any instrument which at a future date is going to convert into equity (or provide a right to purchase equity) is only issued with prior shareholder approval by special resolution. This is an internal approval of the company, and is undertaken so that at a future date the issuance of shares is not jeopardized, otherwise the company may be in violation of its contractual obligations to the holder of the instrument.
The second question which arises is what details need to be mentioned in the filings at the time of issuance. A ‘conversion price’ must be indicated, and merely indicating a formula for conversion is not sufficient.
Case Study: Sahara group, private placements, business structuring and the new Companies Act
In 2008-09, two group companies of the Sahara group, Sahara India Real Estate Corporation Limited (‘SIRECL’) and Sahara Housing Investment Corporation Limited (‘SHICL’), had issued OFCD’s to collect money from investors. Sahara borrowed over 24000 crore rupees from around 2.21 crore people (most of them being from villages and small towns). SEBI ordered Sahara to refund the money of the investors at 15% interest rate. The Supreme Court upheld the order in August 2012.

The question was whether such issuances amounted to public issues, in which case these companies would have to apply for listing. Every company offering or having an intention to offer shares and debentures to the public would have to apply for listing of the shares or debentures to a stock exchange (this concept is the same under both the earlier and new Companies Act). Should Sahara have applied to list its shares? Sahara argued that it was merely carrying out a number of private placements, with each private placement resulting in subscription of up to 49 persons only.

This argument was rejected by SEBI (and even the Supreme Court did not accept this), because there were crores of individuals who had purchased these shares. If this argument were accepted, every company could potentially circumvent compliance or listing requirements by carrying out multiple private placements.
What happens upon failure to apply for listing? Upon failure to do so, the company must return all money received in pursuance of the prospectus (along with interest).

Private placements and business structuring
Under the earlier Companies Act, 1956, the maximum number of investors in a private placement could be 49. However, a company can make multiple private placements, so long as the number of subscribers in each private placement is 49. This process, however, cannot be followed by a private company if it is issuing equity or convertible securities, because the maximum number of shareholders of a private company could only be 50. Since convertible securities were frequently being issued to shareholders, the Sahara group companies were structured as public companies, so that even if the number of members crossed 50, it would not amount to a violation of the membership requirement.  

How has the new Companies Act adapted to this?
The new Companies Act has introduced three major changes, taking cues from the developments in the Sahara case, as below:
  1. The maximum number of persons to whom an invitation for private placement can be issued has been increased to 200 under the Companies Act, 2013.
  2. The limit of 200 members is not applicable to issuances where the purchaser is an institutional investor – hence, qualified institutional placements (QIPs) under the SEBI guidelines, where securities are privately issued (by listed companies) to institutional investors are outside the ambit of this provision. There can be more than 200 QIBs who subscribe to securities pursuant to a private placement. (Note that QIPs can be only undertaken by listed companies.)
  3. Upon failure to apply for listing, the obligation to repay all the money received has been replaced with a fine on the company and every officer in default. The officer-in-default may also be liable to imprisonment.
Issuance of debentures is one of the ways of raising debt finance for a company. Debenture is a recognised instrument used by the companies, which evidences creation of a debt, whether such debt creates a charge on the assets of the company or not. Under the Companies Act, 2013, debentures being a security, it can be issued by a private company only through the route of private placement.  A company can issue debentures with an option to convert such debentures into shares, either partially or fully, at the time of redemption of the share. However, before such option is given, it must be approved by the shareholders of the company by a special resolution in the general meeting of the company. Issuance of such debentures does not give the debenture holder any voting rights.
In case, the company opts for issuance of secured debentures, it needs to meet the following conditions:
  • The date of redemption of such secured debentures should be made within 10 years from the date of issue. However, companies involved in infrastructure projects, infrastructure finance companies, infrastructure debt fund non-banking finance company can issue debentures which can be redeemed within a period not exceeding 30 years.
  • Such issuance shall be secured by the creation of a charge in favour of the debenture trustee, on the properties or assets of the company (including specific movable and immovable property of the company), which must be of a sufficient value needed for the due repayment of the amount of debentures and the interest.
  • The company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures.
  • The company shall execute a debenture trust deed to protect the interest of the debenture holders within sixty days from the date of allotment.
The company issuing debenture must create a debenture redemption reserve (DRR) account out of the profits of the company, which will be utilised only for the redemption of debentures. However, All India Financial Institutions (AIFIs) regulated by Reserve Bank of India and Banking Companies are not required to maintain DRR account for both public as well as privately placed debentures. NBFCs and companies engaged in manufacturing and infrastructure enjoys certain relaxation regarding maintenance of DRR account reserves.

If a company is issuing secured debentures or making an offer, or issue prospectus for more than 500 subscriptions of its debentures, it must appoint one or more debenture trustee as per the conditions laid down in the Companies (Share Capital and Debentures) Rules, 2014.
How to undertake private placements – a step plan for practitioners
Step 1 - Identify the persons to whom private placement offer/invitation has to be made All offers shall be made only to those persons whose names are recorded by the company prior to the invitation to subscribe. Allotments can be made only to such persons addressed specifically to the persons whom the offer is made. 

Step 2 - Prepare the offer letter: The Offer letter must be prepared as per the requirements of Form No. PAS 4.

Step 3 - Take approval of the offer from shareholders
The shareholders of the company must approve the offer of securities by passing a special resolution. The offer must be made within a period of 12 months from the date of passing the resolution.

Step 4 - Circulate the offer letter
All invitation must be sent along with the Offer letter (as per Form No. PAS 4) and accompanied with an application form which must be serially numbered.

Step 5 - Filings
The company needs to maintain a complete record of private placement offers in the Form PAS-5, private placement offer letter in Form PAS-4 along with the names of the persons who were identified as prospective offerees has to be filed with the Registrar of Companies within 30 days from the date of circulation of the Offer letter.

Step 6 - Money payable through cheque/DD
Consideration for subscription of securities must be paid through cheque or demand draft or other banking channels but not by cash. This money must be kept in a separate bank account of the company. The company shall also keep a record of the bank account from where such payments been received, which has to be utilised only for allotment.

Step 7 - Open separate account for keeping the subscription amount
The companies must open a separate bank account with a scheduled bank for receiving the subscription amount.

Step 8 - Make allotment of securities and issue share certificates
Allotment has to be carried out within 60 days of receipt of the application money for such securities. In case of failure to allot the security within the stipulated time, the company must repay the collected amount within 15 days from the end of 60 day period. If the company fails to repay the money, the company is liable to pay interest at the rate of 12% p.a charged from the sixtieth day. Time limit for allotment to foreign investors under the Consolidated FDI Policy is 180 days, which is a much longer period than permitted under the Companies Act.
Company must issue the share certificates to the allotees and make necessary updates in the minute books and registers.

Step 9 - File return of allotment with Registrar
A return of allotment of securities under must be filed with the Registrar within 30 days of allotment in Form PAS-3 and with relevant fees along with a complete list of all security holders containing-
  1. Full name, address, PAN, and E-mail id of such security holders.
  2. Class of security held
  3. Date of becoming security holder
  4. Number of securities held, nominal value and amount paid up on such securities and particulars of consideration received

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