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A company may decide that increasing its subscribed capital after incorporation is economically viable. This is because a new issue would significantly boost the company’s financial resources and incentivize the company’s shareholders, ensuring the company’s smooth operation. Section 62 of the Companies Act, 2013 provides for the provision for companies desirous of increasing their shared capitals if authorized capital of the company is not exhausted and the further allotment of shares is made out of the unsubscribed portion of the capital as held in the case of Nanalal Zaver v. Bombay Life Assurance Co. Ltd.. Whenever a company having a share capital proposes to increase its subscribed capital by further issue of shares, such shares shall be offered to:
- Holders of Equity shares (Section 62(1)(a)): persons who at the time of the offer are the existing holders of the equity shares of the company. Further Issue can be done in proportion to the paid-up capital in those shares by sending an offer subject to such conditions as may be prescribed.
- Employees (Section 62(1)(b)): This is done under the Employee’ Stock Option through a special resolution passed by the company subject to such conditions as may be prescribed.
- Any person (Section 62(1)(c)): The shares can be further issued, if authorized by a special resolution irrespective of whether or not those persons are referred to in Section 62(1)(a) or Section 62(1)(b), either for cash or for a consideration other than cash provided a special resolution in general meeting is passed to this effect and the price of such shares is determined by the valuation report of the registered valuer. This is also subjected to the prescribed conditions.
Further issue of shares to Equity Holders (Right Issue)
- If further share issuance results in an increase in authorised capital, a general meeting must be called to amend the Articles of Association/Memorandum by special resolution.
- The shares can be issued to existing holders through a notice specifying the number of shares offered and a time limit of not more than 15 to 30 days from the date of the offer, after which the offer will be deemed to have been declined if not accepted.
- The notice shall contain s statement that the board of directors may dispose of the shared offered in such manner which won’t be disadvantageous to the shareholders of the company, if the offer is rejected by the equity shareholder after the expiry of the time specified or on receipt of earlier imitation from the shareholder that he declines to accept the shared offered.
- The notice must be sent to all existing shareholders at least 3 days before the issue opens, either by registered post, speed post, electronic mode, courier, or any other method with proof of delivery.
- Unless the articles of the company provide otherwise, the offer is deemed to include the right of renunciation i.e., the shareholders have the right to renounce the offer in whole or in part, in favour of some other person.
- Following the allotment, the company must file a turn of allotment with the registrar within 30 days, along with the necessary fees, as per the Companies (Registration of Offices and Fees Rules, 2014). The company must also notify the depositary of the allotment details as soon as possible after the allotment. The share certificates must be delivered within two months of the date of allotment.
Further Issue of Shares to Employees
Section 62(1)(b) provides that a company may issue further shares to its employees under a scheme of Employee Stock Option(ESOP). The following persons are the employee of the company for the purpose of section 62:
- A permanent employee who has been working in India or outside India: or
- A direction of the company, whether a whole time director or not but excluding an independent director; or
- An employee as defined in clause (a) and (b) of subsidiary, in India or outside India, or of a holding company of the company but does not include-
- An employee who is a promoter or person belonging to the promoter group; or
- A director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10 percent of the outstanding equity shares of the company.
ESOP has been defined under sub-section (37) of section 2 of the Companies Act, 2013, according to which it means the option given to the directors, officers or employees of a company or a holding company or subsidiary company which gives them a benefit or right to purchase or to subscribe for the shares of the company at a future date at a predetermined price.
Rule 12 of the Companies (Share Capital and Debenture) Rules, 2014 provides that a company which is not listed company and thereby is required to comply with the guidelines Securities and Exchange Board of India, shall not offer shares to its employees under ESOP unless it has been approved by the shareholders through special resolution in case of public company and ordinary resolution in case of private company. It is important that all the information with regards to the matter is provided hence, rule 12(2) provides that the company is required to make relevant disclosure in the explanatory statement annexed to the notice for passing of the resolution. Rule 12(2) also provides that the company will have the freedom to determine the exercise price in conformity with the applicable accounting policies.
For the grant of option to the employees of subsidiary or holding company or to identifies employees, during any 1 year, equal to or exceeding to 1% of the issued capital of the company at the time of grant of option, the company is required to take the approval of the shareholders by way of separate resolution according to clause (4) of the rule 12.
According to rule 12(5), the company may vary the ESOP scheme that has not yet been exercised by the employees by special resolution if the variation is not detrimental to the option holders’ interests. The notice in this regard must include a complete description of the variation, and also the rationale for it, as well as the names and contact information for the beneficiaries.
The rule further provides for a minimum period of 1 year between the grant of options and vesting of options with an exception in case of merger or amalgamation. The company is also vested with the freedom to specify the lock in period for the shares issued in pursuance of ESOP Scheme. Unless the shares are issued on the exercise of option, the beneficiary employees will not have the right to vote or in any manner enjoy the benefits of the shareholders in respect of option granted to them.
According to rule 12(10) a company is required to maintain a register of ESOP at the registered office of the company or such other place as decided by the board of directors, in form no. SH.6 and is required to enter the peticulars of option. The entries in the register are required to be authenticated by a company secretary or such other person as decided by the board.
The equity shares granted to the employees are non transferable and shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any manner. If the beneficiary employee dies during the employment, all the options vested on him shall be transferred to his heir or nominee. If an employee suffers from permanent incapacity during the employment, the options vested to him as on the date of incapacitation shall vest on him. Further, if the employee resigns or is terminated all options not vested on that date shall expire.
Post allotment procedure is similar to the further issuance of shares to the existing shareholders. In case of a listed company, the ESOP Scheme shall be issued in accordance with the guidelines of Securities and Exchange Board of India.
Issue of Shares on Preferential Basis
According to rule 13 of the Companies (Share Capital and Debentures) Rules, 2014, the expression preferential offer means an issue of shares and other securities, by a company to any select person or group of persons on a preferential basis and does not include shares or other securities offered through a public issue, rights issue, employee stock option scheme, employee stock purchase scheme or an issue of sweat equity shares or bonus shares or depository receipts issued in a country outside India or foreign securities.
The preferential offer of shares or securities of an unlisted company should be made in accordance with the requirements under clause (2) and (3) of the rule 13. The special resolution should be passed by the shareholders during a general meeting for issuance of shares on preferential basis. It is to be noted that the preferential issue of shares are required to be made in accordance with section 42 of the Companies Act, 2013, also which relates to the private placement. The company shall ensure that all the disclosures in the explanatory statement are annexed to the notice of the general meeting.
The shares on the preferential basis should be allotted to the beneficiaries within 12 months from the date of passing of the special resolution. If this is not complied with, the company is required to pass another special resolution to complete the allotment thereafter.
As already mentioned the price of the shares to be issued on preferential basis either for cash or for consideration other than cash, shall be determined on the basis of the evaluation report of the registered valuer who shall submit the valuation report along with justification to the company. In situations, when convertible securities are offered on the preferential basis with an option to apply for and get equity shares allotted, the price of the resultant shares shall be determined either up front at the time when the offer of convertible securities is made on the basis of valuation report of the registered valuer given at the stage of such offer or at the time, which shall not be earlier than thirty days to the date when the holder of the convertible securities become entitled to apply for shares, on the basis of valuation report of the registered valuer given not earlier than 60 days of such entitlement. The company shall take decision and make proper disclosure in the explanatory statement in this regard at the time of offer for convertible securities is made.
The preferential offer for further issuance of shares or securities by the company listed under a recognised stock exchange must be in accordance with the provisions of the Companies Act, 2013 along with the guidelines of Securities and Exchange Board of India. Further in the case of listed companies, the price of shares to be issued on preferential basis is not required to be determined by the valuation report of the registered valuer.
The exceptions to the applicability of the restrictions of Section 62
The provisions of Section 62 of the Companies Act, 2013 are applicable to all the companies except Nidhi Companies. The restrictions contained in section 62 do not apply to:
- The exercise of an option as a term attached to a debenture issued or loans raised by the firm to convert such debentures or loans into shares in the company raises the company’s subscribed capital. (Section 62(3)).
The terms of issue of such debenture or loan containing such an option have been approved before the such issuance by the special resolution passed in the General Meeting.
- Conversion of part of whole of the debentures issued to or loans obtained from any Government in shares of the company in pursuance of a direction issued by that Government in the public interest on such terms and conditions as appears to be fair and reasonable to the Government even if the terms of issuance of such debentures do not contain a term for an option for such conversion. (Section 62(4)) For determining the terms and conditions of the conversion, the Government shall have due regards to the financial position of the company, the terms of issue of debenture or loans, the rate of interest payable and such other matters as may be considered necessary.
If the terms and conditions of such conversions are not acceptable to the company, it may appeal before a tribunal with 60 days of communication of such order.
Where the Government has, by an order made under section 62(4), directed that any debenture or loan or any part thereof shall be converted into shares in a company and where no appeal has been preferred to the Tribunal under section 62(4) or where such appeal has been dismissed, the memorandum of such company shall, where such order has the effect of increasing the authorised share capital of the company, stand altered and the authorised share capital of such company shall stand increased by an amount equal to the amount of the value of shares which such debentures or loans or part thereof has been converted into.
Right of existing shareholders at the time of further issue of shares
Existing shareholders’ inherent right to new shares of the corporation is backed by considerable legal precedent in India and other jurisdictions. Stokes v. Continental Trust Co., a New York Court of Appeals judgment, was the first well-known judicial pronouncement on the subject. The court ruled in this case that the firm, as a mere trustee for all shareholders, had no power to sell additional stock without first offering it to existing shareholders. In the landmark decision of Nanalal Zaver v. Bombay Life Assurance Co. Ltd, the Supreme Court held that the company must first provide preference to existing shareholders before giving preference to anyone else. The Companies Act of 1956 and the Companies Act of 2013 both expressly grant shareholders a preemptive right to new company shares. In the case of Sahara India Real Estate Corporation v. SEBI, the Supreme Court went on to say that the Companies Act gives existing shareholders a preemptive right to new share issues. As a result, it is self-evident that a company that engages in further share issuance should first offer it to its existing shareholders before giving preference to anyone else.
Only in unusual or extraordinary circumstances can a shareholder interfere with the director’s exercise of discretion. In the matter of Sri Hari Rao v. Gopal Automotive Ltd. the court determined that the director had sufficient evidence to participate in further share issuance and he acted in a bonafide manner. Therefore, the company could not be restrained from issuing further shares for the mere reason that the minority shareholder is unwilling to subscribe to the additional capital.
The article has analysed the existing legal framework with regards to the further issuance of share capital. The article also analyses the existing shareholder’s preemptive right to the new stock of shares along with the scope of interference in the director’s discretion; which is only in exceptional situations where the further issue of shares is restrained. Even though the companies act makes no reference to the director’s fiduciary duties, judicial pronouncements show that the director is expected to operate in a bona fide way with a proper purpose.