Section 23: Public Offer and Private Placement

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Section 23 of Companies Act, 2013 lays down the provision for public offer and private placement. The 2013 Act became effective in stages over 2013 and 2014. This section is a part of chapter III of the act, 2013. It briefly lays down the methods that can be used by public and private companies to issue securities and raise money.  There are two parts to chapter III, the first part relates to public offer and the second part pertains to private placement. Hence every company that wishes to issue securities and raise money has to follow through and compile this chapter. The purpose of his analysis is to give a better understanding of this section and to analyze the rules and regulations governing issuance of securities by company.

Purpose of Section 23

Chapter 3 of Companies Act 2013 lays down the provisions with respect to prospectus and allotment of securities. Section 23 being the first section under this chapter lays down the basic methods of issuing security used by public and private companies. The section briefly lays down the following:

  1. A public company can issue securities in three ways as follows:
  2. Through prospectus to the public.
  3. Private Placement.
  4. Rights issue or Bonus issue.
  5. A listed company or a company, which intends to get its securities listed, can issue securities according to the provisions of Securities and Exchange Board of India Act, 1992 and necessary prescribed rules.
  6. A private company may issue securities in following ways:
  7. Rights issue or bonus issue.
  8. Private Placement.

An explanation of this section clarifies that a “Public Offer” under this section includes initial public offer or further public offer of securities by the company or an offer of sale of securities to the public by an existing shareholder through issue of prospectus. An initial public offer refers to an offer of securities by an unlisted company to the public for subscription and includes an offer for sale of securities to the public by any existing holder of such securities in an unlisted company. A further public offer refers to an offer of securities by a listed company to the public for subscription and includes an offer for sale of securities to the public by existing holders of such securities in a listed company.

By way of public issue that is by issuing securities to public at large a company can be listed on a recognized stock exchange in India. For public issue there are various rules and regulations that have to be followed as well, like SEBI (Issuance of capital and disclosure requirement) regulation, 2009 and SEBI (Listing obligations and Disclosure Requirements), Regulations 2015 as under section 24 of the act, 2013, SEBI has power to regulate issue and transfer of securities by listed and unlisted companies. Publicly traded securities are subject to more regulations and scrutiny than those for private placements by a company.

A prospectus as per companies act, 2013 is defined as a “document inviting deposits from the public or a document-inviting offer from the public for the subscription of shares or debentures of the company”. Private placement is basically a way of raising capital by company by issuing private placement offer letter for securities to a relatively small group of selected investors. In general, private placements do not have to be registered with the Securities and Exchange Commission and do not require majority of disclosure requirements found in public offerings. This way of raising security is governed by section 42 of Companies Act 2013. Section 42 of Companies act 2103 read with rule 14(2)(b) of Companies (Prospectus and allotment of securities) rules, 2014 states that an offer to more than 200 persons in the aggregate in a financial year will constitute a public offer.

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Raising money by way of rights issue is method used by company to offer shares directly to existing shareholders of the company in proportion to their existing holding. Bonus issue is when company issues fully paid up shares to its own members.

Situation Before Enactment of Section 23

This provision was first time introduced in the Companies Bill, 2011. Before this there was no similar provision. This particular clause of the bill was amended by the suggestions of standing committee on finance. There after the amended clause now stands as Section 23 of the act, 2013.

 Application of Section 23

This newly inserted provision lists out the mode and means by which private and public limited companies can issue securities, thus providing explicit means for issuance of securities by both public and private companies in India.  There is confusion and dilemma with respect to its application, which has not been up till now explicitly cleared up by any notification or legislation. It is believed that use of the word “May” with respect to private placement creates ambiguity. If this “May” is to be interpreted in its literal sense than it would mean that a private company issuing securities can also follow the procedure under Section 42 (private placement), Section 54 (issue of sweat equity shares), Section 62 (further issue of share capital), Section 71 (debentures) and Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 independently. But at the same time if the “May” in section 23(2) is to be interpreted and read as shall, it would become a mandatory provision and it would mean that if a company has to issue securities under the act, 2013 it has to be done as per the provision of section 23(2), that is every time any security, whether shares, debentures or employee stock options, are proposed to be issued either a private placement or a rights issue process will have to be followed by the private company, unless such shares are being issued as bonus shares.

Amendments to Section 23

This section has been quite constant and has not been amended as it was is a fairly new section, incorporated for the first time in 2013 act and merely lays down the methods to be used by companies to issue securities. More detailed procedure about each method is further explained under different provisions following this section. There has been a circular providing clarity on the applicability of this section. The M.C.A circular clarifies that unless the applicable law and rules/regulations of RBI explicitly specify the application of this section and all other sections under chapter III of the act, 2013 will not be applicable for issuance of foreign currency convertible bonds and foreign currency bonds by companies to person resident outside India.

Cases at a Glance

  • APL Industries LTD. v. Security and Exchange board of India: in this particular case SEBI ordered the refund of monies with interest to the subscribers where public issue of shares was unsubscribed. The court further ordered that after two decades of litigation the matter of refund along with interest cannot be delayed any further and have to be compiled with.
  • Sahara Real Estate Corporation v. SEBI: When issuing security, it is very essential to make sure that the company has complied with all the regulation and laws, or else the company would be in a very bad situation and will have to bear sanctions of court and even SEBI. This case is a good example of what happens when a company tries to bypass regulations to make the process of issuance of security smoother. In this case the company in question made public offer under the garb of private placement route by offering optionally fully convertible securities, which are hybrid securities, in order to, circumvent laws relating to public offers and evade compliances including listing in stock exchange. It was held that unlisted companies like Sahara when made an offer of shares or debentures to fifty or more persons, it was mandatory for the company to follow the legal requirements of listing their securities. Once the number forty-nine is crossed, it is considered an issue to the public, and thus an application for listing on any recognized stock exchange becomes mandatory. After this judgement many provisions of chapter III of the act, 2013 were amended to overcome the loopholes of law used by Sahara.
  • Fisherman Development Micro Finance Ltd. case: this company had issued equity shares through public issue to 3410 persons. This case was against this issuance by company, it was contented that this was an illegal issuance and all the regulations were not compiled with. Here SEBI reiterated the importance of following all the regulations and not trying to bypass the laws. Here the company raised money by public issue without issuing prospectus. SEBI held that this type of issue is not valid and ordered the company and directors to refund all the money raised with 15% interest. Further even the directors were held liable and were banned to issue any more security till the time all the refunds were taken care off.
  • Target People Social Security Scheme Micro Finance Limited case: this case is very similar to the fishermen development case. The company in question issued equity share to public, more than fifty people. They did not file prospectus. This issuance was challenged, as all the regulations were not compiled with. The company claimed that firstly that the new provision of the act 2013, that is section 23 will not be applicable as it came into force after its issuance and secondly that it is an NBFC, functioning as a micro finance institution and thus falls under the exemption under section 67(3) of the act, 1956 and thus this issuance will not be considered a public issue and hence no prospectus is required. The court negated this argument and held that provisions of 2013 act will be applicable and further the SEBI regulations will also be applicable and thus an issuance of equity shares without prospectus invalidates such issuance and the company is liable to refund the monies with interest.
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Concluding Summary

Any company requires funds to sustain and continue their business. The need for funds can be short term or long term and is met by issuance of securities to public, members or other persons by the way of section 23 of the act, 2013. The different methods stated by section 23 are very useful ways of generating capital by a company. All the different ways as states under section 23 can be used to generate capital, but the criteria, procedure and disclosure requirements differ for each type of issue. For public issues, a prospectus is a very important document, and way of issuing security and raising capital. Specifically, for a first time IPO, prospectus is very important as it helps investors gain knowledge about the company. There is a whole different section that governs private placement, which has been amended in multiple ways to make sure that there are no loopholes. This section is very important, as it lay down the ways to make sure that company has capital and is hence functioning. This section along with other provisions of the act and the rules and regulations by SEBI and MCA helps the companies stay afloat and hence the understanding of this section is very important.

Also read, Conversion of Private Limited to Public Limited Company: Meaning, Categories and Procedure.