Sunday, February 7, 2016

Recommendations of the Companies Law Committee: A Proposed Overhaul of the Private Placement Regime

[The following guest post is contributed by Amitabh Robin Singh, who is an Associate at DSK Legal]

The recently released Companies Law Committee report (“Report”) has recommended a plethora of amendments to the current company law regime. However, some of the most sweeping changes have been proposed in relation to private placement of securities. In this post, some of the key changes proposed on this front will be discussed.

Under the Companies Act, 2013 (“Act”), private placement of securities is governed by Section 42 read with Section 62. One major requirement for a preferential allotment of securities is the circulation and filing of a private placement offer letter in the form PAS-4, which is prescribed under the Companies (Prospectus and Allotment of Securities) Rules, 2014. This requirement was often said to be cumbersome for a private placement due to the fact that a form PAS-4 entailed extra time and costs while the subscribers to the securities were relatively small in number.

In a sweeping recommendation, the Report has proposed doing away with form PAS-4. However, to ensure adequate disclosure and investor protection, certain disclosures which are to be made in an explanatory note sent along with a notice for the general meeting convened to pass the requisite special resolution for preferential allotment of securities have been recommended to be incorporated in the application form for the private placement. These disclosures relate to the objects of the issue, the price/price band of the issue along with the valuation report of the securities, the intention of promoters, directors or key managerial personnel to subscribe to the offer, the name of the proposed allottees and percentage of the capital they will hold post the offer, whether there will be a change of control pursuant to the issue and if so the nature of the change, among other things.

The Report also goes on to propose that other important information which is currently contained in form PAS-4 can be moved into the abovementioned explanatory notice. This information may consist of matters such as any investigations conducted on the company under the Act or any previous company law in the last 3 financial years, related party transactions entered into by the offeree in the last 3 financial years, summary of reservations or adverse remarks made by the auditors in the last 5 financial years, etc.

The requirement of circulating and filing a form PAS-4 for preferential allotment of shares to persons who are existing members of the company has been rather dynamic. From April 1, 2014 (when the relevant sections were brought into force) until March 18, 2015 (the date on which the Companies (Share Capital and Debentures) Amendment Rules 2015 (“Share Capital Amendment Rules) were brought into force), there was a requirement of circulating and filing a form PAS-4 for a preferential allotment even to persons who were existing members of the company. Following the Share Capital Amendment Rules, it is no longer necessary for a form PAS-4 to be circulated and filed for a preferential offer of shares to existing members of the company. This has helped companies issue shares to existing members of the company without having to either circulate and file a form PAS-4 or go through the entire rights issue process and having the members who are not to subscribe to the offered shares waive their rights.

Now, as we can see from the Report the form PAS-4 has been recommended to be discontinued altogether. This appears to be a good move as it will make raising of capital easier, but with the suggested added disclosures to the securities application form it will not excessively imperil the investors.

Another very interesting point raised in the Report is the right to renounce securities offered to a member in pursuance to a rights issue. Section 62(1)(a)(ii) states that shares offered to a person pursuant to a rights issue may be renounced in favour of “any other person”. Then section 62(1)(a)(iii) goes on to state that after the rights issue period has expired (between 15 and 30 days as per Section 62) or the person to whom the shares has been offered declines to subscribe to them and does not renounce in anyone’s favour, then the board of the company may dispose of the shares in a manner “which is not disadvantageous to the shareholders and the company;”.

The committee has noted that this provision for renouncing in favour of a non-member or letting the offer period expire and then allotting the shares at the boards discretion is being misused to circumvent the preferential allotment mechanism which mandates the passing of a special resolution at a general meeting of the company and also currently requires a form PAS-4 to be circulated and filed. These activities result in both extra costs and take more time to execute due to the time and expenses involved to convene an extraordinary general meeting.

To control such circumvention of the process of the preferential allotment mechanism, the Report recommends looking into the procedure given in the (English) Companies Act, 2006 (“English Act”). Section 756(4)(a) of the English Act states that an offer will be regarded as a private concern of the person receiving it if it is only made to a person already connected with the company and this person may only renounce his/her/its rights in favour of another person who is connected with the company.

The English Act has also gone on to define the term “person already connected with the company” as:

(a) an existing member or employee of the company,

(b) a member of the family of a person who is or was a member or employee of the company,

(c) the widow or widower, or surviving civil partner, of a person who was a member or employee of the company,

(d) an existing debenture holder of the company, or

(e) a trustee (acting in his capacity as such) of a trust of which the principal beneficiary is a person within any of paragraphs (a) to (d).”

An interesting point raised on this provision is that the relative of a former member will be eligible to have renunciation in his favour, but a former member or employee him/herself of the company is not eligible to be the beneficiary of renunciation.[1]

While there may be loopholes in this system provided by the English Act, it is a good base to work from while formulating a similar provision for India to curtail misuse of renunciation of shares offered on a rights basis.

Interestingly, also in the case of rights issues of shares to foreign investors, the shares are allowed be freely issued by the Foreign Exchange Management Act, 1999. In the case of an unlisted company, the shares are required to be offered to the foreign investors at a price which is not less than what has been offered to domestic investors. This means that rights issues to foreign investors are exempt from having to be at least at the price determined as per the valuation report done by a merchant banker registered with the Securities and Exchange Board of India or a chartered accountant.

As it can be seen, the recommendation of the committee to curtail the practice of misusing the rights issue process to actually allot securities to designated non-members seems to be a welcome step, so that when the pre-emption rights of the current shareholders is by-passed it is with the proper sanction of the company at a general meeting.

The last major change that will be examined in this post relates to the number of offers of securities that a company can keep open simultaneously. Currently Section 42(3) of the Act prohibits making a fresh offer or invitation unless the allotments with regard to any earlier offer or invitation have been completed or it has been withdrawn or abandoned. The Report recommends allowing a company to keep open more than one offer of securities simultaneously to specific classes of investors which may be prescribed by rules. This is a welcome recommendation because if this is made into law, then a company can then allot of securities through different offers simultaneously and will not have to wait for full allotment of securities under one offer before commencing the other.

Looking at the above discussed proposals, it can be said that the recommendations made in the Report appear to both liberalize the environment for doing business by making fund raising simpler for companies while also trying to plug loopholes which may be detrimental to the interests of the companies and their shareholders.

- Amitabh Robin Singh

[1] "Share Issues By Private Companies", Institute of Directors, available at: section 756 of the english companies act

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