Where the Rules effectively nullify the intent of the Act – Sec 62 of the Companies Act 2013 & the Rules

Companies Act 2013 (CA 2013) is structured in manner whereby all Rights & Preferential Issues for raising Share Capital are covered by Section 62 and Private Placements have to follow the process laid down u/s 42. The distinction between a Private Placement and a Preferential Issue is clear wherein a “private placement” has been defined as under:

“Private Placement means any offer of securities or invitation to subscribe securities to a selected group of persons by a company (other than by way of public offer) through issue of a private placement offer letter and which satisfies the conditions specified in this section.”

The intent of the legislature was to bring in stricter norms to cover the misuse, as in the case of Sahara, where the Group effectively structured a Public Issue by its two private companies, under the garb of private placement, issued optionally fully-convertible debentures (“OFCDs”) amounting to about Rs 24,000 crores to more than 2 crore investors.

One can understand the intent and sympathise with it as the system was beaten by Sahara and its lawyers by a devious method which was later struck down by the Supreme Court. However, we are sure, that it was never the intent of the Legislature of bring all Preferential issues, not amounting to a private placement, under the strict provisions of Section 42. But this is what the Rules have effectively done – specifically Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014 which mandates that issue of shares on a Preferential basis u/s 62(1)(c) should also comply with conditions laid down in section 42 of the Act.

This has thrown up a peculiar problem for startups where the initial paid up Share Capital is say Rs 1,00,000/- which is subscribed for and paid by the Founders and now a Venture Capital/ Angel Investor comes in and agrees to value the Company at say Rs 2 crore for taking a stake of 10%. The said transaction/ investment is typically structured as a) issue of Equity Shares at a Premium, which in this case would be Equity Shares of Rs 10,000 issued at a Premium of Rs 19,90,000/- totalling Rs 20,00,000/- OR b) issue of Rs 10,000 Equity Shares at a lower Premium of Say Rs 90,000/- along with .001% CCPS for Rs 19,00,000/- at Par.

Now the question is whether this satisfies the provisions of Sec 62(1)(c ) read with Rule 14(2)(c ) that requires the “value of such offer or invitation per person shall be with an investment size of not less than twenty thousand rupees of face value of the securities”

An interpretation given by one of the top Law firms doing Due Diligence was that both the structuring options discussed above violated the Rule and as such attract penal provisions as the Equity Shares being allotted at face value are less than Rs 20,000/-. In their opinion the violation attracted penalty u/s 42 and not Sec 62, but that’s another story!!

In our opinion there is no violation of Sec 42 read with Rule 14 as the “investment size” in the second case is more than Rs 20,000/- of face value of the “securities”, the thrust being on “investment size” and “securities” which would logically include the Equity Shares and CCPS.

PS: the penalty, if any, would be leviable u/s 62 and not 42 as the offer and allotment was being made u/s 62 – the triggering of the conditions u/s 42 was incidental.