PROVISIONS OF COMPANIES ACT, 2013 WITH RESPECT ISSUE OF SECURITIES

Pubic Offer and Private Placement

Chapter III (Section 23 to Section 42) of the Companies Act, 2013 deals with prospectus and
allotment of securities. It is divided into 2 parts.
• Part I deals with public offer and
• Part II deals with private placement.

According to section 23(1), a public company may issue securities:

(a) to public through prospectus (herein referred to as "public offer") by complying with
the provisions of this Part(i.e Part I); or
(b) through private placement by complying with the provisions of Part II of this Chapter; or
(c) through a rights issue or a bonus issue in accordance with the provisions of this Act and in
case of a listed company or a company which intends to get its securities listed also with
the provisions of the Securities and Exchange Board of India Act, 1992 and the rules and
regulations made thereunder.

Section 23(2) lays down that a private company may issue securities:
(a) by way of rights issue or bonus issue in accordance with the provisions of this Act; or
(b) through private placement by complying with the provisions of Part II of this Chapter.

As per explanation to section 23, for the purposes of Chapter III, "public offer" includes initial
public offer or further public offer of securities to the public by a company, or an offer for sale of
securities to the public by an existing shareholder, through issue of a prospectus.

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 PROSPECTUS – MEANING

According to section 2(70) of the Act, “Prospectus means any document described or issued as a
prospectus and includes a red herring prospectus referred to in section 32 or shelf prospectus
referred to in section 31 or any notice, circular, advertisement or other document inviting offers
from the public for the subscription or purchase of any securities of a body corporate..”

Invitation to Public: - it can be to any particular section of public……….like CS, CAs,

Doctors etc
One of the features of the prospectus is to make invitation to the public. Hence, a document is not
considered as prospectus unless it is an invitation to the public. Invitation to the public includes
invitation to any section of the public e.g. invitation to all advocates or to all doctors or to all
foreigners living in India or to all the shareholders in a particular Company. (Case: South of
England Natural Gas and Petroleum Co. Ltd.).

However, there are two exceptions, in which offer is not deemed to have been made to the public:

1. Where the offer or invitation cannot be calculated to become available to any person other
than those to whom it is made.
2. Where the offer made is domestic affairs of the person making receiving the offer.

A single private communication does not satisfy the term issue as it was decided in the case of
Nash V. Lynde. In this case several copies of a document marked as “strictly confidential “ and
containing the particulars of the issue transferred by M.D. to client and who in turn transferred it
to the relatives. Relative were allotted shares. The house of lord held that it is not the issue of
shares to public as the offer document was transferred through a private route and cannot be
considered as offer to public.

PUBLIC OFFER
What is Public Offer?
Explanation to Section 23 states that for the purposes of Chapter III, "public offer" includes initial
public offer or further public offer of securities to the public by a company, or an offer for sale of
securities to the public by an existing shareholder, through issue of a prospectus.

When prospectus is not required to be issued

The section 26 is not applicable in the following cases, therefore provisions related to ‘matters to
be stated in prospectus’ as mentioned in section 26 are not required to be complied with.

Section 26(2) states that section 26(1) does not apply to

(a) to the issue to existing members or debenture-holders of a company, of a prospectus or
form of application relating to shares in or debentures of the company, whether an
applicant has a right to renounce the shares or not under sub-clause (ii) of clause (a) of sub-
section (1) of section 62 in favour of any other person; or
(b) to the issue of a prospectus or form of application relating to shares or debentures which
are, or ar to be, in all respects uniform with shares or debentures previously issued and for
the time being dealt in or quoted on a recognised stock exchange.

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Filing Registration of prospectus – no prospectus shall be issued unless the copy of the same is
delivered to the Registrar for filing (registration - deleted by the Companies (Amendment)
Act, 2019) on or before the date of publication [section 26(4)].

 The prospectus cannot be issued more than 90 days after the date when the copy of the
same is delivered to the Registrar for filing (registration - deleted by the Companies
(Amendment) Act, 2019) [section 26(4)].
 If a prospectus is issued after the 90 days (say 91 days or more), it shall be deemed to be a
prospectus a copy of which has not been delivered to the Registrar for registration [section
26(8)].
 The copy of prospectus delivered for fling must be signed by every person name as therein
director or proposed or by authorized agent [Section 26(4)].

The prospectus delivered for registration must be accompanied by -

1. Letter of consent from experts whose statements are included in the prospectus.
2. Copy of every contract appointing or fixing the remuneration of a managing director or
manager.
3. Copy of other material contracts not being a contract entered in the ordinary course of the
business carried on or intended to be carried on by the company or a contract entered into
within two years before the date of the prospectus.
4. Copies of underwriting agreements.
5. Consent letter in writing of the person named in the prospectus as auditor, legal adviser,
solicitor, banker or broker of the company or intended company to act in that capacity.
6. Certified copy of the powers Attorney or the authority given by a director to an agent, if any,
to sign the prospectus on his behalf.

When Registrar can refuse to register the prospectus – Section 26(7) Section 26 (7) deleted
by the Companies (Amendment) Act, 2019.
Section 26(7) states that the Registrar shall not register a prospectus unless the requirements of
this section with respect to its registration are complied with and the prospectus is accompanied by
the consent in writing of all the persons named in the prospectus

Penalty for contravention of Section 26

Section 26(9) states that if a prospectus is issued in contravention of the provisions of this section,
the company shall be punishable with fine which shall not be less than fifty thousand rupees but
which may extend to three lakh rupees and every person who is knowingly a party to the issue of
such prospectus shall be punishable with imprisonment for a term which may extend to three years
or with fine which shall not be less than fifty thousand rupees but which may extend to three lakh
rupees, or with both.

Matters to be stated in the prospectus (as amended by the Companies (Amendment) Act,
2017 notified on 09.02.2018):

Section 26(1) states that every prospectus issued by or on behalf of a public company either with
reference to its formation or subsequently, or by or on behalf of any person who is or has been
engaged or interested in the formation of a public company, shall be dated and signed and shall
state such information and set out such reports on financial information as may be specified by the
Securities and Exchange Board in consultation with the Central Government.

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Provided that until the Securities and Exchange Board specifies the information and reports on
financial information under this sub-section, the regulations made by the Securities and Exchange
Board under the Securities and Exchange Board of India Act, 1992, in respect of such financial
information or reports on financial information shall apply.

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Abridged form of prospectus:
“Abridged Prospectus” means a memorandum containing such salient features of a prospectus as
may be specified by the Securities and Exchange Board by making regulations in this behalf.
[Section 2(1)]

Section 33 states that no form of application can be issued for the purchase of any securities of a
company unless it is accompanied by an abridged prospectus.

There are, however, four exceptions to this rule:

(a) where the offer is made in connection with the bona fide invitation to a person to enter into
an underwriting agreement with respect to such securities;
(b) where the securities are not offered to the public;
(c) where the offer is made only to the existing members or debenture holders of the company
with or without a right to renounce;
(d) where the shares or debentures offered are in all respects uniform with shares or
debentures already issued and quoted on a recognized stock exchange.

However, the copy of full prospectus shall be furnished if request is made for the same before the
closing of subscription list. It is however, open to a company to attach full prospectus along with
the application forms.
If a company makes any default in complying with the provisions of this section, it shall be liable
to a penalty of fifty thousand rupees for each default.

Statement by Expert:
The expression expert includes an engineer, a valuer, an accountant and any other person whose
profession gives authority to a statement made by him.

The statement of expert to be included in a prospectus should be from a person who is not, has not
been, engaged or intended in the formation or promotion, or in the management of the company
[Section 26(5)]. In other words that expert must not be connected with the function of the
company.

The prospectus that includes the statement from an expert cannot be issued unless –
(a) That expert has given his written consent for inclusion of the statement in the prospectus and
he has not withdrawn such consent before the delivery of prospectus for filing (registration -
deleted by the Companies (Amendment) Act, 2019) [Section 26(5)].
(b) He has not withdrawn his consent to the statement which has given as appeared in the
prospectus.

Deemed Prospectus
The company to evade statutory provisions related to prospectus sometimes issues a document to
invite public to purchase share or debentures of the company. Now, the aforesaid document is
covered by section 25 and deemed to be a prospectus issued by the company.

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Where a company allots or agreed to allot any shares or debentures with a view to these being
offered for the sale to the public, any document by which the offer of sale to the public is made
shall for all purposes be deemed to be a prospectus issued by the company [Section 25(1)].

It will be presumed that allotment of shares or debentures was made with a view to these being
offered for sale to the public if –

(a) The offer to the public for sale was made within 6 months after the allotments or agreement
to allot. In other words share was first allotted to the issue house that in turn made offer to the
public [Section 25(2)] or
(b) The whole consideration in respect of shares / debentures was not received by the company at
the time when the offer was made to the public by the issue house.

In case of a deemed prospectus all the matters that are required to be stated under section 26, also
required to be given in addition to it also state –
(a) Net amount of consideration received or to be received by the company in respect of the offer
relates; and
(b) The place and time at which relevant contract related to aforesaid offer may be inspected.

The person making the offer were deemed to be the person named in the prospectus as the director
of a company [Section 25(4)].

Therefore, this provision was inserted to catch those companies those who were offering their
shares to few persons (issue houses) and these persons were selling the shares to the public.

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Offer of Sale by Members:-
Section 28 (1) states that where certain members of a company propose, in consultation with the
Board of Directors to offer, in accordance with the provisions of any law for the time being in
force, whole or part of their holding of shares to the public, they may do so in accordance with
such procedure as may be prescribed.

Section 28(2) further states that any document by which the offer of sale to the public is made
shall, for all purposes, be deemed to be a prospectus issued by the company and all laws and rules
made thereunder as to the contents of the prospectus and as to liability in respect of mis-statements
in and omission from prospectus or otherwise relating to prospectus shall apply as if this is a
prospectus issued by the company.

Sub-section (3) states that the members, whether individuals or bodies corporate or both, whose
shares are proposed to be offered to the public, shall collectively authorise the company, whose
shares are offered for sale to the public, to take all actions in respect of offer of sale for and on
their behalf and they shall reimburse the company all expenses incurred by it on this matter.

Rule 8 of Companies (Prospectus and Allotment of Securities) Rules, 2014

(1) The provisions of Part I of Chapter III namely “Prospectus and Allotment of Securities” and
rules made there under shall be applicable to an offer of sale referred to in section 28 except
for the following, namely:-

(a) the provisions relating to minimum subscription;

(b) the provisions for minimum application value;
(c) the provisions requiring any statement to be made by the Board of directors in respect of
the utilization of money; and
(d) any other provision or information which cannot be compiled or gathered by the offeror,
with detailed justifications for not being able to comply with such provisions.

(2) The prospectus issued under section 28 shall disclose the name of the person or persons or
entity bearing the cost of making the offer of sale along with reasons.

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Dematerialization of Securities-mandatory
Section 29 (1) states that notwithstanding anything contained in any other provisions of this Act:

(a) every company making public offer; and

(b) such other class or classes of (public - deleted by the Companies (Amendment) Act,
2019 dated 31.07.2019 effective from 15.08.2019) companies as may be prescribed, shall
issue the securities only in dematerialised form by complying with the provisions of the
Depositories Act, 1996 and the regulations made thereunder.

Section 29(1A) - inserted by the Companies (Amendment) Act, 2019 dated 31.07.2019 effective
from 15.08.2019)
In case of such class or classes of unlisted companies as may be prescribed, the securities shall be held or
transferred only in dematerialised form in the manner laid down in the Depositories Act, 1996 and the
regulations made thereunder.

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Section 29 further states that any company, other than a company mentioned in sub-section (1),
may convert its securities into dematerialised form or issue its securities in physical form in
accordance with the provisions of this Act or in dematerialised form in accordance with the
provisions of the Depositories Act, 1996 and the regulations made thereunder.

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Rule 9A: Issue of securities in dematerialised form by unlisted public companies -as inserted
by the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018
w.e.f. 02.10.2018:

(1) Every unlisted public company shall:

(a) issue the securities only in dematerialised form; and
(b) facilitate dematerialisation of all its existing securities

in accordance with provisions of the Depositories Act, 1996 and regulations made there under.

(2) Every unlisted public company making any offer for issue of any securities or buyback of
securities or issue of bonus shares or rights offer shall ensure that before making such offer,
entire holding of securities of its promoters, directors, key managerial personnel has been
dematerialized in accordance with provisions of the Depositories Ac! 1996 and regulations
made there under.

(3) Every holder of securities of an unlisted public company:

(a) who intends to transfer such securities on or after 02nd October, 2018, shall get such
securities dematerialised before the transfer; or
(b) who subscribes to any securities of an unlisted public company (whether by way of
private placement or bonus shares or rights offer) on or after 2nd October, 2018 shall
ensure that all his existing securities are herd in dematerialized form before such
subscription.

(4) Every unlisted public company shall facilitate dematerialisation of all its existing securities by
making necessary application to a depository as defined in clause (e) of sub-section (1) of
section 2 of the Depositories Act, 1996 and shall secure International security Identification
Number (ISIN) for each type of security and shall in-form all its existing security holders
about such facility.

(5) Every unlisted public company shall ensure that:

(a) it makes timely payment of fees (admission as well as annual) to the depository and
registrar to an issue and share transfer agent in accordance with the agreement executed
between the parties;
(b) it maintains security deposit at all times, of not less than two years, fees with the
depository and registrar to an issue and share transfer agent in such form as may be
agreed between the parties; and
(c) it complies with the regulations or directions or guidelines or circulars, if any, issued by
the securities and Exchange Board or Depository from time to time with respect to
dematerialisation of shares of unlisted public companies and matters incidental or related
thereto.

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Listed company = widely held company ------------where public is involved

Unlisted co. ----closely held co. --------where public is not involved………

(6) No unlisted public company which has defaulted in sub-rule (5) shall make offer of any
securities or buyback its securities or issue any bonus or right shares till the payments to
depositories or registrar to an issue and share transfer agent are made.

(7) Except as provided in sub-rule (8), the provisions of the Depositories Act 199, the securities
and Exchange Board of India (Depositories and participants) Regulations, 2018
(Regulations, 1996 – Deleted by the Companies (Prospectus and Allotment of Securities)
Third Amendment Rules, 2019 dated 22.05.2019 effective from 30.09.2019) and the
securities and Exchange Board of India (Registrars to an Issue and share Transfer Agents)
Regulations, 1993 shall apply mutatis mutandis to dematerialisation of securities of unlisted
public companies.

(8) Every unlisted public company governed by this rule shall submit Form PAS-6 to the
Registrar with such fee as provided in Companies (Registration Offices and Fees) Rules, 2014
within sixty days from the conclusion of each half year duly certified by a company secretary
in practice or chartered accountant in practice (Sub-Rule 8 as amended by the Companies
(Prospectus and Allotment of Securities) Third Amendment Rules, 2019 dated
22.05.2019 effective from 30.09.2019).

(8A) The company shall immediately bring to the notice of the depositories any difference
observed in its issued capital and the capital held in dematerialised form (Sub-Rule 8A as
inserted by the Companies (Prospectus and Allotment of Securities) Third Amendment
Rules, 2019 dated 22.05.2019 effective from 30.09.2019).

(9) The grievances, if any, of security holders of unlisted public companies under this rule shall
be filed before the Investor Education and protection Fund Authority.
 

(10) The Investor Education and protection Fund Authority shall initiate any action against a
depository or participant or registrar to an issue and share transfer agent after prior
consultation with the securities and Exchange Board of India.

(11) This rule shall not apply to an unlisted public company which is: (Rule 11 inserted by
the Companies (Prospectus and Allotment of Securities) Amendment Rules, 2019 dated
22.01.2019)
(a) a Nidhi;
(b) a Government company or
(c) a wholly owned subsidiary.”.

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What is an untrue statement in prospectus?

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1. An untrue statement or mis-statement is one, which is misleading in the form and content in
which it has been included in the prospectus.
2. Where the omission from a prospectus of any matter is calculated to mislead, the prospectus
shall be deemed, in respect of such omission, to be a prospectus containing an untrue
statement.

Case: Rex V. kylsant

In this case a prospectus was issued and it was as stated in the prospectus that the Company is
paying dividend regularly for the last number of years. The truth was that the Company had been
incurring losses during the seven years and the dividend had been paid from the capitalized profits
and not from the trading profits.

It was held the prospectus was false and misleading. The statement though true in itself was
rendered false in the context in which it was stated.

Golden Rule for framing of Prospectus

The Golden Rule was laid down in the case of New Brunswick & Canaa Railway Co. V.
Muggeridge. It was held those who issue prospectus holding out to the public great advantage,
which will accrue to the person who will take shares in the proposed undertaking in the
prospectus. Public is invited to take share on the faith of the representation contained in the
prospectus. Therefore everything must be stated in the prospectus with scrupulous accuracy.
Nothing should be stated as a act which is not so and no fact should be omitted. If there is a
concealment of any fact it would amount to mis-representation.

Onus for Proof of Mis-statement

The burden of proof in a suit by an allottee that he has been misled by the mis-statement in the
prospectus lies on the allottee. He must prove the following:

i. The misrepresentation was of a fact;

ii. It was in respect of a material fact. What is a material statement of fact will depend upon the
circumstances of each case.
iii. He acted on the misrepresentation; and
iv. He suffered damages in consequence.

Who are liable or to be sued for untrue statement?

The following persons are responsible for issue of prospectus may be held liable to the investor for
loss cause to them because of untrue statement in the prospectus:
a) Every person who is a director of the company at the time of the issue of the prospectus;
b) Every person who as authorized himself to be named and is named in the prospectus either as a
director or as having agreed to become a director immediately or after an interval of time;
c) Every person who is a promoter of the company; and
d) Every person who has authorized the issue of the prospectus.
e) Every person who is an expert referred to in sub-section (5) of section 26

Who are entitled to sue for untrue statement?

Every person who subscribes for any shares / debentures and sustained loss or damages because of
any untrue statement in the prospectus.

Liability for untrue statement:

Where an untrue statement occurs in the prospectus the two liabilities arises –

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 a) Civil liability [section 35]
b) Criminal liability [section 34]

Civil liability
(1) Remedies against the company- The subscriber may have the following remedies against the
company: -
(i) Rescission of the contract (voidable contract) - A contract made with the company to
purchase shares is an uberrimae fidei contract (i.e., a contract based on the utmost good
faith). It implies that if a misrepresentation or non-disclosure of fact renders a statement
untrue in a material particular or renders the whole prospectus untrue, the contract is
voidable at the option of the aggrieved party. In other words, the subscriber to the shares
can file a suit against the company to rescind the contract under the general law of
contracts.
(ii) Damages for deceit- the second remedy against the company is damages for deceit under
the general law of tort. The allottee may recover damages from the company for any loss
he may have suffered if he was induced to take share based on a fraudulent
misrepresentation of material facts.

The allottee cannot, however, both retain the shares and get damages against the company. He
must show that he has repudiated the shares and has not acted as a shareholder after discovering
the misrepresentation.

(2) Remedies against Directors, Promoters and Experts

Every director, promoter and every person who is responsible for the issue of the prospectus
containing false or untrue information are liable to compensate all those persons who subscribe
to the shares on the faith of the prospectus.

Criminal Liability for mis-statements

According to Section 34 of the Companies Act, 2013, where a prospectus, issued, circulated or
distributed includes any statement which is untrue or misleading in form or context in which it is
included or where any inclusion or omission of any matter is likely to mislead, every person who
authorizes the issue of such prospectus shall be liable under section 447.

However, where a person who has authorized the issue of prospectus proves, either that such
statement or omission was immaterial or that he had reasonable grounds to believe, and did up to
the time of issue of the prospectus believe, that the statement was true or the inclusion or omission
was necessary may be relieved from the criminal liability

Section 447 (as amended by the Companies (Amendment) Act Ordinance, 2019 w.e.f. 02nd
November 2018) provides that any person who is found to be guilty of fraud involving an amount
of at least ten lakh rupees or 1 % of the turnover of the Company, whichever is lower, shall be
punishable with imprisonment for a term which shall not be less than six months but which may
extend to ten years and shall also be liable to fine which shall not be less than the amount involved
in the fraud, but which may extend to three times the amount involved in the fraud.

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However, where the fraud in question involves public interest, the term of imprisonment shall not
be less than three years.

Provided further the fraud involves an amount less than ten lakh rupees or 1 % of the turnover of
the Company, whichever is lower and does not involve public interest, any person guilty of such
fraud shall be punishable with imprisonment for a term which may extend to five years or with
fine which may extend to fifty lakh rupees or with both.

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SHELF PROSPECTUS [SECTION 31]

Shelf prospectus for first issue = prospectus

Information memorandum + shelf prosp = prosp for subsequent issue

"Shelf Prospectus" means a prospectus in respect of which the securities or class of securities
included therein are issued for subscription in one or more issues over a certain period without
the issue of a further prospectus.

Accordingly as per Section 31:

 Any public financial institution, public sector bank or scheduled bank whose main object

isfinancing shall file a Shelf prospectus.

 Such institutions/banks also required to file an information memorandum on all material
facts relating to new charges created, changes in the financial position as have occurred
subsequent to previous issue, prior to make any subsequent offer of securities under the
shelf prospectus, within such time as may be prescribed by the Central Government.
 Such Company filing a shelf prospectus with ROC shall not be required to file afresh
prospectus at every stage of offer of securities within a period of validity (i.e. one year) of such
shelf prospectus.
 Shelf prospectus shall be valid for a period of one year from the date of opening of the first
issue of securities under shelf prospectus.
 Where an update of information memorandum is filed every time an offer of securities is
made, such memorandum together with the shelf prospectus shall constitute the prospectus.
 Where a company or any other person has received applications for the allotment of securities
along with advance payments of subscription before the making of any such change, they shall
intimate the changes to such applicants.
 If the applicants express a desire to withdraw their application, the company or other person
shall refund all the monies received as subscription within fifteen days.

Information Memorandum to be filed before the issue of a second or subsequent offer of

securities under the shelf prospectus
Rule 10 of Companies (Prospectus and Allotment of Securities) Rules, 2014 states that the
information memorandum shall be prepared in Form PAS-2 and filed with the Registrar along
with the fee as provided in the Companies (Registration Offices and Fees) Rules, 2014 within one
month prior to the issue of a second or subsequent offer of securities under the shelf prospectus.

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 RED-HERRING PROSPECTUS – SECTION 32

"Red Herring Prospectus" means a prospectus which does not include complete particulars of
the quantum or price of the securities included therein.

Section 32 of the Act deals with Red Herring Prospectus, it provides that:
1. As per this section, a company proposing to make an offer of securities may issue a red herring
prospectus prior to the issue of a prospectus.
2. A company proposing to issue a red herring prospectus shall file it with the Registrar at least
three days prior to the opening of the subscription list and the offer.
3. A red herring prospectus shall carry the same obligations as are applicable to a prospectus.
Any variation between the red herring prospectus and a prospectus shall be highlighted as
variations in the prospectus.
4. Upon the closing of the offer of securities, the prospectus stating therein the total capital
raised, whether by way of debt or share capital, and the closing price of the securities and any
other details as are not included in the red herring prospectus shall be filed with the Registrar
and the Securities and Exchange Board.

Red herring prospectus is issued during book building process. Red herring prospectus
contains either the floor price of securities offered or a price band along with the range within
which the Bids can move.

Where price band is fixed………..where co. fixes the min and max price of share
…………floor price and cap price……….investor to apply shares within the price
band……………..

e.g. 100-120 per share

The applicants bid for the shares quoting the price and the quantity that they would like to bid at.
SEBI (ICDR) Regulations prescribe certain disclosures to be made in the red-herring prospectus.
Once the offer for securities is closed, a final prospectus stating therein the total capital raised
whether by way of debt or share capital, the closing price of the securities and any other details
which are not complete in the red-herring prospectus shall be filed with SEBI in the case of listed
public company and in any other case with the Registrar of companies only.

The compliances under SEBI (ICDR) Regulations 2009 relating to shelf prospectus and red-
herring prospectus is covered under chapter ‘’issue of Securities’’ in paper Capital Markets and
Securities Laws of Executive programme.

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In case of public issue, co comes up with two options:

1. Fixed price
where price is fixed and co decides the premium and final price.
e.g. FV is 10/- premium is 120/- for issue prioce is 130/-

co issues prospectus (final prosp) and for FI banks that becomes shelf prosp.

2. Co comes up with book building process where co fixes a price band

Face value 10/- floor price 100/- and cap price would be 120/
Investors will bid…………….between 100-120
Then final price will be decided……………….lets say 114/- at which max bidding has come.
So final price would be 114/-

Final price would be included in RHP and that will become final prosp and will be filed with
ROC and SEBI.
For Bank FIs that will be treated as Shelf prosp.

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 PRIVATE PLACEMENT

Chapter III (Section 23 to Section 42) of the Companies Act, 2013 deals with prospectus and
allotment of securities. It is divided into 2 parts.
• Part I deals with public offer and
• Part II deals with private placement.

According to section 23(1), a public company may issue securities:

(d) to public through prospectus (herein referred to as "public offer") by complying with the
provisions of this Part (i.e. Part I); or
(e) through private placement by complying with the provisions of Part II of this Chapter; or
(f) through a rights issue or a bonus issue in accordance with the provisions of this Act and in
case of a listed company or a company which intends to get its securities listed also with
the provisions of the Securities and Exchange Board of India Act, 1992 and the rules and
regulations made there under.

Section 23(2) lays down that a private company may issue securities:
(c) by way of rights issue or bonus issue in accordance with the provisions of this Act; or
(d) through private placement by complying with the provisions of Part II of this Chapter.

As per explanation to section 23, for the purposes of Chapter III, "public offer" includes initial
public offer or further public offer of securities to the public by a company, or an offer for sale of
securities to the public by an existing shareholder, through issue of a prospectus.

As per Explanation (ii) to Section 42(2), "private placement" means any offer of securities or
invitation to subscribe securities to a select 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 section 42.

Private placement offer letter – Section 42 as amended by the Companies (Amendment) Act,
2017 notified of 07.08.2018
Section 42(1) provides that a Company may, subject to the provisions of this section, make
private placement of securities through issue of a private placement offer letter in Form No. PAS-
4.

Refer to Rule 14 of Companies (Prospectus and Allotment of Securities) Rules 2014 - as

amended by the companies (prospectus and Allotment of Securities) Second Amendment
Rules, 2018 on 07.08.2018

Rule 14 (1):
For the purposes of sub-section (2) and sub-section (3) of section 42, a company shall not make an
offer or invitation to subscribe to securities through private placement unless the proposal has
been previously approved by the shareholders of the company, by a special resolution for each of
the offers or invitations.

Provided that in the explanatory statement annexed to the notice for shareholders' approval, the
following disclosure shall be made:
(a) particulars of the offer including date of passing of of Board resolution
(b) Kinds of securities offered and the price at which security is being allotted

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 (c) basis or justification for the price (including premium, if any) at which the offer or
invitation is being made
(d) name and address of valuer who valuation
(e) amount which the company intends to raise by way of such securities
(f) material terms of raising such securities, proposed time schedule, purposes or objects of
offer, contribution being made by the promoters or directors either as part of the offer or
separately in furtherance of objects; principle terms of assets charged as securities:

Provided further that this sub-rule shall not apply in case of offer or invitation for non-
convertible debentures, where the proposed amount to be raised through such offer or invitation
does not exceed the limit as specified in clause (c) of sub-section (1) of section 180 and in such
cases relevant Board resolution under clause (c) of sub-section (3) of section 179 would be
adequate.

Provided also that in case of offer or invitation for non-convertible debentures, where the proposed
amount to be raised through such offer or invitation exceeds the limit as specified in clause (c) of
sub-section (1) of section 180, it shall be sufficient if the company passes a previous special
resolution only once in a year for all the offers or invitations for such debentures during the year.

Maximum number of persons to whom offer can be made and other incidental matters
As per section 42(2), the offer of securities or invitation to subscribe securities i.e. private
placement, shall be made only to a select group of persons who have been identified by the Board,
whose number shall not exceed fifty or such higher number as may be prescribed, [excluding
qualified institutional buyers and employees of the company being offered securities under a
scheme of employees stock option as per provisions of clause (b) of sub-section (1) of section 62],
in a financial year and on such conditions as may be prescribed.

Rule 14(2) of Companies (Prospectus and Allotment of Securities) Rules, 2014 states that
such offer or invitation to subscribe securities under private placement shall not be made to
more than two hundred persons in the aggregate in a financial year.

Provided that any offer or invitation made to qualified institutional buyers, or to employees of the
company under a scheme of employees stock option as per provisions of clause (b) of sub-section
(1) of section 62 shall not be considered while calculating the limit of two hundred persons.

For the purposes of this sub-rule, it is hereby clarified that the restrictions would be reckoned
individually for each kind of security that is equity share, preference share or debenture;

No fresh offer, in case of earlier offer being withdrawn, pending allotments with respect to
earlier offer etc.,
Section 42(3) A company making private placement shall issue private placement offer and
application in such form and manner as may be prescribed to identified persons, whose names and
addresses are recorded by the company in such manner as may be prescribed.

Provided that the private placement offer and application shall not carry any right of renunciation.

Explanation I: “Private Placement" means any offer or invitation to subscribe or issue of

securities to a select group of persons by a company (other than by way of public offer) through
private placement offer-cum-application, which satisfies the conditions specified in this section.

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Explanation II: “Qualified Institutional Buyer" means the qualified institutional buyer as
defined in the Securities and Exchange Board of India (Issue of Capital and Disclosure
Requirements) Regulations, 2009, as amended from time to time, made under the Securities and
Exchange Board of India Act, 1992.

Explanation III: If a company, listed or unlisted, makes an offer to allot or invites subscription,
or allots, or enters into an agreement to allot, securities to more than the prescribed number of
persons, whether the payment for the securities has been received or not or whether the company
intends to list its securities or not on any recognised stock exchange in or outside India, the same
shall be deemed to be an offer to the public and shall accordingly be governed by the provisions of
Part I of this Chapter

Rule 14 (3):
A private placement offer cum application letter shall be in the form of an application in Form
PAS-4 serially numbered and addressed specifically to the person to whom the offer is made and
shall be sent to him, either in writing or in electronic mode, within thirty days of recording the
name of such person pursuant to sub-section (3) of section 42.

Provided that no person other than the person so addressed in the private placement offer cum
application letter shall be allowed to apply through such application form and any application not
conforming to this condition shall be treated as invalid.

Rule 14 (4):
The company shall maintain a complete record of private placement offers in Form PAS-5.

Mode of payment of subscription money

Section 42(4) Every identified person willing to subscribe to the private placement issue shall
apply in the private placement and application issued to such person along with subscription
money paid either by cheque or demand draft or other banking channel and not by cash:

Provided that a company shall not utilise monies raised through private placement unless
allotment is made and the return of allotment is filed with the Registrar in accordance with sub-
section (8).

Rule 14 (5):
The payment to be made for subscription to securities shall be made from the bank account of the
person subscribing to such securities and the company shall keep the record of the bank account
from where such payment for subscription has been received:

Provided that monies payable on subscription to securities to be held by joint holders shall be paid
from the bank account of the person whose name appears first in the application.

Provided further that the provisions of this sub-rule shall not apply in case of issue of shares for
consideration other than cash.

Section 42(5) No fresh offer or invitation under this section shall be made unless the allotments
with respect to any offer or invitation made earlier have been completed or that offer or invitation
has been withdrawn or abandoned by the company:

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Provided that, subject to the maximum number of identified persons under sub-section (2), a
company may, at any time, make more than one issue of securities to such class of identified
persons as may be prescribed.

Time limit for allotment and payment of interest/refund of subscription money otherwise
Section 42(6) A company making an offer or invitation under this section shall allot its
securities within sixty days from the date of receipt of the application money for such
securities and if the company is not able to allot the securities within that period, it shall
repay the application money to the subscribers within fifteen days from the expiry of sixty
days and if the company fails to repay the application money within the aforesaid period, it
shall be liable to repay that money with interest at the rate of 12 % p.a. from the expiry of
the sixtieth day:

Subscription money to be kept in a separate bank account

Proviso to Section 42(6) states that monies received on application under this section shall be
kept in a separate bank account in a scheduled bank and shall not be utilised for any
purpose other than:
(a) for adjustment against allotment of securities; or
(b) for the repayment of monies where the company is unable to allot securities.

Section 42(7): No company issuing securities under this section shall release any public
advertisements or utilize any media, marketing or distribution channels or agents to inform the
public at large about such an issue.

Return of allotment
Section 42(8) A company making any allotment of securities under this section, shall file with the
Registrar a return of allotment within fifteen days from the date of the allotment in Form No.
PAS-3, including a complete list of all allottees, with their full names, addresses, number of
securities allotted and such other relevant information as may be prescribed.

Rule 14 (6) of Companies (Prospectus and Allotment of Securities) Rules, 2014

Rule 14 (6) states that a return of allotment of securities under section 42 shall be filed with the
Registrar within fifteen days of allotment in Form PAS-3 and with the fee as provided in the
Companies (Registration Offices and Fees) Rules, 2014 along with a complete list of all security
holders containing:
(a) the full name, address, Permanent Account Number and E-mail ID of such security holder;
(b) the class of security held;
(c) the date of allotment of security ;
(d) the number of securities held, nominal value and amount paid on such securities; and
particulars of consideration received if the securities were issued for consideration other
than cash.

Section 42(9): If a company defaults in filing the return of allotment within the period prescribed
under sub-section (8), the company, its promoters and directors shall be liable to a penalty for each
default of one thousand rupees for each day during which such default continues but not exceeding
twenty-five lakh rupees.

Penalty

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Section 42 (10) Subject to sub-section (11), if a company makes an offer or accepts monies in
contravention of this section, the company, its promoters and directors shall be liable for a penalty
which may extend to the amount raised through the private placement or two crore rupees,
whichever is lower, and the company shall also refund all monies with interest as specified in sub-
section (6) to subscribers within a period of thirty days of the order imposing the penalty.

Section 42(11) Notwithstanding anything contained in sub-section (9) and sub-section (10), any
private placement issue not made in compliance of the provisions of sub-section (2) shall be
deemed to be a public offer and all the provisions of this Act and the Securities Contracts
(Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992 shall be
applicable.

Rule 14 (7):
The provisions of sub-rule (2) shall not be applicable to:
(a) non-banking financial companies which are registered with the Reserve Bank of India
under the Reserve Bank of India Act, 1934
(b) housing finance companies which are registered with the National Housing Bank under the
National Housing Bank Act, 1987

if they are complying with regulations made by the Reserve Bank of India or the National Housing
Bank in respect of offer or invitation to be issued on Private placement basis

Provided that such companies shall comply with sub-rule (2) in case the Reserve Bank of India or
the National Housing Bank have not specified similar regulations.

Rule 14(8):
A company shall issue private placement offer cum application letter only after the relevant
special resolution or Board resolution has been filed in the Registry:

Provided that private companies shall file with the Registry copy of the Board resolution or special
resolution with respect to approval under clause (c) of subsection (3) of section 179.

**********

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 FURTHER ISSUE OF SHARES (SECTION 62)

Section 62 of the Companies Act provides for the issue of “Rights Shares” and states that
whenever at any time, a company having a share capital proposes to increase its subscribed capital
by the issue of further shares, such shares shall be offered to the existing holders of equity shares
in proportion to the paid-up share capital on their shares at the time of further issue by sending a
letter of offer.

For listed companies, the information as regards the quantum of such issue and the proportion in
which rights shall be offered shall be supplied to the concerned Stock Exchanges in advance.

The Company must give notice to each equity shareholders, giving him option to take shares
offered to him by the Company.

The shareholder must be informed of the number of shares he has opted to buy giving him at least
15 days but not more than 30 days to decide. The said notice shall be dispatched through
registered post or speed post or through electronic mode tor courier or any other mode having
proof of delivery to all the existing shareholders at least three days before the opening of the issue.
– section 62(1)(a)(i) and section 62(2) (as amended by the Companies (Amendment) Act, 2017,
notified on 09.02.2018).

Note: This provision does not applicable to a private company. MCA has amended the earlier
provision that notwithstanding anything contained in section 62(1)(a)(i) and section 62(2) of
the Act, now private companies upon receiving the consent of 90% of its members in writing or
in electronic mode can prescribe lesser period for:
opening of issue pursuant to dispatch of offer letter; and
acceptance of offer made to the existing shareholders of such company.

Vide notification dated 05.06.2015.

Unless AOA of the provide, the notice must also state that the shareholders shall have the right to
renounce the offer in whole or in part, in favour of some other person who need not be a member
of the company.

If the shareholder does not inform the company about his decision within the stipulated time, he
shall be deemed to have declined the offer and such case the Board of Director may dispose of the
share in such manner as it thinks would be most beneficial to the company.

FURTHER ISSUE OF SHARES TO THE PERSONS OTHER THAN EXISTING

SHAREHOLDERS (SECTION 62(1) (C)
(PREFERENTIAL ALLOTMENT OF SHARES)

As per Section 62(1)(c) of the Act a Company can issue further shares to the persons other than
existing shareholder if:

1. Approval of shareholders has been taken by passing Special Resolution (SR);

2. The price of such shares is determined by the valuation report of a registered valuer subject
to the compliance with the applicable provisions of Chapter III and any other conditions as
may be prescribed.

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Where the preferential offer of shares or other securities is made by a company whose share or
other securities are listed on a recognized stock exchange, such preferential offer shall be made in
accordance with the provisions of the Act and regulations made by the Securities and Exchange
Board, and if they are not listed, the preferential offer shall be made in accordance with the
provisions of the Act and rules made hereunder and subject to compliance with the following
requirements, namely:-

(a) the issue is authorized by its articles of association;

(b) the issue has been authorized by a special resolution of the members;
(c) the securities allotted by way of preferential offer shall be made fully paid up at the time
of their allotment. (deleted by notification dated 19.07.2016).
(d) The company shall make the following disclosures in the explanatory statement to be
annexed to the notice of the general meeting pursuant to section 102 of the Act:

(ii) the objects of the issue;

(iii) the total number of shares or other securities to be issued;
(iv) the price or price band at/within which the allotment is proposed;
(v) basis on which the price has been arrived at along with report of the registered
valuer;
(vi) relevant date with reference to which the price has been arrived at;
(vii) the class or classes of persons to whom the allotment is proposed to be made;
(viii) intention of promoters, directors or key managerial personnel to subscribe to the
offer;
(ix) the proposed time within which the allotment shall be completed;
(x) the names of the proposed allottees and the percentage of post preferential offer
capital that may be held by them;
(xi) the change in control, if any, in the company that would occur consequent to the
preferential offer; the number of persons to whom allotment on preferential basis
have already been made during the year, in terms of number of securities as well
as price;
(xii) the justification for the allotment proposed to be made for consideration other than
cash together with valuation report of the registered valuer.
(xiii) The pre issue and post issue shareholding pattern of the company

(e) the allotment of securities on a preferential basis made pursuant to the special resolution
passed shall be completed within a period of twelve months from the date of passing of the
special resolution.
(f) if the allotment of securities is not completed within twelve months from the date of
passing of the special resolution, another special resolution shall be passed for the
company to complete such allotment thereafter.
(g) the price of the shares or other securities to be issued on a preferential basis, either for cash
or for consideration other than cash, shall be determined on the basis of valuation report of
a registered valuer;
(h) (as modified by notification dated 19.07.2016) Where convertible securities are offered
on a preferential basis with an option to apply for and get equity shares allotted, the price
of the resultant shares pursuant to conversion shall be determined:
(i) either upfront 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

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 (ii) at the time, which shall not be earlier than thirty days to the date when the holder of
convertible security becomes entitled to apply for shares, on the basis of valuation
report of the registered valuer given not earlier than sixty days of the date when the
holder of convertible security becomes entitled to apply for shares:

Provided that the company shall take a decision on sub-clauses (i) or (ii) at the time
of offer of convertible security itself and make such disclosure under sub-clause (v)
of clause (d) of sub-rule (2) of this rule.

(i) where shares or other securities are to be allotted for consideration other than cash, the
valuation of such consideration shall be done by a registered valuer who shall submit a
valuation report to the company giving justification for the valuation;
(j) where the preferential offer of shares is made for a non-cash consideration, such non-cash
consideration shall be treated in the following manner in the books of account of the
company-
(i) where the non-cash consideration takes the form of a depreciable or amortizable
asset, it shall be carried to the balance sheet of the company in accordance with the
accounting standards; or
(ii) where clause (i) is not applicable, it shall be expensed as provided in the accounting
standards.

Explanation:-
1. For the purposes of these rules, it is hereby clarified that, till a registered valuer is appointed
in accordance with the provisions of the Act, the valuation report shall be made by an
independent merchant banker who is registered with the Securities and Exchange Board of
India or an independent Chartered Accountant in practice having a minimum experience of
ten years”.;
2. The price of shares or other securities to be issued on preferential basis shall not be less than
the price determined on the basis of valuation report of a registered valuer.”.

Non-applicability of Section 62:

The restrictions contained in Section 62 of the Act regarding issue of further shares do not
apply to:-
(a) increase of the subscribed capital of a company caused by the exercise of an option as a term
attached to the debentures issued or loans raised by the company to convert such debentures or
loans into shares in the company [Section 62(3)].
Provided that the terms of issue of such debentures or loan containing such an option have
been approved before the issue of such debentures or the raising of loans by a special
resolution passed by the company in the general meeting.

(b) Conversion of part or 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 public interest on such terms and conditions as appear to be fair and reasonable to the
Government even if the terms of issue of such debentures or loans do not contain a term
providing for an option for such conversion.[Section 62(4)].

Provided that where the terms and conditions of such conversion are not acceptable to the
company, it may, within sixty days from the date of communication of such order, appeal to the

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Tribunal which shall after hearing the company and the Government pass such order as it deems
fit.

In determining the terms and conditions of conversion under section 62(4), the Government shall
have due regard to the financial position of the company, the terms of issue of debentures or loans,
as the case may be, the rate of interest payable on such debentures or loans and such other matters
as it may consider necessary. [Section 62(5)]

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. [Section 62(6)]

**********

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 EMPLOYEE STOCK OPTION SCHEME – intention to launch ESOP is to retain the
employees.

As per section 2 (37) of the Act Employees Stock Option (ESOP) means an option given to
whole time director, officers or employees of a company or of holding company or subsidiary
company or companies, if any, which give such directors, officers or employees the benefit or
right to purchase or subscribe at a future date, the shares offered by the company at a pre-
determined price.

Section 62(1)(b) provides that a company may issue further shares to its employees under a
scheme of employees’ stock option, subject to special resolution (Note: for Private Companies
Ordinary Resolution is required. Vide notification dated 05.06.2015) passed by company and
subject to such conditions as may be prescribed. Rule 12 of Companies (Share Capital and
Debentures) Rules, 2014 with regard to issue of Employee stock options covers issue of ESOPs.

As per Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 for the purpose of
issue of shares under ESOP:

 Approval of shareholders required by special resolution.

 Disclosures in explanatory statement: Rule 12 (2) states that the company shall make the
following disclosures in the explanatory statement annexed to the notice for passing of the
resolution:
o total number of stock options to be granted;
o identification of classes of employees entitled to participate in the Employees Stock Option
Scheme;
o the appraisal process for determining the eligibility of employees to the Employees Stock
Option Scheme;
o the requirements of vesting and period of vesting;
o the maximum period within which the options shall be vested;
o the exercise price or the formula for arriving at the same;
o the exercise period and process of exercise;
o the Lock-in period, if any ;
o the maximum number of options to be granted per employee and in aggregate;
o the method which the company shall use to value its options;
o the conditions under which option vested in employees may lapse e.g. in case of
termination of employment for misconduct;
o the specified time period within which the employee shall exercise the vested options in
the event of a proposed termination of employment or resignation of employee; and
o a statement to the effect that the company shall comply with the applicable accounting
standards.
 In case of employee being offered 1% or more of issued share capital, specific disclosure and
separate resolution would be necessary as per Rule 12(4).
 Minimum period of one year should be there between grant of options and its vesting as per
Rule 12(6)(a). After one year the company would determine the period during which the
option can be exercised.
 Rule 12(3) states that the companies granting option to its employees pursuant to Employees
Stock Option Scheme will have the freedom to determine the exercise price in conformity with
the applicable accounting policies, if any.

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 ESOP would be under the superintendence and direction of Compensation Committee of the
Board of Directors.
 With the specific approval of shareholders the scheme would be allowed to cover employee of
a subsidiary or a holding company as per Rule 12(4).
 ESOP would be open to:
o a permanent employee of the company who has been working in India or outside India; or
o a director of the company, whether a whole time director or not but excluding an
independent director; or
o an employee as above of a subsidiary, in India or outside India, or of a holding company of
the company. (or of an associate company – Omitted by notification dated 18.03.2015)

 **The ESOP is not for an employee who is promoter or belongs to promoter group.
 **Also, a director who either himself or through his relative or through any body
corporate, directly or indirectly holds more than 10% of the outstanding equity shares
shall not be eligible to participate in ESOP.
**Provided that in case of a startup company, as defined in notification number G.S.R. 127(E),
dated 19th February, 2019 issued by the Department for Promotion of Industry and Internal
Trade (GSR 180(E) dated 17th February,2016 issued by the Department of Industrial
Policy and Promotion, - deleted by the Companies (Share Capital and Debentures)
Amendment Rules, 2019 dated 16.08.2019) Ministry of Commerce and Industry Government
of India, Government of India, the conditions mentioned above shall not apply upto Ten Years
(five years – deleted by the Companies (Share Capital and Debentures) Amendment
Rules, 2019 dated 16.08.2019) from the date of its incorporation or registration (inserted by
notification dated 19.07.2016).

 The company shall not vary the terms of ESOP in any manner, which may be detrimental to
the interest of the employees. A company may by SR vary the terms of the ESOP, which not
has been exercised yet by the employee provided such variation is not prejudicial to the
interest of the options holders Rule 12(5)(a).
 The company shall have the freedom to specify the lock-in period for the shares issued under
ESOP (Rule 12(6)(b).
 An employee shall not have the right to receive any dividend or to vote or in any manner enjoy
the benefits of a shareholder in respect of option granted to him, till the exercise of the option
(Rule 12(6)(c).
 Rule 12(7) states that, the amount, if any, payable by the employees, at the time of grant of
option:
o may be forfeited by the company if the option is not exercised by the employees
within the exercise period; or
o the amount may be refunded to the employees if the options are not vested due to
non-fulfillment of conditions relating to vesting of option as per the Employees
Stock Option Scheme.
 Option granted to an employee shall not be transferable to any person (Rule 12(8). In case of a
death of employee while in employment, all the options till such date shall vest in the legal
heirs or nominees of the deceased employee.
 The option granted to the employees shall not be pledged, hypothecated, mortgaged or
otherwise encumbered or alienated in any other manner (Rule 12(8).
 Director’s report shall contain the following disclosures as per Rule 12(9):
(i) The total number of shares covered by the ESOP as approved by the shareholders;
(ii) The pricing formula;

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 (iii)Options granted;
(iv) Option vested
(v) Options exercised,
(vi) Options forfeited,
(vii) Extinguishments or modification of options;
(viii) Money realised by exercise of options;
(ix) Total number of options enforced
(x) Employee-wise details of options granted to:
a. key managerial personnel;
b. any other employee who receives a grant of options in any one year of option
amounting to 5 % or more of options granted during that year.
c. identified employees who were granted option, during any one year, equal to or
exceeding 1 % of the issued capital (excluding outstanding warrants and
conversions) of the company at the time of grant;

Maintenance of Register
Rule 12(10) states that the company shall maintain a Register of Employee Stock Options in Form
No. SH.6 and shall forthwith enter therein the particulars of option granted under clause (b) of
sub-section (1) of section 62.

The Register of Employee Stock Options shall be maintained at the registered office of the
company or such other place as the Board may decide. The entries in the register shall be
authenticated by the company secretary of the company or by any other person authorized by the
Board for the purpose.

Listed companies has to comply with the SEBI guidelines

Where the equity shares of the company are listed on a recognized stock exchange, the Employees
Stock Option Scheme shall be issued, in accordance with the regulations made by the Securities
and Exchange Board of India in this behalf.

***********

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 ISSUE OF SWEAT EQUITY for consideration other than cash

According to Section 2 (88) ‘Sweat equity shares’ means equity shares issued by the company to
employees or directors at a discount or for consideration other than cash for providing know-how
or making available right in the nature of intellectual property rights or value additions, by
whatever name called.

According to Explanation to Rule 8(1) of Companies (Share Capital and Debentures) Rules, 2014:

(i) the expressions ‘‘Employee’’ means-

(a) a permanent employee of the company who has been working in India or outside India;
(for at least last one year deleted by the Companies (Share capital and Debentures)
Second Amendment Rules, 2018); or
(b) a director of the company, whether a whole time director or not; or
(c) an employee or a director as defined in sub-clauses (a) or (b) above of a subsidiary, in India
or outside India, or of a holding company of the company;

(ii) the expression ‘Value additions’ means actual or anticipated economic benefits derived or to
be derived by the company from an expert or a professional for providing know-how or
making available rights in the nature of intellectual property rights, by such person to whom
sweat equity is being issued for which the consideration is not paid or included in the normal
remuneration payable under the contract of employment, in the case of an employee

**********

A Company may issue sweat equity shares of class of shares already issued if the following
conditions are fulfilled – Section 54(1):
(a) authorized by a special resolution passed by the company in the general meeting;
(b) The resolution specifies -
- the number of shares,
- current market price,
- consideration, if any, and
- the class or classes of directors or employees to whom such equity shares are to be
issued;
(c) on the date of issue of such shares, at least one year has expired since the date on which the
company was entitled to commence business; (deleted vide the Companies (Amendment)
Act, 2017).
(d) issue of ‘sweat equity shares’, of a company whose equity shares listed, are in accordance
with the regulations made by the SEBI in this behalf,
(e) a company whose shares are not so listed should issue sweat equity shares in compliance
with the rules made in this behalf by the Central Government (i.e., Companies (Share
Capital and Debentures) Rules, 2014)

***********

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COMPANIES (SHARE CAPITAL AND DEBENTURES) RULES, 2014- ASPECTS RELATING TO
SWEAT EQUITY SHARES

Special resolution
For the purpose of passing a special resolution, an explanatory statement to be annexed to the
notice for the general meeting containing the following particulars:

(i) the date of the meeting at which the proposal for issue of sweat equity shares was
approved by the Board of Directors of the company;
(ii) the reasons / justification for the issue;
(iii) the number of shares, consideration for such shares and the class or classes of directors
/ employees to whom such equity shares are to be issued;
(iv) the value of the sweat equity shares along with valuation report / basis of valuation and
the price at the which the sweat equity shares will be issued;
(v) the names of the directors or employees to whom the sweat equity shares will be issued
and their relationship with the promoter or/and Key Managerial Personnel;
(vi) the time period of association of such person with the company;
(vii) ceiling on managerial remuneration, if any, which will be affected by issuance of such
equity;
(viii) a statement to the effect that the company shall conform to the accounting policies
specified by the Central Government; and
(ix) diluted earning per share pursuant to the issue of securities to be calculated in
accordance with the Accounting Standards

Approval of shareholders by way of separate resolution in the general meeting shall be obtained
by the company in case of grant of shares to identified employees and promoters, during any one
year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and
conversion) of the company at the time of grant of the sweat equity shares.

Validity of Special Resolution authorizing sweat equity shares

Rule 8(3) the special resolution authorizing the issue of sweat equity shares shall be valid for
making the allotment within a period of not more than twelve months from the date of passing of
the special resolution.

Restriction on issue of sweat equity shares - Rule 8 (4)

The company shall not issue sweat equity shares for more than 15% of the existing paid up equity
share capital in a year or shares of the value of Rs. 5 crores, whichever is higher. The issuance of
sweat equity shares in the Company shall not exceed twenty five percent, of the paid up equity
capital of the Company at any time.

Provided further that a start-up company, as defined in notification number GSR 180(E) dated
17th February, 2016 issued by the Department of Industrial Policy and Promotion, Ministry of
Commerce and Industry Government of India, may issue sweat equity shares not exceeding fifty
percent of its paid up capital upto five years from the date of its incorporation or registration
(inserted by notification dated 19.07.2016).

Sweat Equity Shares to be locked for three years

The sweat equity shares issued to directors or employees shall be locked in/non transferable for a
period of three years from the date of allotment.

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Valuation aspects
 Rule 8(6) states that the sweat equity shares to be issued shall be valued at a price determined
by a registered valuer as the fair price giving justification for such valuation.
 Rule 8(7) states that the valuation of intellectual property rights or of know how or value
additions for which sweat equity shares are to be issued, shall be carried out by a registered
valuer, who shall provide a proper report addressed to the Board of directors with justification
for such valuation.
 Rule 8(8) states that a copy of gist along with critical elements of the valuation report obtained
under Rule 8 (6) and Rule 8 (7) shall be sent to the shareholders with the notice of the general
meeting.

Sweat equity shares for non-cash consideration

Rule (9) states that when sweat equity shares are issued for a non-cash consideration on the basis
of a valuation report in respect thereof obtained from the registered valuer, such non-cash
consideration shall be treated in the following manner in the books of account of the company-
(a) where the non-cash consideration takes the form of a depreciable or amortizable asset, it shall
be carried to the balance sheet of the company in accordance with the accounting standards; or
(b) where clause (a) is not applicable, it shall be expensed as provided in the accounting standards.

Disclosure in the Directors' Report – Rule 8 (13)

The Board of Directors shall disclose either in the Directors' Report or in the annexure to the
Director's Report, the following details of issue of sweat equity shares:
a) the class of director or employee to whom sweat equity shares were issued;
b) the class of shares issued as Sweat Equity Shares
c) Number of shares to be issued to the directors, key managerial personnel or other
employees showing separately the number of such shares issued to them , if any, for
consideration other than cash and the individual names of allottees holding one percent or
more of the issued share capital;;
d) conditions for issue of sweat equity shares;
e) the pricing formula;
f) the total number of shares arising as a result of issue of sweat equity shares;
g) money realised or benefit accrued to the company from the issue of sweat equity shares;
h) diluted Earnings Per Share (EPS) pursuant to issuance of sweat equity shares.

Maintenance of Register
Rule 8(14)(a) The company shall maintain a Register of Sweat Equity Shares in Form No. SH.3
and shall forthwith enter therein the particulars of Sweat Equity Shares issued under section 54.

The Register of Sweat Equity Shares shall be maintained at the registered office of the company or
such other place as the Board may decide. The entries in the register shall be authenticated by the
Company Secretary of the company or by any other person authorized by the Board for the
purpose.

Sweat equity shares forming part of managerial remuneration

Rule 8(10) states that the amount of sweat equity shares issued shall be treated as part of
managerial remuneration for the purposes of sections 197 and 198 of the Act, if the following
conditions are fulfilled:

a. namely.-the Sweat Equity shares are issued to any director or manager; and,

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b. they are issued for non-cash consideration, which does not take the form of an asset which
can be carried to the balance sheet of the company in accordance with the relevant accounting
standards.

Certificate from auditors.-

In the case of every company that has allotted shares under these Rules, the Board of Directors
shall at each annual general meeting place before the shareholders a certificate from the auditors
of the company/ practicing company secretary that sweat equity shares have been allotted in
accordance with the resolution of the company in the general meeting and these Rules.

************

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 ISSUE OF BONUS SHARES - issued out of reserves can be issued even out of capital
reserves

A Company may, if AOA provides, capitalize its profits by issuing fully paid up shares to the
members of the company thereby transferring the sums capitalized from the profit and loss
account or reserve account to share capital. Such shares are known as Bonus Shares and issued to
exiting shareholders of the company free of charge.

The bonus shares allotted to the members do not represent taxable income in their hands.

Advantages of Issuing Bonus Shares

1. Fund flow is not affected adversely.
2. Market value of the Company’s shares comes down to their nominal value by issue of bonus
shares.
3. Market value of the members’ shareholdings increases with the increase in number of shares
in the company.
4. Bonus shares is not an income. Hence it is not a taxable income.
5. Paid-up share capital increases with the issue of bonus shares.

Sources for issue of Bonus shares

According to section 63(1), a company may issue fully paid-up bonus shares to its members, in
any manner whatsoever, out of—
(a) its free reserves;
(b) the securities premium account; or
(c) the capital redemption reserve account.

The following conditions must be satisfied for issuing bonus shares – Section 63 (2):
1. Bonus issue must be authorised by AOA of the company.
2. Bonus issue must be sanctioned by the shareholders in their general meeting
3. it has not defaulted in payment of interest or principal in respect of fixed deposits or debt
securities issued by it;
4. it has not defaulted in respect of the payment of statutory dues of the employees, such as,
contribution to provident fund, gratuity and bonus;
5. the partly paid-up shares, if any outstanding on the date of allotment, are made fully paid-up;
6. In case of listed company, SEBI guidelines must have to be complied with.
7. Authorised capital must be increased, if necessary.

Note: Rule 14 states that the company which has once announced the decision of its Board recommending
a bonus issue, shall not subsequently withdraw the same.

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 RESTRICTIONS ON PURCHASE BY COMPANY, OF ITS OWN SHARES
[SECTION 67]

Section 67(1) provides that no company limited by shares or by guarantee and having share
capital can buy its own shares, except on the consequent reduction of share capital. However, a
company can redeem its preference shares issued.

Section 67(2) No public Company shall give to any person, (directly or indirectly), any financial
assistance (whether by means of a loan, guarantee, the provision of security or otherwise), for
purchase / subscribe of any shares in the company or in its holding company:

However, the above provision shall not apply in the following cases: (Exceptions) –
(a) The lending of money by a banking company in the ordinary course of its business; or
(b) Providing money by a company, under any scheme approved by company through special
resolution, for the purchase or subscription of fully paid-up shares in the company or its
holding company, by trustees of the employee for the benefit of employees of the company or
shares held by the employees of the company; or
(c) Providing loan by the company to the bona fide employee of the Company, (other than
directors or key managerial personnel) for purchase fully paid-up shares in the company or its
holding company provided such loan should not exceed six months salary / wages of that
employee
(d) Redemption of preference shares by the company
(e) Purchase by a Company of its own shares under an order of court under section 402 of the Act.

Penalty – Section 67(5) - in the default of above provisions, the company and every officer in
default shall be punishable with fine of not less than Rs. 1 Lac which may extend to Rs. 25 Lacs
and also every officer in default shall be punishable with imprisonment for a term which may
extend to 3 years

***********

Non- applicability of Section 67 on Private Companies – vide notification dared 05.06.2015

In terms of amended provision, the provisions of section 67 shall not apply to the private
companies fulfilling following criteria:
 in whose share capital no other body corporate has invested any money;
 if the borrowings of such a company from banks or financial institutions or any body-
corporate is less than twice its paid up share capital or fifty crore rupees, whichever is
lower; and
 such a company is not in default in repayment of such borrowings subsisting at the time of
making transactions under this section.

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 BUY-BACK OF SHARE [SECTION 68]

To buy back its shares by the co from its shareholders

Buy back enables the Company to give offer to purchase shares from the holder of shares /
specified securities.

Purpose of Buy Back:

1. To increase the EPS in the hands of the shareholders
2. Safeguard against the hostile take-over by increasing promoters’ shareholding.
3. To return the surplus money to the shareholders
4. To provide an exit opportunity to the shareholders in case if the shares are undervalued or
non-traded.

Source of fund for buy-back [Section 68(1)]

The company can buy back the shares / securities out of-
(i) Its free reserve; or
(ii) The securities premium account; or
(iii) The proceeds of any shares or other specified securities (except proceeds of an earlier issue
of the same kind of shares / securities).

Thus, the company must have at the time of buy-back, sufficient balance in any one or more of
these accounts to accommodate the total value of the buy-back.

Conditions for the buy-back: [Sub-section (2)]

(a) Authorized by AOA of the Company;

(b) Special Resolution (SR) to be passed in general meeting to authorize the buy-back;

As per section 68 (3) the notice of the meeting / Special resolution shall be accompanied by
an explanatory statement stating:
a) A full and complete disclosure of the all material facts;
b) The necessity for the buy-back;
c) The class of security intended to be purchased under the buy-back;
d) The amount to be invested under the buy-back; and
e) The time limit for completion of buy-back.

Rule 17(1) Companies (Share Capital and Debentures) Rules, 2014 states that explanatory
statement to contain certain disclosures

Explanatory statement to the special resolution authorizing buy-back, to be annexed to the notice
of the general meeting pursuant to section 102 shall contain the following disclosures:

(a) the date of the board meeting at which the proposal for buy-back was approved by the board
of directors of the company;
(b) the objective of the buy-back;
(c) the class of shares or other securities intended to be purchased under the buy-back;
(d) the number of securities that the company proposes to buy-back;
(e) the method to be adopted for the buy-back;

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(f) the price at which the buy-back of shares or other securities shall be made;
(g) the basis of arriving at the buy-back price;
(h) the maximum amount to be paid for the buy-back and the sources of funds from which the
buy-back would be financed
(i) the time-limit for the completion of buy-back;
(j) (i) the aggregate shareholding of the promoters and of the directors of the promoter, where
the promoter is a company and of the directors and key managerial personnel as on the
date of the notice convening the general meeting;

(ii) the aggregate number of equity shares purchased or sold by persons mentioned in (i)
above during a period of twelve months preceding the date of the board meeting at
which the buy-back was approved and from that date till the date of notice convening
the general meeting;

(iii) the maximum and minimum price at which purchases and sales referred to in (ii)
above were made along with the relevant date;

(k) if the persons mentioned in sub-clause (i) of clause (j) intend to tender their shares for buy-
back –
(i) the quantum of shares proposed to be tendered;
(ii) the details of their transactions and their holdings for the last twelve months
prior to the date of the board meeting at which the buy-back was approved
including information of number of shares acquired, the price and the date of
acquisition

(l) a confirmation that there are no defaults subsisting in repayment of deposits, interest payment
thereon, redemption of debentures or payment of interest thereon or redemption of preference
shares or payment of dividend due to any shareholder, or repayment of any term loans or
interest payable thereon to any financial institution or banking company;

(m) a confirmation that the Board of directors have made a full enquiry into the affairs and
prospects of the company and that they have formed the opinion-

(i) that immediately following the date on which the general meeting is convened there will be
no grounds on which the company could be found unable to pay its debts;
(ii) as regards its prospects for the year immediately following that date, that, having regard to
their intentions with respect to the management of the company’s business during that year
and to the amount and character of the financial resources which will in their view be
available to the company during that year, the company will be able to meet its liabilities
as and when they fall due and will not be rendered insolvent within a period of one year
from that date; and
(iii) in forming their opinion for the above purposes, the directors have taken into account the
liabilities(including prospective and contingent liabilities); as if the company were being
wound up under the provisions of the Companies Act, 2013.

(n) a report addressed to the Board of directors by the company’s auditors stating that:
(i) they have inquired into the company’s state of affairs;
(ii) the amount of the permissible capital payment for the securities in question is in their view
properly determined;

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 (iii) that the audited accounts on the basis of which calculation with reference to buy back is
done is not more than six months old from the date of offer document,

Provided that where the audited accounts are more than 6 months old, the calculations with
reference to buy back shall be in the basis of unaudited account not older than 6 months from
the date of offer document which are subjected to limited review by the auditors of the
Company (inserted by notification dated 29.06.2016).

(iv) the Board of directors have formed the opinion as specified in clause (m) on reasonable
grounds and that the company, having regard to its state of affairs, will not be rendered
insolvent within a period of one year from that date;

No need of shareholder approval for buy-back - As per section 68(2) of the Act, the company
can buy back the shares without the approval of the shareholders provided the buy back is not
more than 10% of the total paid up equity capital and free reserves of the company, however it
must be approved by the Board of Directors in its meeting.

(c) Quantum of Buy Back – Section 68 (2): The buy-back is not more than 25% of the total
paid-up capital and fee reserves. Provided that the buy-back of equity shares in any financial Comment [w1]: Here it means total
amount can be given
year shall not exceed 25% of its total paid-up equity capital in that financial year.
Comment [w2]: Here max number of
shares that can be BB

Ques:

Share capital:
Eq share capital 100000 shares @ 10//- Rs. 10,00,000/-
Pref share capital 20000 shares @ 100/- Rs. 20,00,000/-
Reserves: Rs. 50,00,000/-

Co wants to go for BB. Pls advise the max no. of share that can be bought back and total
max amount of BB.
Ans:
Max payout would be 25% of PUC and FR: 1000000+2000000+5000000=8000000/-

25% is : 2000000/-
Max number of shares that can be BB: 25 % of Eq shares: 25% of 100000 i.e.

25000 shares
25000 shares can be BB and total amount that can be given to SHs is 20 Lacs.

BB Price= Rs. 2000000/25000 shares = 80 per share

BB is done at a premium of Rs. 70/- per share. Face value of Eq share is 10/-

NEXT YEAR BS:

Share capital:
Eq share capital 75000 shares @ 10//- Rs. 7,50,000/-
Pref share capital 20000 shares @ 100/- Rs. 20,00,000/-

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 Reserves: Rs. 32,50,000/- (Premium on BB shall be paid out of reserves)

(d) After such buy-back, debt equity ratio (debt to the capital and free reserves) is not more than
2:1. However, the Central Government may prescribe a higher ratio for a class or classes of
companies – Section 68(2)(d).

Note: vide order issued by CG dated 10.03.2016: CG has notified that the debt to capital
and free reserves ratio shall be 6:1 for Government Companies within the meaning of section
2 (45) of the Act which carry on Non-Banking Financial institution activities and Housing
Finance Activities.

(e) All the shares / securities for buy-back are fully paid-up – Section 68 (2);

Letter of Offer to be Filed with Registrar of Companies before Buy-Back (Rule 17(2))
The company which has been authorized by a special resolution shall, before the buy-back of
shares, file with the Registrar of Companies a letter of offer in Form No SH 8, along with the fee
as prescribed. Such letter of offer shall be dated and signed on behalf of the Board of directors of
the company by not less than two directors of the company, one of whom shall be the managing
director, where there is one.

Dispatch of letter of offer to shareholders (Rule 17(4)

The letter of offer shall be dispatched to the shareholders or security holders immediately after
filing the same with the Registrar of Companies but not later than 21 days from its filing with the
Registrar of Companies.

Offer for buy back open for (Rule 17(5)

The offer for buy-back shall remain open for a period of not less than 15 days and not exceeding
30 days from the date of dispatch of the letter of offer.

Provided that where all members of a company agree, the offer for buy-back may remain open for
a period less than fifteen days (inserted by notification dated 29.06.2016).

Time gap between two buybacks (proviso to Section 68(2)

No offer of buy-back under Section 68(2) shall be made within a period of one year reckoned from
the date of the closure of the preceding offer of buy-back, if any.

Time limit for completion of buy-back: [Section 68 (4)]

Every buy-back shall be completed within 1 year from the date of passing the special resolution or
Board Resolution.

Manner of Buy-back [Sub-section (5)]:

(a) From the existing security holders on a proportionate basis; or
(b) From the open market (through stock exchanges); or
(c) By purchasing the securities issued to employees of the company under a scheme of stock
option or sweat equity.

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Declaration of solvency [Sub-section (6)]
After a company has passed a special resolution but, before making such buy-back, file with the
Registrar and if the shares are listed to both, Registrar and the SEBI, a declaration of solvency in
the prescribed ‘Form No. SH 9 and verified by an affidavit.
 The solvency declaration should be that company is capable of meeting its liability and will
not be rendered insolvent within a period of 1 year of the date of declaration adopted by the
Board.
 It should be signed by at least two directors of the company, one whom shall be the managing
director, if any.

Physical Destroy of securities [Sub-section (7)]

When a company buys-back its own securities, it shall extinguish and physically destroy the
securities within 7 days of the last date of completion of buy-back.

No further issue of Shares/securities (i.e. Cooling period) [Sub-section (8)]

After the complication of buy-back, the company shall not issue of same kind of shares/ securities
(including right issue of same kind) within period of 6 months.
 However, the company may issue - bonus shares or in the discharge of subsisting obligations
such as conversion of warrants, stock option schemes, sweats equity or conversion of
preference shares or debentures into equity shares.

Register of Buy-back [Sub-section (9)]

The company shall maintain a register of the securities buy-back in the Form No. SH 10. It
contain the following details namely-
- the consideration paid for the securities bought-back;
- the date of cancellation of securities;
- the date of extinguishing and physically destroying of securities;
- and such other particulars as may be prescribed.

Return of Buy-back [Sub-section (10)]

Within 30 days after the completion of the buy-back, the company shall file with the Registrar
and, if the shares are listed, the both Registrar and SEBI, a return in Form No. SH.11 containing
prescribed particular.

Rule 17(14) of Companies (Share Capital and Debentures) Rules 2014 states that there shall be
annexed to the return filed with the Registrar in Form No. SH.11, a certificate in Form No.
SH.15 signed by two directors of the company including the managing director, if any, certifying
that the buy-back of securities has been made in compliance with the provisions of the Act and the
rules made thereunder.

Penalty [Sub-section (11)] –

If a company makes any default in complying with the provisions of this section or any regulation
made by the Securities and Exchange Board, in case of listed companies, the company shall be
punishable with fine which shall not be less than one lakh rupees but which may extend to three
lakh rupees and every officer of the company who is in default shall be punishable with
imprisonment for a term which may extend to three years or with fine which shall not be less than
one lakh rupees but which may extend to three lakh rupees, or with both.

Transfer of certain sums to capital redemption reserve account [section 69]

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Where buy-back was out of free reserves or securities premium account, then a sum equal to the
nominal value of the shares so purchased shall be transferred to the capital redemption reserve
account. The details of such transfer shall be disclosed in the balance sheet.

Prohibition for buy-back [section 70]

Sub-section (1) - No company shall (directly or indirectly) purchase its own shares / securities –
a) Through any subsidiary company including its own subsidiary companies; or
b) Through any investments company or group of investment companies or
c) If a default is made by the Company:
 In repayment of deposit or interest thereon; or
 Redemption of debentures, or preference shares; or
 Payment of dividend to any shareholder; or
 Repayment of any term loan or interest thereon to any financial institution or bank.

However, the buy-back is not prohibited, if the default is remedied and a period of three years has
lapsed after such default ceased to subsist. (Proviso to Section 70(i))

No company shall, directly or indirectly, purchase its own shares or other specified securities in
case such company has not complied with the provisions of sections 92 (Annual Return), 123
(Declaration of Dividend), 127 (punishment for failure to distribute dividend) and section 129
(Financial Statement).

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