Consequences of grant of stock option by company without obtaining the approval of

members – a case study

Prof R Balakrishnan
FCS - FCWA

Employee stock option

1. The term employee stock option refers to a type of equity compensation granted by companies to their
employees and executives. Rather than granting shares of stock directly, the company gives derivative options
on the stock instead. These options come in the form of regular call options and give the employee the right to
buy the company's stock at a specified price for a finite period of time. Terms of employee stock options are by
and large fully spelt for an employee in an employee stock options agreement.

Framework of the Companies Act on employee stock option

2. As per the provisions of section 62(1)(b) of the Companies Act 2013, where 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 employees under a scheme of employees stock option, subject to a special resolution passed by the
company and subject to such condition as may be prescribed and in this regard the Rule 12 (4) (b) of the
Companies (Share Capital and Debentures) Rules 2014 spells out the details.

Provisions under the Companies Act 2013 relating to this case

3. Following are the relevant provision relating to this case law.

S. Act / Rules Provisions

No
1 Section 62(1) Whereas pursuant to section 62(1)(b) of the Companies Act 2013, where at any time, a
(b) of the company having a share capital proposes to increase its subscribed capital by the issue
Companies Act of further shares, such shares shall be offered to employees under a scheme of
2013 employees stock option, subject to a special resolution passed by the company and
subject to such condition as may be prescribed
2 Rule 12 (4) (b) Whereas, Rule 12(4)(b) of the Companies (Share Capital and Debentures) Rules 2014
of the specifies as follows:
companies
The approval of shareholders by way of a separate resolution shall be obtained by the
(Share Capital
company in case of-
and
Debentures) (a) Grant of option to employees of subsidiary or holding company; or
Rules 2014
 (b) Grant of option to identified employees, during any one year, equal to or exceeding
one per cent of the issued capital (excluding outstanding warrants and conversions) of
the company at the time of grant of an option.
Penal Provisions for default (if any) committed by the company

4. The relevant section for penal action is provided in section 450 of the Companies Act 2013 and as per this
section that whereas pursuant to section 450, if a company or any officer of a company or any other person
contravenes any of the provisions of this Act or the rules made thereunder, or any condition, limitation or
restriction subject to which any approval, sanction, consent, confirmation, recognition, directions or
exemption in relation to any matter has been accorded, given or granted, and for which no penalty or
punishment is provided elsewhere in this Act, the company and every officer of the company who is in default
or such other person shall liable to a penalty of ten thousand rupees, and in case of continuing contravention,
with a further penalty of one thousand rupees for each day after the first during which the contravention
continues, subject to a maximum of two lakh rupees in case of a company and fifty thousand rupees in case of
an officer who is default or any other person.

Consequences of any default

5. To understand the consequences of any default while complying with the provisions of section 62 (1) (b) of
the Companies Act 2013 relating to the procedural requirements in connection with the issue of stock options,
let us go through the decided case law by the Registrar of Companies, Chennai vide his order dated 9th
February 2023.

The relevant case law on this matter

6. We shall go through the adjudication order passed by the Registrar of Companies, Chennai bearing
adjudication order F.NO./CHN/Guvi/Greek//ADJ Order/S.62 (1) (b)/2023 dated 9th February 2023 - order of
adjudication of penalty under section 454 of Companies Act 2013 for violation of provisions of section 62(1)
(b) of the Companies Act, 2013 by M/s Guvi Geek Network Private Limited

Details of the company

7. M/ s. Guvi Geek Network Private Limited was incorporated on 10th January 2014 under the provisions of
the Companies Act 2013 and the company falls under the jurisdiction of Registrar of Companies, Chennai with
the registered office situated Module No 9, Third Floor, D Block, Phase 2, ITT Madras Research Park,
Kanagam Road, Taramani, Chennai, Tamil Nadu, in the state of Tamil Nadu. The company, as per the details
shown at the MCA portal is having five directors on its board and one of them is the Chief Executive officer
/KMP. The company provides Internet-based services and offers an online technical learning platform in the
native language for students, mentors, and recruiters.

Facts relating to this case

8. The following are the relevant facts of the case:-

(a) The company at its board meeting convened on 5th April 2021 unanimously accorded its approval for
grant of 327 options under the scheme to identified employees during the financial Year-2021-2022
which exceeds 1% of the issued capital of the company.
(b) In view of the above, the approval of shareholders by way of separate resolution was required to be
obtained by the company at the time of grant of 327 employee stock options as required under Rule
12(4)(b) of the companies (Share Capital and Debentures) Rules 2014.
(c) However, the company failed to convene a shareholders meeting for obtaining approval from its
shareholders for the grant of stock options to identified employees exceeding 1% of the issued
capital.
 (d) Having realized that the company defaulted in getting the consent of the shareholders for the issue
of the stock option to the employees, much later, the convened the extraordinary general meeting
convened on the 9th of September 2022.
(e) During this shareholders meeting held on 9th September 2022 the company obtained the approval of
the shareholders by way of a special resolution for ratification and approval for the grant of stock
options to identified employees already approved by the board of directors, in excess of 1% of the
Issued capital of the company during the financial year 2021-2022.
(f) After obtaining the consent of the shareholders for the employee stock option scheme at the
extraordinary general meeting, the company filed e-form MGT-14 with the Registrar of companies,
Chennai on 15th September 2022 for reporting the special resolution passed at the extraordinary
general meeting convened on 9th September 2022.
Action taken by the company upon the filing of e-form MGT-14

9. Upon realizing the default committed by the company and its directors i.e., not having obtained the consent
of the shareholders as required under the provisions of the Companies Act for the issue of the stock option to
the employees, filed an adjudication application for compounding on 17th October 2022 under section 441 of
the Companies Act 2013 for the violation of section 62(1) (b) of the Companies Act 2013 read with Rule 12 (4)
(b) of the Companies (Share Capital and Debentures) Rules 2014

Response from the regulator

10. Since the above matter pertains to the adjudication under section 454 of the Companies Act 2013, the
Registrar of Companies, upon receipt of the adjudication application from the company issued a personal
hearing notice to the company and its directors on 5th January 2023. The personal hearing was fixed for the
matter to be heard on 24th January 2023.

On the day of the personal hearing

1 1 . On 24th January 2023, at the time of the personal hearing, the duly authorized practising company
secretary appeared before the authorities and made representations on behalf of the company and its
directors.

The practising company secretary while admitting the violation of section 62(1) (b) of the Companies Act 2013,
submitted to the authorities that the failure for convening a meeting of shareholders as stipulated under Rule
12(4)(b) of the Companies (Share Capital and Debentures) Rules 2014 was only due to oversight and
inadvertence on the part of the company. The practicing company secretary further submitted that soon after
the company was made aware that a default has occurred by not obtaining approval of its shareholders for the
grant of options in excess of 1% of its issued capital, the company convened the extraordinary general meeting
and obtained the consent of the approval of the shareholders as required. Upon obtaining consent from the
shareholders the company also filed the required e-form MGT 14 along with a copy of the resolution. The
practising company secretary ended up his submissions with a request to the Registrar that a lenient view may
be taken on this matter.

The Conclusion reached by the Registrar of Companies / Adjudication Officer

12. Based on the documents available on this matter at the MCA portal, considering the compounding
application filed by the company for violation on this matter and having regard to the submissions made by
the company and its directors during the personal hearing, the Registrar had come to a conclusion that the
company and its directors committed the violence of section 62(1)(b) of the Companies Act, 2013 read with
Rule 12(4)(b) of the Companies (Share Capital and Debentures) Rules 2014 and therefore he decided to
proceed with passing the adjudication order for a penalty.

Adjudication order passed by the Registrar / Adjudication officer

13. In view of the violation of section 62(1)(b) of the Companies Act, 2013 committed by the company and its
directors, the Registrar of Companies / Adjudication Officer in the exercise of the powers vested to him under
section 454(1) & (3) of the Companies Act, 2013, imposed a penalty of Rs.2,10,000/- to the company and
Rs.60,000 /- each to two of the directors in default – amounting to a total penalty of Rs.3,30,000/- in all for
the year 2021-22 as per details shown below in the table.

S. Company & Amount of Additional penalty for a Max. Total amount of

No Directors penalty continuing offence Penalty penalty Imposed
Delay of 522 days
Rupees Rupees Rupees Rupees
1 Company 10,000 @1000/- day= 5,22,000/- 2,00,000 2,10,000
2 Director 1 10,000 @1000/- day= 5,22,000/- 50,000 60,000
3 Director 2 10,000 @1000/- day= 5,22,000/- 50,000 60,000
Total Penalty 3,30,000

Delay period calculated from 5th April 2021 (the first day of contravention to 9th September 2022 ( the EGM
date at which the resolution was passed) resulting in a total delayed period of 522 days)

a. The order spelt out that the sub-section (5) of section 454 of the Companies Act,2013 provides that
any person aggrieved by an order made by the adjudicating officer under sub-section(3) may prefer
an appeal to the Regional Director having jurisdiction in the matter and further sub-section(6)
provides that every appeal under sub-section(5) shall be filed within sixty days from the date on
which the copy of the order made by the adjudicating officer is received by the aggrieved person and
shall be in such form, manner and be accompanied by such fees as may be prescribed.
b. The order drew the attention of section 454(8) (i) of the Companies Act 2013, where the Company
does not pay the penalty imposed by the adjudicating officer or the Regional Director within a period
of ninety days from the date of the receipt of the copy of the order, the company shall be punishable
with fine which shall not be less than Twenty-five thousand Rupees but which may extend to five
lakh rupees.
(ii) Where an officer of a company who is in default does not pay the penalty within a period of
ninety days from the date of the receipt of the copy of the order, such officer shall be punishable with
imprisonment which may extend to six months or with fine which shall not be less than twenty-five
thousand rupees but which may extend to one lakh rupees, or with both.
c. The order concluded by stating that in case of default in payment of a penalty, the prosecution would
be filed under section 454(8) (i) and (ii) of the Companies Act, 2013 at the cost of the company
without any further notice. Along with the penalty to be imposed and the same should be submitted
Despatch of the order

14. The order was sent by the Registrar of Companies in terms of the provisions of sub-rule (9) of Rule 3 of
Companies (Adjudication of Penalties) Rules 2014 as amended by Companies (Adjudication of Penalties)
Amendments Rules 2019 to the company and its defaulting directors and also to the Regional Director,
Southern Region, Ministry of Corporate Affairs at 5th Floor, Shastri Bhavan, 26 Haddows Road, and Chennai.

The complete order for reading

1 5 . The readers may like to read thecomplete adjudication order passed by the Registrar of Companies,
Chennai bearing adjudication order no F.NO. /CHN/ Guvi/ Greek//ADJ Order/S.62 (1) (b)/2023 dated 9th
February 2023 - order of adjudication of penalty under section 454 of Companies Act 2013 for violation of
provisions of section 62(1) (b) of the Companies Act, 2013 by M/s Guvi Geek Network Private Limited and the
relevant website is https:// www.mca.gov.in/ content/ mca/ global/en/data-and-reports/ rd-roc-info /roc-
adjudication-orders.html
Conclusion

1 6 . The companies when incorporated and registered under the provisions of the Companies Act, the
companies are governed by the provisions of the framework of the Act, under which the companies are
incorporated and registered. For carrying out the various activities of the company, the law provides the set
rules and procedures which are meticulous to be followed. By not following / adhering to the laid down
procedures as per the law, amounts to default / non-compliance / violation – whatever name one could call it.
For such defaults, the law also provides fines, penalties, and prosecution depending upon the nature of default
/ non-compliance. For a violation committed by the company without any ulterior motive or guilty mind
(mens-rea) the law provides for penalties and in cases where the ulterior motive / intention of committing the
violation is deliberately established, imprisonment is provided.

Therefore it is important for the companies to ensure, stricter adherence to the laid down rules / provisions /
procedures are met in absolute terms failing which the company has to face the penal actions as has been in
this case, the company was to pay a heavy penalty amounting to rupees three lakhs and thirty thousand rupees
for not obtaining the shareholders' approval before allotting the employee stock option to its employees. It is
essential for any company, before undertaking any activity, to have a thorough checklist prepared and ensure
that absolute compliance is met in order to avoid penal actions from the regulators. In cases of non-
compliance, the company has to spend its valuable time sorting out the matter and also ends up paying heavy
penalties.

Reference:-

1. Companies Act 2013

2. Companies (Share Capital and Debentures) Rules 2014
3. Companies (Adjudication of Penalties) Rules 2014
4. Companies (Adjudication of Penalties) Amendment Rules 2019
5. Adjudication order passed by the Registrar of Companies, Chennai bearing adjudication order no
F.NO. /CHN/Guvi/Greek//ADJ Order/S.62(1)(b)/2023 dated 9th February 2023 - order of
adjudication of penalty under section 454 of Companies Act 2013 for violation of provisions of
section 62(1)(b) of the Companies Act, 2013 by M/s Guvi Geek Network Private Limited
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