Applicability of Section 62(1) of the Companies Act, 2013

If the company needs additional capital and keeps the voting rights of existing shareholders proportionally balanced, the company will issue Rights shares. The issue is called as it gives the existing shareholders a preferential right to buy new shares at a price that is lower than the market price. A rights issue is an invitation to existing shareholders to buy new shares in proportion to their existing holding. In this article, let us have a look at the applicability of Section 62(1) of the Companies Act, 2013.

Issue of Rights under Section 62 Companies Act 2013

Issue of rights shares and issue of preference shares are subject to section 62 of the Companies Act 2013 and the Companies (Share Capital and Debentures) Rules 2014 and the Companies (Prospectus and Allotment of Securities) Rules 2014.

A right issue of shares is a formal invitation to existing shareholders of the Company to purchase additional new shares, such shares being issued in proportion to existing share ownership. While preferential allotment involves the mass allotment of new issues of shares of companies to any person such as individuals, venture capitalists, and others at a predetermined price. Usually, a company decides to give preferential allotment to people who want to acquire a strategic stake in the company. This includes existing shareholders such as promoters, venture capitalists, and financial institutions who want to increase their stake in the company. Therefore, preferential allotment allows the company to obtain equity participation from those it considers value-added shareholders.

“Preferential Offer” means the issue of shares or other securities by companies to any selected person or group of persons on a preferential basis and does not include shares or other securities offered by way of a public issue, share issue, employee share options, employee share purchase scheme, or share or bonus issue shares or certificates of deposit issued in a country outside India or foreign securities.

Applicability of Section 62(1) of Companies Act, 2013

The meaning of Section 62 of the Companies Act, 2013, which provides for the issuance of rights shares to existing equity shareholders, must be understood. It also allows for the issuance of shares to employees through the Employees Stock Option Scheme and the issuance of shares on a preferential basis. Subsections (4) to (6) deal with the conversion of loans granted/debentures subscribed for by the Central Government into company shares.

By virtue of the provisions of clause (a) of section 62(1) of the Companies Act, 2013, which speaks to offer to holders of equity shares, it may be inferred that issue of preference shares falls outside the ambit of this section. The opening part of section 62(1) of the Companies Act, 2013 generally refers to an increase in the subscribed capital of the company by allotment of further shares, without restricting the same to the equity shares.

Since capital includes both Equity Share Capital and Preference Share Capital, it would appear that Section 62(1) of the Companies Act, 2013 would apply in the event of the issuance of additional shares (i.e., Preference Shares).

Reason for Issuing Rights

As the company expands, it looks for avenues of capital expansion, so the company turns to issuing shares. Instead of issuing shares to the general public, which will cause an imbalance in the voting rights of existing shareholders, the company will resort to issuing additional shares to existing shareholders in proportion to its current holding. This solves the purpose of the additional capital and existing shareholders will retain their voting rights.

Benefits of Rights Issue

Making a rights issue, compared to raising capital through a preferential allotment or private placement, provides the company with two additional advantages. First, unlike a private placement or preferential allotment, a rights issue does not require shareholder approval by special resolution. Second, the board of directors has absolute discretion in determining the price of the securities, which need not be determined based on a valuation carried out by a registered valuer.

On the other hand, a preferential allotment of securities must comply with the pricing rules set out in the Companies (Prospectus and Allotment of Securities) Rules, 2014 (hereinafter referred to as the “PAS Rules”) and the Companies (Share Capital and Bonds) Rules. , 2014 (“Capital Rules”). In addition, listed companies seeking private placement/preferential allotment should comply with the pricing guidelines set out in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.

Legal framework of Section 62(1) of the Act

According to Section 62(1) of the Act, if the company proposes to increase its subscribed capital by issuing additional shares, then these shares will be offered to the company’s shareholders in proportion to the paid-up share capital by sending a letter of the offer under the following conditions:

• The offer should state the number of shares offered and the acceptance period should be 15 to 30 (fifteen to thirty) days. If the offer is not accepted within this period, it will be considered rejected.
• Unless otherwise provided by the company’s articles of association, the offer is deemed to include a right of withdrawal.
• After the expiration of the period specified in the notice or after receiving earlier notice from the person that he refuses to accept the shares offered, the board of directors may dispose of the shares in a manner that is not disadvantageous to the shareholders and the company.

The conditions specified are exhaustive and rights can be issued without the prior consent of the shareholders. However, it should be noted that following Section 179(3) (c) of the Act, rights can only be issued with the approval of the board of directors, namely by a resolution from a board meeting.

Procedure for issuing rights

According to Section 62(1) of the Companies Act of 2013, the procedure for issuing shares is as follows:

• Sending notices of Board Meetings: According to Section 173(3) of the Companies Act 2013, notices of board meetings must be sent at least 7 days before the board meeting and must contain an agenda.
• Convene the first meeting of the Board of Directors: The meeting of the board of directors is held and a resolution is passed to issue legal shares. The rights issue does not require the approval of the shareholders and therefore the board of directors can proceed with the issue.
• Issuance of Letter of Offer: After the resolution is passed, the letter of offer is issued to all shareholders and is sent by registered post or speed post. There are 15-30 days for the shareholders to accept the offer, which means that the maximum period that the shareholders can accept is 30 days and the minimum period is 15 days. An offer shall be deemed rejected if not accepted before the expiration date. The offer must be opened at least three days after the issue of the offer letter.
• File MGT – 14: After the adoption of the resolution of the board of directors, the company is required to file MGT -14 within 30 days of the adoption of the resolution of the board of directors. Form MGT 14 is mandatory for a joint-stock company. A true certified copy of the board resolution must be attached to MGT 14.
• Receive Request Money: Shareholders must send the received request along with the requested money.
• Convene the 2nd meeting of the Board of Directors: The Company is obliged to convene the 2nd meeting of the board of directors, the notice of which must be sent 7 days before the meeting of the board of directors. The requisite quorum must be present and a resolution for the allotment of shares must be passed. When passing a resolution on the allotment of shares, the allotment of shares must be done within 60 days of receiving the request for money.
• File the forms with ROC: The Company must file Form PAS -3 within 30 days of allotment of shares with the Registrar of Companies. A certified copy of the board resolution and a list of authorized persons must be attached to the form. In addition, MGT – 14 has to be filed for both allotment and issue of shares.
• Issue of Share Certificates: Share certificates must be issued; if the shares are in Demat form, the company must immediately inform the depository about the allotment of shares. When the shares are in physical form, the share certificates must be issued within 2 months from the date of allotment of shares. It must be signed by a minimum of 2 directors. Share certificates must be issued on form SH-1.

Final words

Issuance of rights shares benefits the existing shareholder and gives them the advantage of being able to apply for shares at a discounted price and retain voting rights. A company can raise a significant portion of its share capital by resorting to issuing shares. Section 62 of the Act does not impose any restrictions on the board of directors’ discretion in allocating unsubscribed rights to issue shares to a non-shareholder if it can demonstrate that such allocation is not disadvantageous for the company and its shareholders.
However, companies would have to comply with the NDI rules for any subscription by a non-resident shareholder beyond his rights. It is also necessary to ensure that the number of subscribers who are not shareholders in this category does not exceed 200. The discretion of the board of directors in this regards otherwise remains unlimited.

Connect to the Experts at Legal Window if you want to gain more explanation regarding the applicability of Section 62(1) of the Companies Act, 2013.