Fallout of the Sahara case: Companies Bill, 2012 too strict on private placement provisions
The new Companies Act will ensure that innocent investors will not be cheated the way they were by. However, the provisions are severe and small companies will face unnecessary problems in raising funds through group companies or other family members and relatives
Companies raise funds for working capital, capital expenditure, and general corporate purposes by issuing securities. Securities do not necessarily mean shares—it may be bonds, debentures, preference shares, and convertibles. Companies raise such funds by issuing securities either by way of public offers or through private placements. Public offers are few and far between. This option is available only to listed companies, and given the level of preparation involved, companies cannot afford to go public every now and then. Hence, the most common way of raising capital by companies is through private placements, which is the issue of securities other than public or rights offers. All offers of securities by private companies are private placements.
The Sahara case highlighted abuse of this provision—some Rs20,000-plus crores were raised from a few million investors. But it was still termed private placement. In response, the Companies Bill, 2012, passed by the Lok Sabha on 18 December 2012 and Rajya Sabha on 20 December, has tightened the provisions pertaining to private placements. But the rules are now so stringent that it may choke companies’ attempts to flexibly raise capital.
What adds to the rigours of the section is that that section is applicable to all securities—debt and equity, and to all companies, public and private.
‘Private Placement’ under the Companies Act, 2012
Part II of Chapter III of the Companies Bill 2012 (on notification, Bill to be called Companies Act, 2012) deals exclusively with private placements. The process of private placements has greatly tightened under the Act. Every offer of securities other than public, rights or bonus offer amounts to a private placement and shall be governed by the Section 42. The Section also requires issue of private placement offer letters for every privately placed offer of securities.
Explanation II (ii) to sub section (2) of section 42 of the Act defines “private placement” as:
“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 this section.
In terms of Section 42(2) of the Act, a company can make allotment of securities to a maximum of 49 persons in a private placement offer during a financial year. Whiles counting the maximum limit of allottees, qualified institutional buyers (QIBs) and employees who have been issued securities under ESOP may be excluded.
Deemed public offers
Section 42(4) of the Act makes it very clear that all offers or invitations which do not comply with the provisions of the Section 42 shall be deemed public offers. The explanation to sub-section (2) of the said section also clarifies that any offer to more than 49 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, shall be deemed to be a public offer and shall be regulated by the provisions of the Act as prescribed for a public offer. In addition, compliance with applicable provisions SCRA and SEBI will also be required.
It is important to note here that no exception has been provided to any class of companies, including the NBFCs (non-banking finance companies). However, the limit of 50 subscribers can be extended as and when so deemed fit by the central government. Unless specified, NBFCs and other small private companies will be facing big time as the section covers all companies, whether small or big, private or public.
The provisions on the private placements are applicable to all companies, including small and private companies. This is evident from the language of Section 23 (2) which specifically burdens private companies with compliance of Section 42 in case of private placement offers.
It is important to note here that the Act has relaxed certain provisions for “small companies”; however, no such exemption has been provided to even small companies for making allotments through private placements.
Extremely stringent provisions—thanks to Sahara ruling
The effect of the Sahara ruling is apparent from the extremely stringent provisions of Section 42 of the Act prescribed for private placements by ALL companies. The compliances/procedure for a privately placed offer is explained below:
- Every private placement is to be made by way of an offer letter [Section 42 (1)]
- The company has to prove that the company had the names of the each of the recipients of the offer and the offer will be addressed by name of such subscribers [Section 42(7)]
- Offer can be made only to 49 persons in a financial year [Section 42(2)]
- Unlike the existing Companies Act, 1956, under which the private companies’ members are restricted to 50, private companies under the Act can have members up to 200 and under private placement, in a year, a company (including private company) can make allotment to a maximum of 49 people.
- No further offer or invitation of securities can be made by the company unless securities under previous offer have been fully allotted or offer has been withdrawn or abandoned by the company [Section 42[3)]
- This mean if there are unallotted applications out of the past issues, one cannot invite further applications from the subscribers unless the offer has been withdrawn or abandoned by the company.
- One of the rigorous conditions prescribed is that the application money cannot be received in cash. Cheque, demand draft or banking channels is the only way for issue of securities even under privately placed offers. [Section 42(5)]
- All securities under private placement are to be allotted within a period of 60 days from the receipt of application money. If the securities are not allotted within the specified period, the application money is to be refunded within a period of 15 days from completion of 60 days’ time. [Section 42(6)]
- Like public offers, interest penalty has been prescribed if the application money is not refunded within the said period of 15 days. The companies shall be liable to pay interest at 12% per annum from the 16th day along with the application money.
- The entire amount raised by the issue of offer or invitation will need to be parked in a separate bank account and cannot be used until allotted. [Proviso to section 42(6)]
- Additional compliances for every private placement offers is that:
- The particulars of every private offer shall be filed with the Registrar within 30 days of circulation of offer letter. [Section 42(7)]
- The companies offering or inviting subscriptions under private placement cannot advertise or utilise any marketing media. [Section 42(8)]
- Return of allotment is required to be filed with the Registrar. [Section 42(9)]
Important to note that the time for filing such return has not been prescribed. In the existing Companies Act, 1956, the time limit for filing return of allotment is 30 days from the date of allotment.
The authority to approve the private placements—whether is to be approved by board or the members—has not been specified in the Section. However, adding to other harsh and rigorous provisions on private placements, the Section has prescribed severe monetary penalties for promoters and directors of companies making default in compliance with the prescribed provisions. Section 42(10) lays down the penalty as amount involved in the offer or Rs2 crore—whichever is higher—and, in addition, the company shall also be liable to refund whole monies to the subscribers so raised under the relevant privately placed offer.
Last December, the finance ministry issued Unlisted Public Companies (Preferential Allotment) Amendment Rules, 2011 (the Rules) and made the preferential allotment rules as applicable to public companies more stringent. The private placement provisions as contained in the Act appear to have been prepared incorporating the provisions of the Rules. The difference between the two is that the Rules are applicable to public companies only and the provisions of the Act on private placement will apply to all companies. The other point of difference is that the Rules require consent of members by way of special resolution for making preferential allotments whereas the Act is silent on such authority approving the private offers. Once the Act comes into force, one will have to wait and watch that whether the Rules will be repealed or the public companies will be required to comply with both the Act as well as the Rules.
 Small companies has been defined in section 2(85) as companies other than public companies having:
- Paid up share capital of less than Rs50 lakh or such amount not exceeding Rs5 crore; or
- Turnover as per last profit and loss account does not exceed Rs2 crores or such higher amount not exceeding Rs20 crores
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