The Ministry of Corporate Affairs (‘the MCA’) vide its notification dated October 27, 2023, amended the Companies (Prospectus and Allotment of Securities) Rules, 2014 (‘PAS Rules’). This move has heightened compliance requirements for large private companies. For the purpose of this article, private companies imply all private companies which are not small companies as per Section 2(85) of the Companies Act, 2013 (‘the Act’).
Given the government’s notification regarding the payment of stamp duty for the issuance and transfer of dematerialised securities in 2020, it has been a question of “when” and not “if” to determine when private companies would be mandated to dematerialise their securities. For the purpose of the article, the definition of ‘Securities’ is borrowed from Section 2(h) of Securities Contracts (Regulation) Act, 1956. The MCA has introduced Rule 9B in the PAS Rules. The purpose of this article is not to go through each provision in-depth, but to look at few practical issues and the interpretation. This Rule now requires private companies not being small companies, as of the last day of the financial year ending on or after March 31, 2023, to dematerialise their securities within 18 months following the conclusion of that particular financial year. Upon the successful completion of the dematerialisation process, or, after the completion of 18 months from the last date of the financial year whichever is earlier, all issues and transfers of securities shall be done exclusively in dematerialised mode. Additionally, the company is obligated to support the dematerialisation of all its securities in compliance with the regulations outlined in the Depositories Act, 1996.
On a bare reading of these provisions, it is worth nothing that issue of securities is covered but not allotment. It implies – even if the allotment is due after September 30, 2024, it can still be in physical mode provided the issue was made on or before September 30, 2024. Further, Rule 9B(6) of PAS Rules enables the provisions of Rule 9A(4) to Rule 9A(10) of PAS Rules for such private companies. In effect, the requirements to file Form PAS-6 for such companies under Rule 9A(8) of PAS Rules will apply for the first period of October 2023 to March 2024 (or January 2024 to June 2024 for those companies where the financial year ends on December 31, 2023).
In the author’s perspective, there might have been an alternative approach to drafting Rule 9B of the PAS Rules. Specifically, all the responsibilities outlined within the Rules have been extended to private companies, as indicated in Rule 9B(2), which is as follows:
“9B(2) A private company, which as on last day of a financial year, ending on or after 31st March, 2023, is not a small company as per audited financial statements for such financial year, shall, within eighteen months of closure of such financial year, comply with the provisions of this rule.”
It is a reasonable assertion to suggest that the Rules may not be applicable to a private company incorporated after March 31, 2023, as such newly established entities would not meet the criteria outlined above. Furthermore, Rule 9B(1) delineates specific compliance requirements that are applicable to all private companies, except small companies, and, therefore, the legislative intent can be inferred from this provision. An issue with this perspective is that it necessitates compliance to be completed by September 30, 2024, indicating that the law is likely not applicable to private companies incorporated after that specific date.
The drafting approach adopted in Rule 9A, which extends the Rule’s applicability to all unlisted public companies with compliance requirements triggered by specific transactions occurring beyond a specified period, could have been employed here as well. In this case, the Rules could have been made applicable to all private companies while expressly excluding Small Companies. Furthermore, the Rules could have referred to distinct compliance timelines for entities in existence as of the date of rule publication and those incorporated after the publication date. However, that does not seem the intention of the amendment.
Let’s also examine the provision outlined in Rule 9B(4)(b), which are shared below:
“9B(4)(b) who subscribes to any securities of the concerned private company [….] on or after the date when the company is required to comply with this rule shall ensure that all his securities are held in dematerialised form before such subscription.”
The literal interpretation of the Rules implies that, before subscribing to securities of a private company, an individual would have to ensure that all of their securities, regardless of the nature of the entity in which such securities are held, are dematerialised. However, this interpretation might not align with the intended purpose of the Rules. The aforesaid confusion could have been avoided, by substituting the word ‘such’ in place of ‘his’ using the following alternate language:
“9B(4)(b) who subscribes to any securities of the concerned private company [….] on or after the date when the company is required to comply with this rule shall ensure that all such securities are held in dematerialised form before such subscription.”
Under Rule 9A(11)(c) of PAS Rules, unlisted public companies that function as wholly owned subsidiary companies benefit from an exemption from compliance of dematerialisation and filing of reconciliation statement in Form PAS-6. However, private companies operating as wholly owned subsidiary companies do not enjoy a similar exemption from these compliance requirements. In the author’s opinion, the government should consider extending such exemptions to this category of companies as well.
This amendment presents a couple of distinct aspects that warrant consideration. The need to have share certificates in Form SH-1 under Section 46 of the Act and the need to maintain the Register of Members in Form MGT-1 under Section 88 of the Act will diminish. Furthermore, the dematerialisation process is expected to curb benami transactions, yet it may introduce additional expenses associated with maintaining securities in a dematerialised format, especially for such private companies who are fully family-owned business with 2 or 3 shareholders.
Another point worth noting is – these amendments were notified on October 27, 2023 and the timeline starts from March 31, 2023. We all agree that most of the companies in India have their financial year closure as on March 31, instead of December 31, to align with the tax laws. In effect, the companies have less than 12 months to comply with these aforesaid requirements. It will be interesting to see how RTAs and Depositories enable their facilities to accommodate the compliance. We are eagerly awaiting clarity from the MCA to enable the stakeholders proceed with the compliance in a healthy manner.
Disclaimer: All the views in this article belong to the author, and all the interpretations are as on date of publishing of this article, which are subject to change based on clarifications provided by the MCA.
