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Articles > Company law

2 yrs ago


Author: Advocate Ankit Juneja
Category : Company law

As per the provisions of the Companies Act, 2013 (the “Actâ€) and the Companies (Share Capital and Debentures) Rules, 2014 (the “2014 Rulesâ€), the Company can issue its shares to a person for non-cash consideration by the following means:

(i)                 Employee Stock Options. Employee stock options can be issued by a company to its (a) permanent employees; (b) directors (excluding independent director); and (c) such employees as under a subsidiary (in or outside India), holding company or associate company. A minimum period of one year is mandatory between the grant of options and the vesting of options, so the options can be exercised and thereupon be issued only after a minimum period of one year. Furthermore, in cases where the equity shares of a company are listed on a recognized stock exchange, the Employees Stock Option Scheme shall be issued in accordance with the SEBI (Share Based Employee Benefits) Regulations, 2014.


(ii)               Issue of Sweat Equity. A company may issue sweat equity shares at a discount or for consideration other than cash, for their providing know how and making available rights in the nature of intellectual property rights or value additions, only to its (a) a permanent employee working for at least last one year; (b) a director; (c) such employees as under a subsidiary or a holding company. However, such sweat equity shall not be issued for more than 15% or the existing paid up equity share capital in a year or shares of the issue value of more than five crores, whichever is higher. Also, a company cannot issue sweat equity shares for more than 25% of its paid up share capital at any time.


(iii)             Preferential Allotment. A company can issue its shares or other securities on a preferential basis to any person irrespective of whether such person is an existing equity shareholder, an employee of the Company or otherwise, if such issue is authorized by a special resolution passed in a general meeting. Such issue on preferential basis can be made either for cash or for consideration other than cash.


Based on the above, it can be stated that issue of shares by way of preferential allotment is not as restrictive and regulated as opposed to stock options and sweat equity shares. More importantly, as explained above issue of shares can be made by the Company to its Advisors, who are not employees or directors of the Company, whether resident in or outside India, only by way of preferential allotment of shares since stock options and sweat equity shares cannot be issued to persons other than employees and directions. As stated above, Section 62 (1)(c) of the Act and Rule 13 of the corresponding 2014 Rules form the legal framework for issue of shares to any person on a preferential basis under the Companies Act. However, in case any such person is a resident outside India, then applicable guidelines issued by the Reserve Bank of India under the Foreign Exchange Management Act, 1999 will also be applicable and have to be complied with. For purposes of explanation and clarity, this Note has hereafter been divided into two parts: (A) Preferential Allotment under Companies Act, 2013; and (B) Issue of shares in lieu of services as per the extant foreign investment guidelines.


(A) Preferential Allotment under Companies Act, 2013


Allotment of shares or other securities (including equity shares, fully or partly convertible debentures or other securities convertible or exchangeable with equity shares) can be made by a private or unlisted public company in any manner including that on ‘preferential basis’, and the same can be made subject to the following conditions:


(i)                 the price of such shares or other securities to be issued, for cash or consideration other than cash is determined by the valuation report of a registered valuer, except in case of preferential issue by listed companies, in which case SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2009 have to be followed;


(ii)               the issue of shares (or other securities) complies with conditions prescribed under the 2014 Rules. However, in case of listed companies, SEBI Regulations in this behalf shall have to be complied with as well.


(iii)             the issue of shares (or other securities) is authorized by its articles of association;


(iv)             the issue of shares (or other securities) is authorized by special resolution passed in a general meeting;


(v)               the allotment of shares (or other securities) shall be completed within a period of 12 months from the date of passing of the special resolution;


(vi)             where shares or other securities are to be allotted for consideration other than cash, valuation should be done by a registered valuer who shall submit a valuation report to the company giving justification for the valuation.


For issue of shares (or other securities) by the Company to its Advisors, the value of services and technical know-how provided may be determined by the Company based on any agreement or unwritten arrangements between the Company and the Advisor. The justification for the valuation to be given by the registered valuer can therefore be based on the value of services provided, as determined by the Company.

Further, issue of shares on a preferential basis should also comply with conditions laid down in Section 42 of the Act (Private Placement). An offer under this Section has to be made through issue of a private placement offer letter. Private placement can be made by a company only when approved by its shareholders by a special resolution and the value of such offer or invitation per person has to be with an investment size of not less than twenty thousand rupees of face value of securities. For the purposes of this rule, it is advisable that the services provided by the Advisors should be of such value or should be valued in a manner such that at least 2,000 shares are issued to each of the Advisors (assuming face value of the shares or securities to be issued is Rs. 10/-), irrespective of the premium on such shares which is determined by valuation by the registered valuer. Alternatively, assuming the class of shares (proposed to be issued) in the Company’s authorized capital has a face value of not more than Rs. 10/-, a separate class of shares (proposed to be issued) may be created with a face value higher than Rs. 10/-. For instance, if equity shares of face value Rs. 50/- are to be issued, then in such case only 400 shares will be required to be issued to comply with the above mentioned private placement rule of Rs.20,000/- face value.

For a listed company however, to make a preferential allotment, the provisions of Chapter VII of the SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2009 are to be complied with.


(B)  Shares in lieu of services as per the Master Circular on Foreign Investments in India.


As per the extant guidelines issued by the Reserve Bank of India on July 01, 2015, Indian companies can issue equity shares, fully and mandatorily convertible debentures, fully and mandatorily convertible preference shares and warrants subject to the pricing guidelines / valuation norms and reporting requirements amongst other requirements as prescribed under FEMA Regulations.


Cancellation of Shares


Shares once issued by the company cannot be cancelled at the discretion of the company, though they have some options including buyback of shares and forfeiture of Share as both the cases are not relevant for our case.


In our case agreement is in between the company and the distributor, where company is issuing equity shares to distributor in exchange of services and to protect company’s interest, company can take following steps:


·         Shareholders agreement will be contingent to distributor agreement (where obligation on distributer can be enforced);

·         Lock in period of 2 or more years with exception of selling shares to the company (buy back of shares);

·         Bank Guarantee from company in favour of distributor.





As enunciated above, the Company may issue shares to its Advisors, both residents in and outside India on a preferential basis by complying with all necessary rules and regulations under the Companies Act, 2013, corresponding rules there under and the extant guidelines on foreign investments, as detailed in the Opinion. Based on the Opinion, it can be concluded that the best possible manner in which the Company may issue shares to its Advisor, whether resident in or outside India, by way of preferential allotment under Section 62(1)(c) of the Act and the rules prescribed there under. 

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