Further Issue of Share Capital

Introduction

Share capital, or the amount invested in the company to enable it to conduct business, is a need for all companies limited by shares. It can be changed or enhanced under specific circumstances. A company’s share capital may also be split into smaller shares of several classes. A ‘share’ is the interest of a member in a company, primarily to ascertain the quantum of dividend and liability of the shareholder. Section 2(84) of the Companies Act, 2013 defines shares as a ‘share in the share capital of a company and includes stock’.

Issue of Shares

(i)    Issue of shares at a premium

The shares are said to have been issued at a premium when the company issues shares at a price higher than the face or nominal value of shares. For example, if the nominal value of the shares is Rs. 100 but they are issued at Rs. 500, then the issue of shares is at a premium of Rs. 400. In such cases, a sum equal to the aggregate amount of the premium on those securities are to be transferred to the Securities Premium Account.

(ii)  Issue of shares at a discount

When shares are issued at a price lower than the face or nominal value then the shares are said to be issued at discount. Section 53(1) of the Companies Act, 2013 lays down a general rule that a company shall not issue shares at a discount and Section 53(2) provides that any issue of shares at discount by a company shall be void.

But this provision has 2 exceptions:

  1. Section 53(2A): A company may issue shares to its creditors when the debt is converted into shares by virtue of any statutory resolution plan or debt restructuring scheme in line with any directions or guidelines or regulations specified by the Reserve Bank of India Act, 1934 or Banking Regulation Act, 1949.
  2. Section 54: Sweat equity shares viz. shares that are provided to employees and directors for providing their know-how or making value additions or making rights available in the form of intellectual property rights, may be issued at discount.

Concept of Further Issue of Share Capital

At any point in time if the company proposes to increase the subscribed capital by the issue of further shares, then as per Section 62 of the Companies Act, 2013, such shares shall be offered to:-

  • Existing shareholders
  • Employees under a scheme of Employees’ Stock Option (ESOS) which shall be subject to a special resolution passed by the company and other conditions as prescribed, or
  • Any persons authorized by a special resolution, either for cash or for consideration other than cash if the price of such shares is determined by the valuation report of a registered valuer subject to conditions prescribed.

Modes of Further Issue of Share Capital

Right Issue of Share Capital

Rights shares are shares that are offered to current owners. When rights shares are issued, the ensuing regulations apply:

  • Further shares must be issued via a letter of offer to persons who are currently holding equity shares of the company. The equity shares owned in this manner should be in a ratio that is consistent with the paid-up share capital on those shares.
  • The aforementioned offer must be made in writing, stating the number of shares being offered and allowing at least 15 days, but no more than 30 days, from the offer date. It will be regarded as having been declined if it is not accepted in the allotted time.
  • Such notice may be delivered by courier, electronic means, registered post, speed post, or any other method with delivery proof at least three days prior to the issue’s opening.
  • Unless the company’s articles of association provide otherwise, the existing shareholder must also have the option to reject the offer in favor of any other party. The mention of such a right, however, must be included in the notice.
  • The Board of Directors may dispose of the parties in the manner they deem most advantageous to the company after the time period specified in the notice has expired and they have been informed of their rejection by the parties to whom the notice was delivered.

The Stokes v. Continental Trust Co[i]. judgment by the New York Court of Appeals was the first notable legal ruling to establish the same. In this case, the court determined that the company, which just acts as a trustee for all of the owners, had no authority to sell the new stock without first making it available to the existing shareholders. The same principle has also been accepted by other countries, like the UK, where the Companies Act specifically cites the existing shareholders’ pre-emptive right.

Additionally, the Supreme Court has held that Section 81 presupposes a preemptive right on the part of the existing shareholders to the new issue of shares in the landmark case of Sahara India Real Estate Corporation v. SEBI[ii]. Therefore, it is obvious that a corporation that issues further shares should first offer them to its current shareholders giving preference to anyone else.

This rule exists to protect the shareholder from being treated unfairly. If further shares are issued without being distributed proportionately to the existing owners’ holdings, then those shareholders’ share of control over the company would be significantly reduced. Pre-emption rights also serve as a significant restraint on the directors’ power to issue more shares.[iii]

Employee Stock Option Scheme (ESOS)

The Employees Stock Option Scheme (alternatively called Employees Stock Option Plan) is an employee benefits scheme by which a company may reward its employees by granting them an option to buy the shares of the company at a future date at a pre-determined price which is generally lower than the market price, based on the performance of the employees.[iv] The scheme extends to directors, officers, and employees of the company or its holding or subsidiary company or companies as per Section 2(37) of the Companies Act, 2013.  

The ESOS gives the employee a right and does not impose any obligation to buy the shares. The option must be held for a minimum period before it is actually exercised. This period is called the vesting period and is decided by the company. At the expiry of the vesting period, the employees get the option of buying the shares.

As per the notification issued by the Ministry of Corporate Affairs dated 05.06.2015, a private company may come out with an issue of employee stock options by passing an ordinary resolution. The listed companies will have to comply with the SEBI (Share Based Employee Benefits) Regulations, 2014.

According to Rule 12 of the Companies (Share Capital and Debenture) Rules, 2014, the unlisted companies will have to comply with the following requirements for offering shares under ESOS:

  • A special resolution has to be passed by the shareholders of the company approving the issue of ESOS.
  • Certain disclosures shall be made in the explanatory statement that needs to be annexed to the notice of the passing of the resolution:
  • Total number of stock options to be granted
  • Identification of classes of employees entitled to participate in the ESOS
  • The requirements of the vesting and vesting period
  • The maximum period within which the option shall be vested
  • The exercise price and exercise period
  • Lock-in period
  • The condition under which the option vested in the employee may lapse, and
  • Statement to the effect that the company shall comply with the accounting standards if any.
  • Approval of the shareholders shall be obtained by way of a special resolution by the company in the case of –
  • Grant of option to employees of the subsidiary or holding company, or
  • Grant of option to identified employees, during any 1 year, equal to or exceeding 1% of the issued capital of the company at the time of grant of the option.
  • Companies are at liberty to vary the terms of ESOS not yet exercised by the employees by way of a special resolution provided such variations are not prejudicial to the interest of the option holders.
  • There shall be a minimum of one year of vesting period between the grant period (i.e., giving the option to the employees to subscribe to the shares of the company) and the vesting of the option (i.e., the process by which the employees are given the right to apply for the shares). 
  • The employee shall not have the right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of the option granted to them, till shares are issued in exercise of the option.
  • The amount, if any, payable by employees, at the time of grant of option may be forfeited upon non-exercise of option or may be refunded if the options are not vested due to non-fulfillment of conditions relating to vesting of options as per ESOS.
  • Options granted to employees shall not be transferrable to any other person.
  • The Board of Directors has to disclose the prescribed details of the ESOS in the Director’s Report for the year.
  • The company shall maintain a Register of Employee Stock Options as per the prescribed form.[v]

Preferential Issue

Preferential issue or issue of shares on a preferential basis means an issue of shares or other securities by a company to a select person or select group of persons which is not a public issue or rights issue or issue of employee stock of options or issue of sweat equity shares or bonus shares or issue of global depository receipts outside India.[vi]

A special resolution must be passed to address preferential issues. They may be issued to existing shareholders, employees, or other parties in exchange for cash or other types of payment. Although listed companies are free from this requirement under Rule 13 of the Companies (Share Capital and Debenture) Rules, 2014, the price of such shares of unlisted companies must be set by a valuation report from a registered valuer.

The following treatment will be given to the preferential offer of shares made for a non-cash consideration in the company’s books of account:-

  • If the non-cash consideration takes the form of an asset that may be depreciated or amortized, it must be recorded on the company’s balance sheet in accordance with the accounting standards;
  • If clause (a) does not apply, it must be expensed in accordance with the accounting standards.[vii]

Conclusion

Further share capital issuance would significantly boost the company’s financial reserve and motivate the shareholders, assuring the smooth operation of the company. Such a company must follow the method outlined in section 62 of the Companies Act of 2013 as well as any rules and regulations that are created from time to time if it wants to increase its subscribed capital by issuing more shares.

References

[i] Stokes v. Continental Trust Co., 186 NY 285, 299 (1908, Court of Appeals, New York).

[ii] Sahara India Real Estate Corporation v. SEBI, (2013) 1 SCC 1.

[iii] Aditya Rajagopal, “Analyzing the aspect of Further Issue of Share Capital under the Companies Act”, iPleaders, available at: https://blog.ipleaders.in/further-issue-of-shares/#_ftn2 (last visited on October 11, 2022).

[iv] The Companies Act, 2013 (Act 18 of 2013), s. 62(1)(b).

[v] B K Goyal, Company Law (Singhal Law Publications, Delhi, 16th edition, 2022).

[vi] The Companies Act, 2013 (Act 18 of 2013), s. 62(1)(c).

[vii] Companies Act, 2013 Share Capital and Debentures, 31 The Institute of Company Secretaries of India, available at: https://www.icsi.edu/media/portals/0/SHARE%20CAPITAL%20AND%20DEBENTURES.pdf (last visited on October 11, 2022). 

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