Securities to be dealt with in Stock Exchanges

Introduction

Section 40 of the Companies Act, 2013, lays down the guidelines to be followed when a company wants to raise money through a public offering. A public offering is when equity shares or other financial products, like bonds, are sold to the general public in an effort to raise money. This section lays down the penalties for not complying with the requisites, making it mandatory for a company to follow all the rules.

Section 40 of the Companies Act, 2013

“40. Securities to be dealt with in stock exchanges.—(1) Every company making public offer shall, before making such offer, make an application to one or more recognised stock exchange or exchanges and obtain permission for the securities to be dealt with in such stock exchange or exchanges.

(2) Where a prospectus states that an application under sub-section (1) has been made, such prospectus shall also state the name or names of the stock exchange in which the securities shall be dealt with.

(3) All monies received on application from the public for subscription to the securities shall be kept in a separate bank account in a scheduled bank and shall not be utilised for any purpose other than—

(a) for adjustment against allotment of securities where the securities have been permitted to be dealt with in the stock exchange or stock exchanges specified in the prospectus; or

(b) for the repayment of monies within the time specified by the Securities and Exchange Board, received from applicants in pursuance of the prospectus, where the company is for any other reason unable to allot securities.

(4) Any condition purporting to require or bind any applicant for securities to waive compliance with any of the requirements of this section shall be void.

(5) If a default is made in complying with the provisions of this section, the company shall be punishable with a fine which shall not be less than five lakh rupees but which may extend to fifty lakh rupees and every officer of the company who is in default shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to three lakh rupees.

(6) A company may pay commission to any person in connection with the subscription to its securities subject to such conditions as may be prescribed.”

Analysis of the section

Every company undertaking a public offering must submit an application to the stock exchange for listing the securities being sold under sub-section (1) of section 40 of the 2013 Act. Although it could be argued that only listed companies and companies planning to list their securities would need to adhere to the regulations outlined in the Securities and Exchange Board of India (Issuance of Capital and Disclosure Requirements) Regulations, 2009, the word “shall” in this provision is to be interpreted as a mandatory requirement. Any issuer (private limited or unlisted public limited companies) that issues debt securities to the public must get them listed and shall apply to the stock exchange for listing the same in accordance with the SEBI (Issue and Listing of Debt Securities) Regulations, 2008, as the 2013 Act uses the term securities.

The Supreme Court of India, in Sahara India Real Estate Corporation Ltd. v. SEBI, a significant case in this regard, held that the effect of the provision of Section 73 of the Companies Act, 1956 (similar to Section 40 of the Companies Act, 2013) is that the listing is mandatory. A default in this regard makes the allotment of shares or debentures in violation of this provision, and therefore, the listing becomes invalid/void. The allottees’ sums of money have to be refunded. Hence, when a public offer is made, all ICDR Regulations or ILDS Regulations requirements, including eligibility requirements and disclosure responsibilities, would need to be followed, which can be inferred from a joint reading of the regulations and this Supreme Court ruling. Investors in the public offer must be given liquid securities that may be traded on a stock exchange when a public offer is made. As a result, listing securities with a stock exchange would be required in order to make a public offering of shares.

The prospectus must list the names of the stock exchanges where the securities will be traded in accordance with subsection (2) of section 40 of the 2013 Act.

All funds received from the public in response to the public offer must be kept in a separate bank account and used only for the allocation of securities after the securities are allowed to be traded on the stock exchange or for refunds in the event that the company is unable to allocate the shares. This requirement is outlined in sub-section (3) of section 40 of the 2013 Act. In other words, apart from the allocation of securities or for refunds in a separate escrow account, the monies received from subscribers and purchasers in a public offering should be left untouched. Only then may the monies in the account be applied to the purposes for which they were raised.

A statutory prohibition on contracting out of any rights by including any implied or express waiver in the contract papers for the public offer is found in subsection (4) of section 40 of the 2013 Act. Any such clause that would forfeit the ability to list the securities as specified by the section would be void and incapable of performance.

Section 40 of the 2013 Act, subsection (5), makes violations of the section a crime punishable by a company-payable fine of at least Rs. 5 lakhs and up to Rs. 50 lakhs. Every officer who is in default faces a punishment of up to one year in prison, a fine of at least 50,000 rupees and up to 3 lakh rupees, or both.

Subject to the requirements outlined in Rule 13 of the Companies (Prospectus and Allotment of Securities Rules, 2014), section 40 of the 2013 Act allows a company to commit to any person in connection with the subscription to the securities offered by the issuer company.

Some important cases

In the case of Union of India v. Allied International Products Ltd., the Supreme Court of India outlined the purpose of this clause. The objective is to make it possible for shareholders to find a ready market for their shares to sell them at any time for money. The court further determined that the allotment would be legal even if only one of the many stock exchanges filed for and was given recognition, making at least one stock exchange’s service available.

But this was overruled after the amendment of 1974. Following the amendment, the position is that, of the stock exchanges applied for, if a single stock exchange refused to grant listing, the allotment, if already made, becomes null and void. The company could file an appeal with the central government. If the appeal is successful, the stock exchange’s decision would be reversed, and the listing would be granted. This position was confirmed in the case of Rich Paints Ltd v. Vadodra Stock Exchange Ltd.

In the Urmila Bharuka v. Coventry Spring and Engineering Co. Ltd., it was held that when a company filed an appeal after the stock exchange rejected its application, the Central Government’s decision directing the stock exchange to give the listing would reverse the invalidity, making the listing valid.

The Supreme Court ruled in Raymond Synthetics Ltd v. UOI, that the company is holding the money in a separate bank account in a fiduciary position. These sums are not included in the company’s overall assets. Regarding the application money that is currently being held, the applicants and the company are in a bailor and bailee relationship rather than a creditor and debtor one.

In Deccan Farms & Distilleries Ltd. v. Velabai Laxmidas Bhanji, it was held that the conditional licence granted did not constitute approval or consent for the shares to be traded on the stock exchange as required under section 73(1) of the 1956 Act. The provision contemplates an unconditional licence. A qualified approval is equivalent to a denial, and the application should be interpreted as having not been resolved within the timeframe specified by subsection (1).

The ruling in the Deccan Farms case was applied in Goldline Financial Services Ltd. v. Hyderabad Stock Exchange, to assert that a licence with conditions is the same as a rejection. Because conditional authorisation equated to rejection, the deadline for submitting an appeal began to run on the day, it was granted. There is no authority for the Securities Appellate Tribunal (SAT) to excuse tardiness. Therefore, it was not even a question of considering an appeal that was submitted after the period to file appeal ends.

Conclusion

Section 40 lists essential requirements for companies to raise money through a public offering. Thus, it becomes very important for the company to get the required unconditional permission from the stock exchange for a smooth raising of capital for its growth and development.

References

  • Companies Act, 2013.
  • A Ramaiya: Guide to The Companies Act, 19th ed, Vol 1.
  • Avtar Singh, Company Law.
  • Sahara India Real Estate Corporation Ltd. v. SEBI, (2013) 1 SCC 1.
  • Union of India v. Allied International Products Ltd., (1970) 3 SCC 594.
  • Rich Paints Ltd v. Vadodra Stock Exchange Ltd, (1998) 15 SCL 128 (Guj).
  • Urmila Bharuka v. Coventry Spring and Engineering Co. Ltd., (1997) 88 Com Cases 197 (Cal) (DB).
  • Raymond Synthetics Ltd v. UOI, 1992 aIr 847: 1992 SCr (1) 481.
  • Deccan Farms & Distilleries Ltd. v. Velabai Laxmidas Bhanji, (1979) 49 Com Cases 321 (Bom) (DB).
  • Goldline Financial Services Ltd. v. Hyderabad Stock Exchange, (2001) 30 SCL 31 : (2001) CLC 489 (SAT— Mumbai).

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