Introduction

Every company needs funds at some point in time. It can raise funds either through debt or equity. For increasing share capital, the Companies Act, 2013 (“2013 Act”) prescribes four methods: Public Issue, Rights Issue, Bonus Issue and Private Placement. A private placement is defined in the 2013  Act as any offer of securities or invitation to subscribe securities  to a selected group of persons by a company through issue of a private placement offer letter. Due to the speed and fewer procedural requirements, private placement is a preferred method to raise funds. This article will provide a summary of the new provisions of private placement in the 2013 Act and reasons for introducing the changes.

Background

Lacuna in the legal provisions of the Companies Act, 1956 (“1956 Act”) regarding private placement have led to an increase in malpractices.

A classic example of the misuse is of Sahara, where two private companies: Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited   of Sahara group, under the veil of private placement, issued optionally fully-convertible debentures (“OFCDs”) amounting to about Rs 24,000 crores to more than 2 crore investors. They made the private placements in the multiples of 49 (in line with the 1956 Act) and in essence made a public issue through a private placement. They put their case forward saying that there was no prescribed limit of the number of people to whom private placement offers can be made. Also, since they were unlisted, their issue of debentures was outside the purview and jurisdiction to SEBI. The Supreme Court held that OFCDs issued by Sahara Group were public issue of debentures, hence once the number 49 is crossed, the proviso to Section 67(3) of the 1956 Act becomes effective and it is an issue to the public, which attracts Section 73(1) of the 1956 Act and application for listing becomes mandatory. The Court upheld the proceedings of the SEBI and Sahara Group was ordered to refund the amount to investors along with interest.

Hence changes have been brought in the provisions for private placement in the 2013 Act.

Provisions under Companies Act, 2013

• “Private placement” which was not defined in the 1956 Act, Securities and Exchange Board of India Act, 1992 (“SEBI Act”) or Securities Contracts (Regulations) Act, 1956 (“SCRA”) has now been defined under the 2013 Act.
• Maximum persons:
  • The private placement offer can be made to maximum 50 persons in a financial year.
  • However  this  number  does  not  include  Qualified  Institutional  Buyers  and Employees to whom shares have been offered under the ESOP Scheme.
  • Hence if the offer is made to more than 50 persons, then, whether the company intends  to  list  its  securities  or  not  on  any  recognized  stock  exchange  in  or outside India, such issue will be deemed to be under public offer.
• No fresh offers or invitations under private placements can be made by a company unless it has either allotted the shares offered under the earlier private placements or the offer/ invitation has been withdrawn or abandoned.
• Any offer which does not comply with the provisions with regards to private placement under the 2013 Act will be deemed to be a public offer and it shall have to comply with all the relevant provisions of the 2013 Act, SEBI Act and SCRA.
• The payment for subscription under the private placement shall have to be made by cheque or demand draft or through other banking channels, but not by cash.
• The Company shall allot its securities within a period of 60 days from the date of receipt of allotment money. If it fails to allot the securities within such time period, it shall have to refund the application money within 15 days from the completion of the 60 day period. If the company fails to refund the money within the given timeline, it shall have to repay the money with interest @ 12% per annum from the expiry of the 60th day.
• The application money received from the private placement offer shall be deposited in a separate bank account in a scheduled bank.
• Offers under private placements shall be made only to such persons whose names have been recorded by the company prior to the invitation to subscribe. The company shall maintain a complete record of the offer made under private placement and such record shall be filed with the Registrar within 30 days from the date of circulation of private placement offer letter.
• Companies issuing securities under private placements shall not be allowed to release any public advertisements or utilize any media, marketing or distribution channels or agents to inform the public at large about such an offer.
• When a company makes allotment of securities under private placement, it shall file with the Registrar a return of allotment in the Form PAS-3.
• Penalty for contravention of the provisions:
  • Fine for promoters and directors which may extend upto higher of the
    • Amount involved in the offer/ invitation, or
    • Rs 2 crores.
  • Company shall refund the money to the subscribers within a period of 30 days of the order imposing penalty.

 Provisions under the Companies (Prospectus and Allotment of Securities) Rules, 2014

• The offer for private placement shall be made by issue of private placement offer letter in Form PAS-4.
• The offer letter shall be accompanied by an application form addressed to the person to whom the offer is made. It is to be sent, either in writing or in electronic mode, within 30 days from the date on which his/ her name is recorded by the company in the list of people to whom the private placement offer is to be made.
• Only the person to who is addressed in the application form will be allowed to apply through such application form.
• The private placement of securities can be made by the company only on fulfilment of the following conditions:
  • Prior  approval  of  shareholders  by  a  Special  Resolution  for  each  such  offer/ invitation for private placement.
  • Justification  of  price  at  which  the  offer  is  being  made  to  be  given  in  the explanatory statement attached to the notice for the general meeting.
  • In the case of non-convertible debentures, prior approval of shareholders by a Special Resolution only once a year for all the offers for such debentures during the year is sufficient. Separate approvals for each offer, as in the case of other securities, is not necessary.
  • Offer or invitation for private placement shall not be made to more than 200 persons in aggregate in a financial year. This restriction shall be calculated individually for each kind of security.
  • The value of offer/ invitation per person shall be with an investment size of Rs 20,000 of face value of the securities or more.
  • The  payment  for  subscription  of securities  will need  to  be made from  bank account of the person subscribing it. The company shall keep the record of the bank account from which such payments are received.
• The company shall maintain a complete record of the private placement offers in Form PAS-5.
• A copy of record kept in Form PAS-5 and the private placement offer letter in Form PAS-4 shall be filed with the Registrar within 30 days of date of private placement offer. In case of a listed company, such record and offer letter shall also be filed with SEBI.
• The restrictions in these relating to the maximum number of persons to whom private placement can be made and minimum value of offer shall not apply to the following:
  • NBFCs registered with Reserve Bank of India (“RBI”) under the RBI Act, 1934,
  • Housing  finance  companies  registered  with  National  Housing  Bank  (“NHB”) under the NHB Act, 1987.

 Conclusion

On  going  through  the  new  provisions  in  the  2013  Act,  we  can  conclude  that  appropriate measures have been put in place to curb the malpractices. The term “shares” has been replaced by  “securities”  to  fill  the  loophole  that allowed  companies  to  raise  funds  by  u sing  other terminology/  nomenclature  and thereby  escape the regulatory oversight. The  provisions  of private placement have been made applicable to public as well as private companies. A restriction has been brought on the number of persons to whom a private placement offer can be made in a financial year. This number being 200, maximum 4 offers for private placement can be made by a company during a financial year. Use of banking channels has been made compulsory for private placement, which shall reduce the opportunities to launder money. The fact that on non-compliance of any of the provisions relating to the private placement, the offer shall by default be treated as public offer shall result into greater co-ordination between MCA and SEBI. All these changes will lead to better governance and transparency of the affairs of the companies.

However, due to stringent requirements for raising of funds through private placements, there will be a significant increase in the compliance burden for private companies looking to raise funds through private placement. Since, no specific exemption has been provided for private companies or small companies, it will lead to reduced flexibility for private companies.