Preferential Allotment of Securities

Preferential Allotment of Securities

Preferential allotment of securities allows a company to issue shares or other securities to a select group of investors on a priority basis. This approach is beneficial for private limited companies aiming to infuse funds from strategic partners, promoters, or institutional investors. Governed primarily by the Companies Act, 2013, and its associated rules, preferential allotment ensures transparency, fairness, and compliance while enabling targeted fundraising. We will explore the legal framework, key conditions, and a detailed step-by-step process for executing such allotments, drawing on the provisions of the Act to provide a clear roadmap for businesses and legal practitioners.

Preferential allotment under the Companies Act, 2013, offers a strategic avenue for capital infusion, balancing speed with regulatory safeguards. By adhering to the outlined process, companies can mitigate risks and ensure seamless execution. Businesses should consult legal experts for tailored advice, especially in complex scenarios involving conversions or foreign investments. As corporate laws evolve, staying updated is key to leveraging this mechanism effectively.

Legal Framework

The preferential allotment of securities is regulated under key sections of the Companies Act, 2013, read with relevant rules. Specifically:

• Section 62(1)(c): This provision deals with the further issue of share capital to persons other than existing shareholders or employees, allowing allotments on a preferential basis with shareholder approval via a special resolution.
• Section 42: It outlines the norms for private placement of securities, which preferential allotments fall under, limiting offers to a maximum of 200 persons in a financial year (excluding qualified institutional buyers and employee stock options).
• Section 55: Applicable for the issuance of preference shares, requiring adherence to redemption terms and other conditions.
• Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014: This rule provides detailed guidelines on pricing, valuation, and procedural aspects for preferential issues.
• Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014: It specifies requirements for private placement offers, including the format of offer letters and record-keeping.

Key Conditions and Prerequisites

Before initiating a preferential allotment, companies must ensure compliance with several prerequisites to avoid regulatory pitfalls:

1. Authorization in Articles of Association (AoA): The AoA must explicitly permit the issuance of securities on a preferential basis. If not, an amendment via special resolution is required.

2. No Pending Allotments: A fresh preferential issue cannot proceed if any prior offer under Section 62(1)(c) remains incomplete or has lapsed without a new resolution.

3. Valuation Requirements: The price of securities must be determined by a valuation report from a registered valuer (e.g., a chartered accountant or SEBI-registered merchant banker). This is crucial for non-cash considerations or when issuing to non-promoters. The valuation ensures the price is not less than the fair market value.

4. Shareholder Approval: A special resolution (requiring at least 75% approval) must be passed in a general meeting, with an explanatory statement detailing the allotment’s rationale, pricing, and allottees’ identities.

5. Timeline Constraints: The allotment must be completed within 12 months of the special resolution; otherwise, a new resolution is needed.

6. Limit on Allottees: Offers are restricted to 50 persons per offer (or 200 in aggregate per financial year), excluding certain categories.

These conditions promote equitable treatment and prevent misuse of the preferential route.

Process of Preferential Allotment

The process for preferential allotment is methodical and involves multiple stages, from board-level decisions to regulatory filings. Below is a comprehensive outline:

1. Board Approval: Convene a board meeting under Section 173 of the Act, with at least seven days’ notice. In this meeting:

• Approve the proposal for preferential allotment.
• Determine the number and type of securities (e.g., equity shares, convertible debentures).
• Fix the issue price based on the valuation report.
• Approve the private placement offer letter in Form PAS-4.
• Authorize the opening of a separate bank account for application monies.
• Call an Extraordinary General Meeting (EGM) for shareholder approval.

2. Shareholder Consent via Special Resolution: Issue a 21-day notice for the EGM, including an explanatory statement with details such as the allotment’s objectives, pricing justification, allottees’ details, and potential change in control. Pass the special resolution approving the allotment.

3. Filing with Registrar of Companies (ROC): Within 30 days of passing the special resolution, file Form MGT-14 with the ROC, attaching the resolution and explanatory statement.

4. Issuance of Offer Letter: Dispatch the private placement offer cum application letter (Form PAS-4) to the identified allottees. This must include complete disclosures about the company, risks, and terms. The offer remains open for 15-30 days.

5. Receipt of Application Money: Allottees must remit funds into a designated separate bank account within the offer period. Funds cannot be utilized until allotment is complete.

6. Allotment of Securities: Hold another board meeting to approve the allotment within 60 days of receiving the application money. If delayed, refund the money with interest.

7. Filing Return of Allotment: File Form PAS-3 with the ROC within 15 days of allotment, including a list of allottees, valuation report, and special resolution copy. 

8. Issuance of Certificates: Issue share or security certificates in Form SH-1 within two months of allotment.

9. Update Registers: Update the company’s register of members or security holders and make necessary entries in statutory records.

Post-Allotment Compliances

Post-allotment, the Company shall maintain records of offers in Form PAS-5. Annual disclosures in the board’s report shall be made during the relevant financial year. In the event of any non-compliance penalties under Section 450 of the Act, including fines up to Rs. 5 crores, may be levied.