Rights Issue of Shares

Rights Issue Of Shares Under The Companies Act, 2013

The rights issue of shares prioritizes existing shareholders by offering them new shares proportionally to their current holdings. This approach not only maintains equity among owners but also aligns with regulatory mandates to ensure fairness. Governed primarily by the Companies Act, 2013, along with associated rules, a rights issue provides a structured pathway for capital infusion. This blog delves into the legal framework, preconditions, and a detailed procedural outline to help stakeholders navigate this process effectively.

A rights issue under the Companies Act, 2013, exemplifies a balanced method for capital raising, empowering existing shareholders while enabling company growth. By adhering to the outlined framework and process, businesses can execute this efficiently, ensuring compliance and investor confidence. As corporate landscapes evolve, staying abreast of amendments—such as those facilitating digital processes—is crucial. For tailored advice, consulting a company secretary or legal expert is recommended to address company-specific nuances.

Legal Framework Governing Rights Issues

1. Section 62(1)(a): The foundation for rights issues lies in Section 62(1)(a) of the Companies Act, 2013, which addresses the further issuance of share capital. This provision mandates that when a company with share capital proposes to increase its subscribed capital through new shares, these must first be offered to existing equity shareholders in proportion to their paid-up capital.
2. Companies (Share Capital and Debentures) Rules, 2014 & Companies (Prospectus and Allotment of Securities) Rules, 2014: Rule 12A, which outlines procedural aspects such as the format of the offer letter and timelines. Additionally, the Companies (Prospectus and Allotment of Securities) Rules, 2014, under Rule 12, provide guidance on allotment and related filings. For private limited companies, certain exemptions apply through notifications, allowing flexibility in offer periods and procedures if approved by a majority of shareholders. However, unlisted public companies must adhere strictly to these norms without such relaxations unless specified.

Preconditions and Eligibility for a Rights Issue

Before initiating a rights issue, companies must satisfy several prerequisites to ensure legal validity:

1. Authorized Share Capital: Verify that the company’s authorized share capital, as per its Memorandum of Association, accommodates the proposed issuance. If insufficient, amend the Memorandum via a special resolution under Section 61 of the Act, followed by filing Form SH-7 with the Registrar of Companies (ROC).

2. No Pending Defaults: The company should not have defaulted on dividend payments, debt repayments, or statutory dues, as this could invite regulatory scrutiny.

3. Valuation Requirements: While not mandatory for rights issues (unlike preferential allotments), it is advisable to determine the issue price through a fair valuation, often at par or a premium, to reflect the company’s worth and comply with income tax implications under Section 56(2)(viib) of the Income Tax Act, 1961.

4. Dematerialization for Non-Small Private Limited and Unlisted Public Companies: Promoters, directors, and key managerial personnel must hold their securities in dematerialized form, except for exempted entities like Nidhi or government companies.

Step-by-Step Process for Rights Issue

The process for a rights issue is methodical, involving board oversight, shareholder communication, and regulatory filings. Below is a comprehensive breakdown:

1. Preparation and Initial Board Approval

• Determine the quantum of capital to be raised, the number of shares, issue price, and entitlement ratio (e.g., 1:2, meaning one new share for every two held).
• Convene a board meeting under Section 173(3) by issuing a notice at least seven days in advance, including the agenda.
• In the meeting, pass resolutions to approve the rights issue, finalize the list of eligible shareholders based on a record date, and draft the Letter of Offer. For private companies, no special resolution is typically required unless the Articles of Association mandate it.

2. Issuance of Letter of Offer

• Dispatch the Letter of Offer to all eligible shareholders via registered post, speed post, or electronic means at least three days before the offer opens.
• The letter must specify: the number of shares offered, issue price, payment terms, offer period (minimum 7 days, maximum 30 days), and the right to renounce shares in favor of another person.
• The offer is deemed declined if not accepted within the stipulated time.

3. Receipt of Applications and Funds

• Shareholders submit applications along with payment (full or in installments, if specified).
• The company collects funds into a designated bank account. Partial applications may be accepted, but unsubscribed shares can be disposed of by the board in a manner not disadvantageous to shareholders.

4. Allotment of Shares

• Hold a second board meeting to approve allotments, ensuring this occurs within 60 days of receiving application money under Section 39.
• Prepare a list of allottees and pass the allotment resolution.

5. Regulatory Filings

• File Form MGT-14 with the ROC within 30 days of the board resolution (mandatory for public companies; optional for private ones unless involving special resolutions).
• Submit Form PAS-3 (Return of Allotment) within 30 days of allotment, attaching the list of allottees, board resolution, and valuation report (if applicable).

6. Issuance of Share Certificates

• Issue physical or dematerialized share certificates in Form SH-1 within two months of allotment, as per Section 56.
• Update the Register of Members under Section 88.

Handling Renunciation of Rights

A key feature of rights issues is the renunciation option, allowing shareholders to transfer their entitlement to another individual. The Letter of Offer must include a renunciation form. If renounced, the renouncee becomes eligible to apply for the shares. However, the board retains discretion to reject applications if they deem it unfit, provided reasons are communicated. This provision enhances liquidity and flexibility for shareholders who may not wish to subscribe.

Post-Allotment Compliances

After allotment, companies must:

• Stamp share certificates appropriately.
• Update statutory registers and inform depositories if shares are dematerialized.
• Comply with tax withholding obligations and report to authorities if necessary.