This article is written by Ayushi Mahajan, from Centre For Legal Studies, Gitarattan International Business School (Guru Gobind Singh Indraprastha University). This article talks about the dematerialization of public securities under Companies Act, 2013 and its related provisions.

Introduction

Under Indian law, shares of an unlisted company may be held either in physical form (i.e., denoted by letters of allotment/share certificates issued against such shares) or in dematerialized form (i.e., with the depository participant by opening an account, “Demat account”). Section 29 (1) and Section 29 (IA) of the Companies Act, 2013 talks about the issue of securities by unlisted public company in demat form, promoters by unlisted public company and demat of all existing securities of Key Managerial Personnel or KMP, action by the holder of securities of unlisted company, received through a public company. The Ministry of Corporate Affairs or the MCA has made changes to its mission to promote corporate governance in the country and can be described as a part of “The Swachh Corporate Abhiyan”.

Elaboration of the term securities

The term securities is defined under the Companies Act, 2013 as well as the Securities Contracts (Regulation) Act, 1956.

Section 2 (81) of the Companies Act, 2013 defines the term: “Securities” means the securities as defined in clause (h) of Section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956). It says:  “securities” include—

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.

The key change

Section 29 of the Act mandates public companies or classes of public companies to issue their securities in dematerialized form as prescribed by the Central Government. The new amendment removes the term “public” from section 29 (1)(b), and this section now applies to all “other classes or classes of companies as may be applicable” by the central government.

In addition, a new section 29 (1A) has been added, stating: “In the case of such class or classes of unlisted companies, the securities will be held or transferred in dematerialized form only in the prescribed manner as prescribed in The Depository Act, 1996.

Thus, non-listed companies, public or otherwise, will be required to mandatorily transfer those shares to be dematerialized in the form of government-determined shares and must comply with the provisions of the Depository Act, 1996 and its rules. 

However, the Central Government is yet to notify the class of companies prescribed under this Act which will be affected by this amendment, as well as the related rules. Having said this, it remains to be seen whether private unlisted companies will form part of the defined list of companies, and if yes, whether the government will cover only large-sized private companies or set other criteria for applicability. Small private companies, especially early-stage start-ups that are not wealth/cash-rich, may be affected by the lack of any eligibility criteria, as the cost of dematerialization and compliance can be significant in proportion to their operations. Register to destroy your securities with the respective securities if necessary.

Dematerialization of securities

The promoters of each public company making a public offer of any convertible securities may hold such securities only as securities:

The initial holdings of the convertible securities of the company by the promoters are held until the date of the initial public offer, before such offer will be converted into dematerialized form and thereafter shareholding of such promoter will be held in dematerialized form only.

The effect

At the same time, keeping shares in dematerialized form gives an opportunity to save some stamp duty on the transfer as transfer of shares held in physical form requires execution of share transfer form which gives a stamp duty of 0.25%. The stamp duty benefit of transfer of shares in dematerialized form can also be short-term, given the changes introduced by the Finance Act, 2019, which have not yet been made effective.

In September 2018, however, the Ministry of Corporate Affairs revised these requirements significantly by amending the Companies (Prospectus and Allotment of Securities) Rules, 2014 (“PAS Rules”). Subsequently, the relevant provisions of the PAS Rules were further amended in January 2019 and May 2019.

Summary of the current position

Effective from 2 October 2018:

1. Each public company should only issue “securities” in dematerialized form, proceed, and facilitate dematerialization of all “securities”.
2. A public company may begin offering “securities” (including bonuses, rights, etc.) after ensuring that the securities held by promoters, directors and KMPs are dematerialized and provided that any outstanding payable to the required executives. There is no charge involved in this process (share transfer agent, registrar for issuance, depository).
3. A person willing to subscribe to the “securities” of a public company must ensure that his current stake in the company has collapsed.
4. All of the requirements of the regulations regarding depositories – which usually apply to listed companies and their securities – will now apply to unlisted public companies as well.
5. Every public company should engage with the necessary authorities involved in this process (share transfer agent, registrar for issuance, depository) for activities such as differential payment of fees, maintenance of security deposit, following instructions etc.
6. The Investor Education and Protection Fund Authority shall have authority over the grievances of the securities holders and shall be able to pass necessary orders against the officials in consultation with the Securities and Exchange Board of India.
7. However, it has been clarified that these will not apply to a government company, fund company or a company which is a “wholly-owned subsidiary”.

In addition to the above points, it is also a condition that a shareholder cannot transfer shares in a public company unless such shares are in dematerialized form. This has proved to be a controversial change, and even from a theoretical point of view – a potential challenge for these stipends is that they are contained in the rules governing the issuance and transfer of shares. As that articulation might be, it would be difficult for a well-meaning buyer to see that it could be stipulated.

Implications and points to consider

To open a demat account, the applicant must be registered with the Indian tax authorities and obtain a “Permanent Account Number”. Especially for foreign investors who only want to hold shares with Indian companies and don’t do too many other activities – this may not be a very attractive proposition. 

This may be true forever where foreign investors consider having individual employees in companies to meet the minimum shareholding requirement. Therefore, it may be relevant for foreign public investors seeking to invest in Indian public companies. The acquisition processes are carried out as bidding processes – this is likely to be the first time that investors who have not invested in India are more unattractive as opening a demat account can be a bit time consuming – especially when the shareholder for whom the demat account is to be opened is a non-resident. Jurisdiction to speak English in the form of translation and legalization of KYC documents can be a time consuming and cumbersome matter.

Exceptions

The securities shall not include any unit-linked insurance policy or scrap or any such instrument or entity, by whatever name called, that provides a joint benefit-risk to the life of the individuals and the investment by such individuals and issued by the insurer referred to in clause (9) Section 2 of the Insurance Act, 1938 (4 of 1938) (ie) any certificate or instrument (also called a name), a special purpose separate entity issued by an issuer to an investor that is possessed of any loan or receivable, including a mortgage loan, such entrusted to the entity, and accepting the interest of such investor in such loan or receivable, including mortgage loan, as the case may be.

Process of dematerialization

The process of Dematerialization may be described as follows:

• Shortlisting of a Depository participant

• Depository Participant (DP) is an intermediary between a depository and investors.
• The list of DPs has been made available on the websites of Central Depository Services (India) Limited (CDSL) and National Securities Depository Limited (NSDL).
• The first step in dematerializing shares is to open an account with a DP offering DPT services.
• On opening such an account, investors should not open separate accounts for trading in loans, bonds or any other financial instrument.

• Filling the dematerialization request form

• A Dematerialization Request Form (DRF) available with the DP is required to be filled and submitted by the investor as shown in the image below. With a duly filled DRF form, investors have to hand over their physical share certificates.
• It is important to ensure that on each share certificate, it is surrendered for dematerialization.

• Processing the request

• On submission of DRF and physical certificate, the application is processed by the DP.
• Physical share certificates are presented to the registrar of the issuing company.
• The registrar confirms the dematerialization request.

• Receiving an approval of the request

• After the request is approved, the registrar informs the DP of the completion of the process.
• All share certificates held in physical form are then destroyed.
• The investor’s account will then show the credit of the shares.
• After submitting a dematerialization request, it generally takes about 15 to 30 days for the shares to be transferred electronically.
• This cycle takes about 15 to 30 days after submitting a dematerialization request.

Offer of sale of shares by certain members of the company

Where certain members of a company make proposals, in consultation with the Board of Directors, in accordance with the provisions of any law, the whole or part of the holding of their shares to the public, they may do so by following certain procedures.

Any document by which the sale is offered to the public shall, for all purposes, be considered a prospectus issued by the company and all laws and rules shall be made in accordance with the contents of the prospectus and the liability in relation to the omission or omission of the prospectus or the prospectus. Relating to otherwise shall apply as a prospectus issued by the company.

Responsibility of security holder

Rule 9A provides that each holder of an unlisted public company securities:

(A) who intends to transfer such securities on or after October 2, 2018, will dematerialize such securities prior to transfer; or

(B) who subscribes to any securities of an unlisted public company (whether through private placement or bonus shares or offering rights) on or after 2 October 2001, shall ensure that all its existing securities are subscribed to Is placed in a demonetized form before.

Grievances by security holder

Under this rule, the security holders of unlisted public companies will file their complaints before the Investor Education and Protection Fund Authority. The Investor Education and Security Fund Authority can take action against any depository or participant or registrar on any issue and share the transfer agent after prior consultation with the Securities and Exchange Board of India.

Conclusion

Traditionally, public companies are not preferred as a corporate business vehicle, as the compliance numbers they attract increase. These changes further increase the administrative burden of involving and using public companies. Public companies are likely to be even more ugly – at least in the short term – to foreign shareholders in particular.

References 

• https://ca2013.com/section-281-securities/
• https://www.advocatekhoj.com/library/bareacts/depositories/index.php?Title=Depositories%20Act,%201996#:~:text=Depositories%20Act%2C%201996%20%7C%20Bare%20Acts%20%7C%20Law%20Library%20%7C%20AdvocateKhoj&text=Comment%3A%20The%20Act%20seeks%20to,matters%20connected%20or%20incidental%20thereto

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