This article is written by Sakshi Singh, from Amity Law School, Lucknow. This article provides a detailed analysis of Section 42 of the Companies Act, 2013, dealing with private placement along with further rules incorporated in the Companies (Prospectus and Allotment of Shares) Rules, 2014.
It has been published by Rachit Garg.
Table of Contents
Introduction
For a company to sustain and flourish, it becomes crucial to raise capital for its functioning. Companies limited by shares have to issue shares to raise the necessary capital required for the operation of the company. These shares can be issued in the following ways:-
- By means of issuing a prospectus and inviting the public directly to subscribe for the shares of the company.
- By allotting entire shares to an ‘Issue-House’, which in turn, offers these shares for the general public to subscribe to.
- Lastly, by private placements of shares, a provision for which is given in Section 42 of the Companies Act, 2013 (“the Act”).
Following the report of the Company Law Committee published in February 2016 relating to the requirement of amendment in the provisions of ‘private placement’ in the Act, Section 42 underwent various changes in August 2018. Among others, the Amendment of 2018 changed the heading of Section 42 of the Act from “offer or invitation of security on private placement basis” to “Issue of shares on private placement basis” thereby limiting its interpretation.
Private placement
A private placement is a method of raising capital in which an offer to subscribe for securities is given to a selected number of people. Section 42 of the Companies Act gives power to the companies for the private placements of securities. Explanation I to sub-section 3 of Section 42 defines ‘private placement’ as “any offer or invitation to subscribe for the securities or issue the same to a selective group of people.” These selective groups of people are also known as ‘identified persons’.
The importance of private placement can be assumed from recent statements by RBI deputy governor T Ravi Shankar, who said that companies are placing overwhelming preference for private placement. A maximum of corporate bond insurance in a financial year is obtained through private placements rather than public issuances.
Issue of shares on private placement basis
Section 42 of the Companies Act, 2013 depicts a complete procedure for the issuance of shares through private placement.
Number of identified persons [Section 42(2)]
The board identifies not more than 50 persons to whom an offer of private placement has to be made. Private placement offers shall be made to these identified persons in such form and manner as may be prescribed. This cap of 50 people can be altered upon prescription under any rules or regulations of the government. Any non-compliance with this condition would lead to the conversion of the private placement offer into a public offer.
Offer of private placements cannot be offered to qualified institutional buyers or employees of the company. In this regard, Explanation II of Section 42 states that the meaning of “qualified institutional buyer” is the same as defined in the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009.
Details of identified persons [Section 42(3)]
Further, the company has to make a record of the names and addresses of the identified persons. In the case of Mrs. Proddaturi Malathi vs. SRP Logistics Pvt. Ltd (2018), directors of the respondent company allotted shares on a private placement basis without following the necessary procedure. It was held by the National Company Law Appellate Tribunal that the increase in share capital and subsequent allotment of shares are invalid and thus, can be set aside.
Payment of the subscription money [Section 42(4)]
After that, every identified person who is willing to subscribe to the offered securities shall have to apply for private placement along with subscription money either in the cheque, demand draft, or any other banking medium. The subscription money can’t be paid in cash.
Allotment of securities [Section 42(6)]
After the application money has been paid by the identified persons, the company shall allot the securities within 60 days from the date of the application money.
Repayment of application money
In case, the company is unable to allot the securities within the prescribed period, it has to repay the application money within 16 days from the expiration of the above-mentioned 60 days. Further, if the company fails to return the application money as required, it would be liable to repay such an amount with interest at 12% per annum from the date of expiration of the 16th day.
In the case of Kushan Mitra vs. Amit Goyal (2021), the National Company Law Appellate Tribunal has dealt with the question as to whether application money in case of non-allotment of shares would be treated as ‘loan/debt’ and would be in the ambit of Section 5(8) of the Insolvency and Bankruptcy Code (IBC). The tribunal has opined that “in the event of non-allotment of shares, application money attracts the interest under Section 42(6) of the act and therefore falls with the ambit of ‘financial debt’ as defined under Section 5(8) ICB, 2016.” The tribunal has further held that the concerned person would be compensated for the time value of the money given to the company as the application money.
Filling the return allotment [Section 42(8)]
The company needs to file a return allotment through the Registrar of the Company (“ROC”) within 15 days from the date of the allotment. The return allotment shall also contain a list of all the allottees with their names, addresses, number of allotted securities, and other relevant information.
Failure to file a return allotment would cast a liability on the company’s promoters and directors, along with the company itself. Upon each default, a penalty of Rs. 1,000 per day will be imposed. In any case, such a penalty should not exceed 25 lakh rupees.
Utilisation of subscription money [Proviso to section 42(6)]
Once a return allotment is filed with the ROC, you can start utilising the funds collected through the subscription amount of the private placement. This fund has to be kept in a separate bank account in any scheduled bank.
It shall only be utilised for the:-
(i) adjustment against allotment of securities; or
(ii) repayment of application money where the company failed to allot securities.
Prohibition on advertising [Section 42(7)]
As the name suggests, it is a private offer of securities made to a selected group of people. So, any advertisement in the media or elsewhere in the public domain is prohibited in order to maintain the sanctity of the private placement offer.
Fresh offer of securities [Section 42(5)]
As per sub-section 5 of Section 42, a fresh offer of securities on a private placement basis can be made only when the previous offer has been dealt with by the company in the following ways:-
(i) Offer of private placement has been accepted and subsequently completed, or
(ii) offer has been withdrawn by the company; or
(iii) company has abandoned the offer of the private placement.
The above-mentioned condition on the fresh offer of securities does not prohibit a company from issuing securities to one class of identified persons more than once, subject to the limit of identified persons mentioned in Section 42(2).
When a private placement offer becomes a public offer [Section 42(11)]
Sub-section 11 of Section 42 states that in the event of contravention to the condition of a total number of ‘identified persons’ for the issue of shares on a private placement basis, it would be deemed to be a public offer. Thus, the provisions of this Act, the Securities Contracts (Regulation) Act, 1956, and the Securities and Exchange Board of India Act, 1992, shall be applicable to such issues of securities.
A similar connotation is provided by explanation III of Section 42. It states that if a listed or unlisted company allots or offers to allot securities to more than the prescribed number of persons, then such an offer or allotment would be considered a public offer and thus would be governed by Part 1 of the Act. It should be noted that the status of payment of the subscription fee and place of allotment in or outside India would have no effect on it.
In the case of Sanjay Paramanik In Re (2021), SEBI held that where a company offers private placement to more than 200 companies, then in terms of Section 42 of the Companies Act read with Rule 14(2) of the Companies (Prospectus and Allotment of Shares) Rules, 2014 (“the rules’) the said issue would be deemed a public issue.
Liability for breach of procedure [Section 42(10)]
Every company raising capital through private placement has to follow the provisions mentioned under Section 42 of the Companies Act, 2013. Any contravention of the said conditions while making the offer or accepting the application money would render the company liable, along with its promoters and directors.
The company would be imposed with a penalty of the amount raised through private placement or Rs. 2 crore, whichever is less. The company shall also be made to repay the application money to subscribers with an interest rate of 12% per annum within 30 days of the imposition of the penalty.
Why do companies prefer private placement
Following are some of the major advantages of issuing securities on a private placement basis-
A cheaper way of raising capital
Raising money through the issue of securities via private placement is comparatively cheaper, as it requires only the passing of a resolution by the Board, unlike a public offer which requires issuing a prospectus. Thus, it saves on the issuing cost and time value.
A public offering, on the other hand, is costly because advertising, public disclosure of documents and reports, and updating the public about the financial status of the company quarterly or as prescribed, require money.
Easier compliance formalities
The issue of shares on a private placement basis does not impose an unnecessary burden in the form of registration with the Securities and Exchange Commission (SEC) or compliance with public trade. It allows the company to issue securities with fewer compliance formalities.
Further, private placements also do not require to be filed with the Securities and Exchange Board of India (SEBI) for their comments.
Companies enjoy confidentiality
In the issuing of shares on a private placement basis, companies enjoy confidentiality as it is offered to selected and limited people. In fact, public display of information, i.e., advertisement, is prohibited in the process.
Because of this reason, sometimes it is argued that private placement lacks transparency, but to a great extent it is beneficial for the companies as there are no restrictive rules regarding disclosure to the public.
Benefits of expert advice
Once a company’s securities are subscribed on the basis of a private placement, they raise money along with expert advice in the dealings of the company. This direction and guidance from experienced private equity players, along with a broadened business network, would lead the company to faster success.
A greater degree of control
Companies exercise a greater degree of control when securities are issued on a private placement basis. It is upon their will to issue securities either in the initial stage or the mature stage. There is no such restriction on raising capital through private placement, unlike in public offerings, where companies have to undergo detailed scrutiny as to financial and other statuses of the company.
Drawbacks of private placement
Although the offer of securities on a private placement basis holds way more advantages than drawbacks, there are certain disadvantages that need to be tackled:-
Dependency on private players
Though there is greater control of the company while issuing private placement offers, they still have to undergo the pressure of investors demanding more shares of the profits of the company. Sometimes, inverters also impose their irritable demand of participating in the decision-making process of the company. So to say, not only do they provide funds to the company, but they also try to almost acquire the principal company and often corrupt its ideas.
Companies in their initial stages often fall for this business trap because of the dire need for funds.
Illiquid market & limited investors
Another drawback of offering securities on a private placement basis is the illiquid market, which means there is less opportunity to resell the securities.
The number of potential investors in the company in a private placement offer is comparatively low. Therefore, companies often price the share at a substantial discount for the greater risk of investment and the longer duration of the investment.
Private placement to a public company
Generally, private companies raise capital on a private placement basis, but a public company can also issue securities to private individuals or institutions. For a public company to issue securities privately, a broker or agent is required, who then finds a suitable person willing to buy the securities of the public company. In such a case, it can be said that the securities are allotted on a private placement basis since there have been no conditions for issuing a prospectus, etc.
But then SEBI released a guideline, according to which an unrelated third person cannot be involved in the issue of shares on a private placement basis under Section 42. So, as per the current situation, only direct relations like friends, family, or other such associations can subscribe to the securities offered on a private placement basis.
Applicable rules from the Companies (Prospectus and Allotment of Shares) Rules, 2014
Private placement offer letter [Rule 14(1)]
Rule 14 of the Companies (Prospectus and Allotment of Shares) Rules, 2014 states that a private placement offer letter in Form PAS-4 has to be issued by the company willing to raise capital through private placement. Along with a private placement offer letter, the company is required to send an application form with serial numbers addressed to specific persons. The offer letter and application form have to be sent within 30 days of recording the names of such persons, either in written or electronic mode.
Only such a person has the right to apply whose name is specifically mentioned in the application form. Any person applying for private placement in contravention of the above-mentioned condition for a private placement offer letter, then such application will be treated as invalid.
The private placement offer letter shall contain the following information as per the form PAS-4
| Form no. PAS-4 |
| Private placement offer letter |
| 1. General information(It contains various info about the company including name, address etc.) |
| 2. Particulars of the offer |
| 3. Disclosure with regard to the interest of the directors |
| 4. The financial position of the company |
| 5. A declaration by the director |
| 6. Undersigned |
Special resolution of shareholders [Rule 14(2)(a)]
In order to issue the securities on a private placement basis, a proposal should get the approval of shareholders, by passing a special resolution beforehand. It is pertinent to note that approval is needed for each offer or invitation.
In the notice for the general meetings, along with the explanatory statement, the basis or justification for the price (including premium, if any) at which the offer or invitation is being made is to be disclosed.
In the matter of Gozing Technology Private Ltd. (2022), the ROC of the NCT of Delhi & Haryana has held that a company shall issue a private placement offer letter only after the required special resolution of the board or shareholders, approving the proposals to issue securities on a private placement basis, has been passed.
Consequently, the registrar has imposed a penalty on the company pursuant to Section 450 of the Companies Act, which provides for punishment for the offences or contraventions to the provisions for which there is no specific punishment or penalty provided.
Offer for non-convertible debentures [Proviso to Rule 14(2)(a)]
When an invitation is made for subscribing to non-convertible debentures, relaxation is provided to the company to pass a resolution for it. A special resolution has to be passed only once a year for all such shares to be issued throughout the year. Further, it is provided that when non-convertible debentures are offered within 6 months of the commencement of the rules, the above-mentioned special resolution may be passed within that period.
Limit on private placement offer [Rule 14(2)(b)]
Rule 14(2)(b) of the rules provides that offers of private placements can be made to no more than 200 people in a given financial year. Similar to the provision of Section 42, the rules further state that qualified institutional buyers and employees of the company are excluded while calculating the cap of 200 people.
It is pertinent to note here that the limit of 200 people is for each kind of security. Provided that a company can issue another kind of share only when the allotment of previously offered securities has been made.
Example- A company can issue a maximum of 200 equity shares, 200 preference shares, and 200 debentures in a financial year. Once 200 equity shares have been offered to be issued, preference shares or debentures cannot be issued until allotment with respect to 200 equity shares is made.
Value of private placement offer [Rule 14(2)(c)]
Rule 2(c) states that the value of the offer made to each person must not be less than Rs. 20,000. Further, sub-rule 5 states that such a value of the offer need not be fixed in the following cases:-
- Non-banking financial companies registered with the RBI under the Reserve Bank of India Act, 1934.
- Housing finance companies registered with the National Housing Bank under National Housing Bank Act, 1987.
If RBI or National Housing Bank has not made similar regulations to govern the above-mentioned companies then only the rule mentioned in rule 14(2)(c) would be applicable.
Payment for subscription [Rule 14(2)(d)]
This sub-rule states that the person subscribing to the securities has to make payment from his bank account only. The emphasis on the source of payment can be judged by the fact that companies have to keep a record of bank accounts from which payments are received. In the case of the joint holder of the security, the payment shall be made from the bank account of the person appearing first in the application.
Record of private placement offers [Rule 14(3)]
Records of each private placement offer shall be maintained by the company in the form PAS-5 as given below-
| Name of the company – |
| Registered office of the company – |
| CIN – |
Details of private placement offer
| Date of approval by the authority -(directors or shareholders) |
| Amount of offer – |
| Date of circulation of offer letter – |
Details of person to whom offer was made
| Name – |
| Father’s name – |
| Complete address – |
| Phone no. (if any) – |
| Email Id (if any) – |
| Officer designated to keep the record – |
Copies of the record along with a private placement offer letter shall be filed with ROC or SEBI (in the case of a listed company) with a fee as provided in Companies (Registration Offices and Fees) Rules, 2014 (‘fee rule”). The record shall be filed within 30 days from the date on which the offer was circulated.
Format for return of allotment [Rule 14(4)]
In furtherance of Section 42(8) of the Companies Act, sub-rule 4 provides that a return of allotment shall be filed with the ROC in the form PAS-3 within 30 days. The return shall be accompanied by the fee prescribed in the fee rule. A list of security holders containing the following information –
- Personal details of the security holder including name, address, PAN, Email address, etc.
- The class of security held.
- The date of allotment of security.
- Total no. of securities held, along with nominal value and paid-up capital on these securities.
- Particulars of the consideration received if the securities were issued for consideration other than cash.
Timeline in private placement offer
The following table depicts a clear picture of the timeline in which various procedures have to be adhered to while issuing securities on private placement.
| S. No. | Subject | Time limitation |
| Filing particulars of special resolution | 30 days from the resolution passing | |
| 2. | Issuance private placement offer letter | 30 days from recording the names |
| 3. | Filing record of private placement offer | 30 days from the circulation of the offer |
| 4. | Allotment of securities | 60 days from payment of application money |
| 5. | Repayment of application money | 16 days after the time for allotment of security (60 days) has elapsed |
| 6. | Filing return allotment | 15 days from the allotment |
| 7. | Payment of penalty | 30 days from the imposition of penalty |
| 8. | Completion of allotment | 12 months from the date of resolution |
Recent amendment to the rules
In May 2022, the Ministry of Corporate Affairs notified the Companies (Prospectus and Allotment of Shares) Rules, 2022, which will amend the earlier rule of 2014. The amendment has inserted another proviso to rule 14(1) of the rules. It states that for allotment of shares to corporate bodies incorporated in neighbouring countries of India, prior approval of the government of India is required under the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.
Conclusion
Section 42 provides a complete procedure for private placement, starting from the selection of the ‘identified person’ to the allotment of securities to these persons. It also contains limitations and conditions for issuing shares on a private placement basis. Rule 14 of the Companies (Prospectus and Allotment of Shares) Rules as amended in 2022, is complementary to Section 42 of the Act.
Further, there are certain issues in private placement that remain unresolved. For instance, the imposition of wills of investors on the principal company makes startups suffer the most. Altogether, private placement is a way of raising funds for the company with fewer hurdles, and companies nowadays are preferring it over the public issue of shares. But studies still have to be conducted as to why there is such a craze for private placement in the market.
Frequently Asked Questions (FAQs)
What do you mean by ‘securities’ in a private placement offer?
The following kinds of securities can be issued via private placements:
(i) Debentures; and
(ii) Equity shares and preference shares.
For more, refer to https://blog.ipleaders.in/different-types-of-securities-dealt-with-in-the-capital-market/
What is the maximum number of people to whom private placement offers can be made?
Earlier, the number of identified persons had to be no more than 50. However, according to the Companies (Prospectus and Allotment of Shares) Rules, 2014, private placements could be offered to up to 200 people in a financial year.
What is the validity of the private placement made to the existing shareholders?
There is no specific mention of offering securities to shareholders in the Companies Act. But, as per the definition of private placement, it is an offer made to a select group of people to subscribe to securities. A shareholder also comes under the ambit of private personality; therefore, offering private placement to shareholders is valid.
What is result of non-compliance with Section 42 while issuing shares through private placement?
In case of non-compliance shareholders can take legal action against the company also, SEBI has authority to impose penalty in such cases.
Which type of companies can issue shares through private placement?
Only private companies can issue share through private placement. Public companies are not allowed to do so.
References
- Company law by Dr. N.V. Paranjape
- Taxmann’s Company Law, 22nd edition, Aug 2019
- https://deliverypdf.ssrn.com/delivery.php?ID=403118115089089088000022071090107018098035091034011074117080028026114023126073090028033027032044109027040107086087007073092115103082007012011090099000010113106085108007015042092097087098027091099122088088102127027073092075023073080112013010067078091089&EXT=pdf&INDEX=TRUE
- https://www.moneycontrol.com/news/business/mc-explains-why-do-firms-prefer-private-placement-of-bonds-over-public-issues-9101181.html
- https://www.scconline.com/blog/post/2022/05/06/application-under-private-placement-made-compulsory-for-corporate-bodies-vide-companies-prospectus-and-allotment-of-securities-amendment-rules-2022/
- https://taxguru.in/company-law/restriction-utilisation-subscription-money-private-placement.html
- https://taxguru.in/company-law/summary-companies-prospectus-allotment-securities-amendment-rules-2022.html
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