The Ministry of Corporate Affairs (“MCA”) issued the Companies (Share Capital and Debenture) Amendment Rules, 2016 (“Amendment Rules”) on July 19, 2016 which sets out various amendments to the Companies (Share Capital and Debenture) Rules, 2014 (“Rules”). The Rules, inter alia, contain procedure for issuance of shares, debentures, disclosures, filing requirements and other compliances relating thereto. The Amendment Rules modify rules with respect to, inter alia, issue of equity shares with differential voting rights, sweat equity, employee stock options, secured debentures, pricing requirements for issue of equity shares and other convertible securities.

On July 27, 2016, the MCA amended certain provisions of the Companies (Incorporation) Rules, 2014 (the “Incorporation Rules”) and the Companies (Accounts) Rules, 2014 by notifying the Companies (Incorporation) Third Amendment Rules, 2016 and the Companies (Accounts) Amendment Rules, 2016 respectively, with the aim of providing clarity to the rules and easing the process of incorporation as well as filing of financial documents.

The major amendments are summarised as under:

The Companies (Share Capital and Debenture) Amendment Rules, 2016

1.  Conversion rate under preferential allotment process

The Amendment Rules have done away with the requirement of shares allotted under preferential allotment to be fully-paid up at the time of allotment. Accordingly, now partly-paid securities can be allotted by means of a preferential issue.

As per the Rules, in case of convertible securities issued by way of a preferential issue, companies had to determine the conversion price of such securities upfront. The Amendment Rules now allow companies to either determine the conversion price (i) upfront at the time of offering the convertible securities, or (ii) not later than 30 (thirty) days prior to the date when the holder of convertible securities becomes entitled to convert such convertible securities, based on a valuation report of a registered valuer issued not later than 60 (sixty) days prior to such date. Further, companies would have to choose one of the aforesaid options upfront at the time of offering the convertible securities. The Amendment Rules have offered flexibility to determine the conversion price of convertible securities.

2.  Relaxation of restriction on issue of equity shares with differential voting rights

The Amendment Rules allow companies defaulting in respect of (i) repayment of term loan or interest thereon, (ii) payment of dividend on preference shares, (iii) payment of statutory dues relating to employees or (iv) crediting amounts to Investor Education and Protection Fund, to issue equity shares with differential rights after 5 (five) years from the end of the financial year in which such default is rectified by the company.

3.  Secured Debenture issuance

The Amendment Rules have brought in the much awaited change by allowing creation of charge on the assets or properties of not only the company issuing secured debentures but also of such company’s subsidiaries, holding or associate companies. This relaxation is to the extent of creation of charge on specific movable properties of such company’s subsidiaries, holding or associate companies.

The Amendment Rules also expressly permit companies willing to redeem their debentures before maturity to transfer amounts to the Debenture Redemption Reserve even if it may be in excess of the limits specified under the Rules.

4.  Relaxation to Start-ups for issuance of sweat equity and Employee Stock Option Plan (“ESOP”):

Start-ups (as recognised by the Department of Industrial Policy and Promotion) have been allowed to issue sweat equity shares up to 50% of their paid-up capital for the first 5 (five) years from the date of their incorporation as against the prevailing limit of 25% for other companies.

Further, Start-ups have also been expressly permitted to issue ESOPs to their promoters, promoter group and to directors who hold more than 10% of the Start-up's equity shares for the first 5 years from the date of their incorporation whereas other companies are not permitted to do so.

The Companies (Incorporation) Third Amendment Rules, 2016

1.  Signing of memorandum and articles (Rule 13)

The amendment clarifies that typed or printed particulars by subscribers and witness to the memorandum and articles of association are permitted, if they are appended with the signature or thumb impression of the person furnishing the same.

2.   Publication of name by company (Rule 26)

Every company which has a website for business purposes or for any other purpose, has to publish its name, address of the registered office, the CIN (Corporate Identity Number), telephone number, fax number, e-mail and name of the person to be contacted in case of any query or grievance on the home page of the website.

3.  Alteration of Memorandum by change of name (Rule 29)

Under the Incorporation Rules, a company which has not filed its annual returns or financial statements or failed to pay or repay matured deposits or debentures or interest thereon is not allowed to change its name by altering its Memorandum of Association. However, such a company is now permitted to change its name, provided the company files the above mentioned documents and/or makes payment or repayment of matured deposits or debentures or interest thereon.

4.   Conversion of unlimited liability company into a limited liability company by shares or guarantee (Rule 37)

A new rule has been inserted which provides the procedure for conversion of unlimited liability company into a limited liability company by shares or guarantee.

The Companies (Accounts) Amendment Rules, 2016

1.  Manner of consolidation of accounts (Rule 6)

The companies which meet the following conditions do not have to fulfill the requirements of preparing consolidated accounts:

  1. If the company is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company and all its other members, including those who are otherwise not entitled to vote, have been intimated in writing and do not object to non-presentation of consolidated financial statements,
  2. If the securities of the company are not listed or are not in the process of listing on any of the stock exchange, whether in India or outside, and
  3. Its ultimate or any intermediate holding company files consolidated financial statements with the Registrar which is in compliance with the applicable Accounting Standards.

2.  Companies required to appoint internal auditor (Rule 13)

A clarification has been inserted which states that an internal auditor can either be an individual, a partnership firm or a body corporate. Further, the ambit of “chartered accountant” or “cost accountant” is widened to include even those who have not been in practice and by virtue of the amendment can now be appointed as an internal auditor.

VA View

The Companies (Share Capital and Debenture) Amendment Rules, 2016 enable start-ups to offer more incentives in terms of sweat equity and ESOP issue by relaxing the rules to an extent. The changes have in a way eased issuance of equity and debt. The operational difficulty in offering security while raising money by issuance of secured debentures has been facilitated. While the overall impact of the Amendment Rules is likely to be positive, the provision pertaining to the conversion price of convertible securities still remains ambiguous and more so when read in context of Foreign Direct Investment policy. The option allowed by the Amendment Rules may not necessarily benefit in case of foreign direct investment, since as per the extant Foreign Exchange Management Regulations, the price at the time of conversion or the conversion formula should not in any case be lower than the fair value worked out, at the time of issuance of such convertible security. There is need to sync the amendment provisions under the Companies Act with the FDI policy with respect to conversion price of convertible securities. Nevertheless, other companies sans foreign direct investment could still avail the benefit of exercising this option in case of preferential issue of convertible securities.

The Companies (Accounts) Amendment Rules, 2016 have eased the burden for some companies in respect of exemption from preparation of consolidated financial statements subject to fulfilment of certain conditions. A company can now appoint a chartered accountant or a cost accountant as its internal auditor, regardless of the fact that they are engaged in practice or not.