Mandatory Dematerialisation of securities of certain private limited companies

In accordance with the recent amendment issued by the Ministry of Corporate Affairs (“MCA”) on October 27, 2023, a new rule i.e., Rule 9B (“Rule”) has been inserted under Companies (Prospectus and Allotment of Securities) Rules, 2014 (“PAS Rules”).

According to the Rule, every private company that is not a small company on March 31, 2023 and onwards must:

  1. provide the dematerialization facility to its security holders; and  
  2. dematerialize all its existing physical securities

 within 18 (eighteen) months from the end of the financial year (“Relevant Date”).

The timeline of 18 (eighteen) months to comply with this Rule shall commence from the end of the financial year in which the private company ceases to be a small company.

Any further issue, bonus shares, rights offer or buy back of securities by a private company after the Relevant Date, should be done only if the securities of its directors, promoters, and key managerial personnel have been dematerialized.

The securities holders are also required to open their demat account and convert their physical securities into demat within the Relevant Date. No transfer or subscription shall be permitted unless the securities are dematerialised by the holder.

Exclusion of small companies 

According to the Companies Act, 2013 (“CA, 2013”), a small company means a private limited company having:

  1. paid up share capital of up to INR 40 Million; and
  2. turnover of up to INR 400 Million.

 as per the latest audited financial statement.

However, the holding subsidiary companies are out of the purview of the definition of a small company.

Holding subsidiary company

Subsidiary company means a company in which the holding company:

  1. controls the composition of the Board of Directors; or
  2. exercises or controls more than half of the total voting power either at its own or together with one or more of its subsidiary companies.

The term wholly-owned subsidiary (“WOS”) is not defined under the CA, 2013 but WOS are those companies that are completely owned and controlled by the holding company through 100% share capital and/or voting rights.

Impact of this amendment on foreign subsidiaries and their securityholders

Most of the foreign entities invest in India by establishing their own subsidiaries or WOS in conformity with Indian regulatory requirements.

The definition of the small company specifically excludes the companies having holding subsidiary relationship. Therefore, irrespective of the foreign subsidiary breaching the threshold limit of paid-up share capital and turnover, as applicable for small company, such foreign subsidiary will always be considered as other than small company. This implies that the requirement of foreign subsidiaries to have the securities in demat form would be applicable from the date of their incorporation irrespective of their size. It could be cumbersome to comply with one more procedural requirement in order to hold the Indian securities for those foreign entities that intend to invest in India for the purpose of expanding their business in India and have no intention of transferring their ownership to someone else.

Certainly, securities dematerialization provides various benefits including the elimination of risks associated with physical certificates such as loss, theft, etc., ease in the transfer of securities, and making it easier to hold and maintain securities.

It is also understandable that the intention of the government to bring the amendment is to improve the corporate governance regime by increasing transparency and preventing malpractices. The dematerialization of securities is not only mandated for private companies but also for unlisted public companies. However, PAS Rules provide an exemption from the dematerialization requirement to those unlisted public companies that are WOS. The MCA should consider similar relaxations and make certain modifications to the Rule thereby exempting foreign subsidiaries which does not breach the threshold limit of small company as this amendment might change the mood of new businesses who intend to expand their business boundaries in India.