Revised Section 42: What’s in the name!

By CS Vinita Nair (corplaw@vinodkothari.com)

Section 42 has been substituted by way of section 10 of Companies (Amendment) Act, 2017[1]. Draft rules amending Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 have been issued for public comments[2].

Erstwhile section 42 dealt with ‘Offer or invitation for subscription of securities on private placement’. Substituted section 42 has been titled as ‘Issue of shares on private placement basis’. This leads to a general perception that revised section 42 shall not apply to issue of non-convertible debentures on a private placement basis. It will only apply in case of issue on preferential basis considering corresponding amendment in section 62 (1) (c)[3].

Relevance of marginal note

It is a well settled view that marginal note cannot control/ limit the provisions of the section. In case of Chandroji Rao vs Commissioner of Income-Tax, M.P[4] Hon’ble Supreme Court explained that the marginal heading cannot control the interpretation of the words of the section particularly when the language of the section is clear and unambiguous. There are several other rulings of Hon’ble Supreme Court reiterating the aforesaid interpretation.

Modes of issuance of securities under Companies Act

Chapter III of Act, 2013 deals with prospectus and allotment of securities. Part I deals with public offer and Part II deals with private placement. Section 23 (1) provides the manner in which a public company may issue securities viz.;

  1. by way of public issue by complying with provisions of Part I; or
  2. through private placement by complying with provisions of Part II; or
  3. through rights issue or a bonus issue in accordance with section 62 (1) (a) and section 63 respectively.

Section 23 (2) provides the manner in which private company may issue securities viz.;

  1. by way of rights issue or a bonus issue in accordance with section 62 (1) (a) and section 63 respectively;
  2. through private placement by complying with provisions of Part II.

Private placement under Act, 2013

‘Private Placement’ has been explained in section 42 to mean any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of public offer) through private placement offer-cum-application, which satisfies the conditions specified in the section.

While the marginal note refers to issue of shares, the meaning of private placement clearly refers to ‘securities’. Given the intent under section 23 (1) and (2), it is clear and unambiguous that any private placement of securities will be subject to compliance of provisions of section 42. It cannot be interpreted that ‘securities’ referred in Section 42 refers to the expression, “shares or other securities” explained in Rule 13 of Companies (Share Capital and Debentures) Rules, 2014.

Discussion in CLC Report[5] on issue of debentures by private placement

“3.8 At the moment, in case of non-convertible debentures a prior special resolution only once in a year has been prescribed. The Committee recommends that since Non-Convertible Debentures are pure borrowings and do not form part of equity capital, the proviso to Rule 14(2)(a) may be amended to prescribe that the relevant board resolution under Section 179(3)(c) would be adequate in case the offer under Section 42 is for debentures up to the borrowing limits permissible for Board under section 180(1)(c) of the Act. This would also align the requirements with that of section 180(1)(c). It was, however, felt that the said Board resolution should clearly mention (in the body of the resolution) that the offer of debentures being approved by Board is through private placement under Section 42 and certain other minimum details as may be prescribed in the rules be provided in the Board resolution. Private companies (who have been given exemption from Section 117(3)(g) through section 462 notification) should either be required to file board resolutions under Section 179(3)(c) or pass a special resolution.”

As stated above, the intent was only to exempt the requirement of seeking shareholder’s sanction if the company had already obtained approval of shareholders u/s 180 (1) (c). Apart from this, compliance of entire section is required to be ensured.

Conclusion

Companies should be careful and not interpret that section 42 shall not apply to private placement of debentures. Otherwise, the company, its promoters and directors shall expose themselves to huge amount of penalty.


[1] Yet to be enforced.

[2] http://www.mca.gov.in/Ministry/pdf/DraftCompaniesProspectusSecuritiesRules2018_15022018.pdf

[3] (c) to any persons, if it is authorised by a special resolution, whether or not those persons include the persons referred to in clause (a) or clause (b), either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer subject to such conditions as may be prescribedof a registered valuer, subject to the compliance with the applicable provisions of Chapter III and any other conditions as may be prescribed.

[4] 1971 SCR (1) 422

[5] Company Law Committee Report – February, 2016

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