Preferential issuance norms undergo changes by SEBI

 SEBI (ICDR)(Amendment) Regulations, 2022 notified!

• Payal Agarwal, Senior Executive (payal@vinodkothari.com)

Last updated – 16^th January, 2022

With an attempt to modify the existing preferential issuance norms applicable on listed companies, SEBI in its board meeting (‘ Meeting’) held on 28^th December, 2021 approved several recommendations as contained in the Consultation Paper rolled out on 26^th November, 2021 where it was proposed to revamp the preferential issue norms under Chapter V of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 [‘ICDR Regulations’], especially, for one that entails an open offer or change in control in the issuer company.  With the notification of SEBI (ICDR) (Amendment) Regulations, 2022 (‘Amendment Regulations’) the amendments have been made to the existing ICDR Regulations thereby amending the preferential issuance norms for listed companies with effect from the date of its publication in the official gazette, i.e., 15^th January, 2022.

1.      Timeline and valuation for pricing of shares under preferential issue

 Timeline for considering pricing

Regulation 164 of the ICDR Regulations specifies the pricing guidelines for preferential issuance which required to take the higher of the two into consideration –

1. Average of weekly high and low of the Volume Weighted Average Price (VWAP) of the related equity shares quoted during 26 weeks preceding the relevant date, and
2. Average of weekly high and low of the VWAP of the related equity shares quoted during 2 weeks preceding the relevant date

Representations have been received that the 26 weeks’ time is a very long period for determining price, considering the volatility of market and may therefore, act as a deterrent for promoters and/or willing investors to invest. Further, the erstwhile weekly trade settlement being changed to T+2 (T+1 from February, 2022), the weekly pricing formula may be discontinued.

Valuation under preferential issue

It has been witnessed in a number of cases that the preferential allotment results in change of control. In such cases, there might be concerns as to whether the price, as determined under the pricing norms, have considered and included the component of ‘control premium’ or not.

Amendments

• Pricing norms – In partial adoption of the recommendations in Consultation Paper, the reference to 26 weeks and 2 weeks has been approved to be replaced with 90 trading days (as against 60 trading days as recommended in the Consultation Paper) and 10 trading days respectively. This would ensure consistency and uniformity in the two comparative prices.
• Valuation – By way of insertion of Regulation 166A, the preferential allotment causing a change in control or resulting in allotment of securities made to a single allottee or allottees in concert of more than 5% of post-issue diluted share capital, shall require pricing to be determined by a registered independent valuer in addition to the pricing methodology under Regulation 164. The valuation report shall contain specific guidance on control premium and the report is required to be uploaded on the website of the company, with reference to the same being made in the notice calling general meeting of shareholders.
• Stricter provisions under AoA – Where the AoA of a company provides for a stricter provision in respect of pricing, the same should be complied with in addition to the pricing norms under Chapter V. The pricing as per the AoA shall serve as the floor price while determining the pricing of shares under preferential issue.
• Recommendation of Committee of Independent Directors – Any preferential allotment involving change in control can be done only after reasonable recommendation of Committee of Independent Directors, considering all relevant aspects of such preferential issue, including pricing. All Independent Directors of the board of the company are required to attend such meeting for providing their recommendations.

The voting pattern of the Committee is also required to be disclosed in such a case to the shareholders in the notice calling general meeting.

2.      Relaxation in provisions related to lock-in of shares

The erstwhile Regulation 167 of the ICDR Regulations specified the following lock-in period for shares issued under preferential allotment –

1. Shares allotted to promoters and promoter group are required to be locked-in for a period of three years from the date of allotment or receipt of trading approval, subject to the same not exceeding 20% of the total capital of the issuer;
2. Shares allotted to persons other than promoters and promoter group are required to be locked-in for a period of one year from the date of allotment or receipt of trading approval

Similar lock-in requirements of three years and one year was applicable on the minimum promoters’ contribution and promoters’ contribution in excess of the requisite limit respectively for public issuances. However, the same has been reduced, subject to satisfaction of some conditions as approved in the board meeting of SEBI held on 6^th August, 2021. A detailed analysis of the same can be read here.

Amendments

The lock-in requirements for promoters’ holding, as a result of preferential allotment upto 20% of post-issue capital will be reduced to 18 months from the existing 1 year. In case of non-promoters as well as promoters’ holding in excess of 20% of post-issue capital, lock-in will be applicable upto a period of 6 months only. Further, persons who become promoter subsequent to the preferential issue, will also be required to comply with the lock-in requirements of 18 months, as applicable to the promoters.

3.      Pledge of securities allotted under preferential issue

The ICDR Regulations put out some lock-in requirements on the shares allotted pursuant to preferential allotment as discussed above. Similar lock-in requirements are applicable under the public issue of shares and promoters’ contribution. While Regulation 21 provides a relaxation w.r.t. pledge of shares that are subject to lock-in pursuant to compulsory promoters’ contribution, no such leeway is provided on shares locked-in under preferential issue. Regulation 21 of ICDR Regulations read as follows –

“Specified securities, except SR equity shares, held by the promoters and locked-in may be pledged as a collateral security for a loan granted by a scheduled commercial bank or a public financial institution or a systemically important non-banking finance company or a housing finance company, subject to the following:

a) if the specified securities are locked-in in terms of clause (a) of regulation 16, the loan has been granted to the issuer company or its subsidiary(ies) for the purpose of financing one or more of the objects of the issue and pledge of specified securities is one of the terms of sanction of the loan;

b) if the specified securities are locked-in in terms of clause (b) of regulation 16 and the pledge of specified securities is one of the terms of sanction of the loan.”

Amendments

The Amendment Regulations, by way of insertion of Reg 167A in the ICDR Regulations, has permitted the pledge of shares locked-in pursuant to a preferential issue for loans taken from certain financial institutions, being scheduled commercial bank, PFI, SI-NBFC and HFCs for financing objects of issue, if the same is a condition for sanction of such loans.

4.      Applicability of preferential issue guidelines to convertible loans and instruments

Under the erstwhile applicability clause – Regulation 158 of Chapter V of ICDR Regulations, the Chapter was not applicable for issue of shares under Section 62(3) and 62(4) of the Companies Act, 2013 (‘Act’). The aforesaid sections of the Act deals with issue of shares on a preferential basis against loans or other instruments, whose terms of issue included the right of conversion into equity, or where the same is demanded by the Central Government vide an order made in this behalf.

Amendments

Amendments have been made to clause (a) of Regulation 158(1) to extend the applicability of Chapter V to the preferential issue of shares, arising out of conversion of loans or debt securities subject to the compliance of the proviso under Section 62(3) of the Act, 2013.

5.      Preferential issue for consideration other than cash

Chapter V of the ICDR Regulations permits the consideration for shares to be in cash or for consideration other than cash. Where shares are issued for consideration other than cash, the same is required to be disclosed in the notice calling shareholders meeting, and the valuation be derived at by a registered valuer. However the same created an ambiguity on the following in respect of ‘consideration other than cash’ –

• Which components can be included within the meaning of ‘consideration other than cash’?
• What will the procedure for valuation of such consideration?
• How will the payment of such consideration be made to the issuer?

Amendments

In order to deal with the ambiguity present in respect of ‘consideration other than cash’, the same has been restricted to include only share swaps accompanied with a valuation report from an independent registered valuer.

6.      Timeline for seeking in-principle approval

ICDR Regulations require the issuer company to obtain in-principle approval from the stock exchanges for shares to be issued by the company pursuant to the preferential offer. There has been no clarity as to the point of time within which the company is required to apply for and obtain in-principle approval.

Amendments

It has been clarified by way of insertion of clause (f) under Regulation 160 that an issuer company will be required to necessarily apply for in-principle approval from stock exchanges on the date of dispatch of notice to shareholders for general meeting approving the preferential allotment.

7.      Conditions to be satisfied by the issuer and/ or the investors w.r.t preferential issue

Reg 159(1) prohibited preferential allotment to persons who have sold the shares of the company at any time during six months prior to the preferential allotment. It also required the prospective investor to hold entire shareholding in demat form and have a valid PAN in its possession.

Amendments

• Since the look back period for pricing under preferential issue has been reduced to 90 trading days, instead of 26 weeks, the same has been aligned for the trading history of prospective allotee as well.
• In line  with  SEBI  circular  on  Scheme  of arrangement, issuer company making preferential issue, should clear the outstanding dues to the Board, the stock exchanges or the depositories, and therefore, the following additional condition has been inserted to be fulfilled by the issuer before making preferential issue  –“An issuer shall not be eligible to make a preferential issue if it has any outstanding dues to the Board, the stock exchanges or the depositories: Provided that sub-regulation (4) shall not be applicable in a case where such outstanding dues are the subject matter of a pending appeal or proceeding(s), which has been admitted by the relevant Court, Tribunal or Authority, as the case may be.”
• It has been clarified that the requirement w.r.t dematerialised holding and valid PAN has to be satisfied before making an application for in-principle approval before stock exchanges.

8.      Additional disclosures under the preferential issue

Regulation 163 of the ICDR Regulations specifies the information required to be provided to the shareholders for obtaining approval for preferential issuance. Some enhanced disclosures have been provided for by way of the Amendment Regulations as follows –

• Disclosures as specified under Schedule VI are required to be provided for in case the issuer/ its promoters/ directors is a fraudulent borrower. Earlier the same was required only for wilful defaulter.
• The current and proposed status of allottee post preferential issue is required to be specified, i.e., whether the same is and/ or remains a promoter or a non-promoter.
• The certificate certifying compliance with the ICDR Regulations at the time of making preferential issue is required to be obtained from a practicing company secretary (earlier, the same was required to be taken from statutory auditors) and also required to be hosted on the website of the company, with link of the same to be provided for in the notice calling general meeting of shareholders for proposed preferential issue.

Concluding remarks

The amendments brought into effect by the Amendment Regulations to the extant preferential issue guidelines under the ICDR Regulations are mixed, being enabling in some areas, and restrictive in others. The legal battles witnessed by the country in the recent months have brought to fore some existing gaps in the Regulations, and the Amendment Regulations seek to fill in the identified loop-holes. At the same time, the amendments provide an ease of raising funds by the company by relaxing conditions on lock-in and pledge of securities under preferential issue.

Our other related articles on the topic may be read here –

·      A Regulatory Affair: Fair Value Discovery in Preferential Share Issues

·    SEBI approves amendments – Public issues | Preferential allotments | Appointment of shareholder-rejected directors