15 November, 2019
Private limited companies are often at a crossroad when it comes to multiple investors looking at investment opportunities to infuse capital in a company. Due to the cautious approach undertaken by companies, it so happens that such investments are kept on a standstill until existing investment transactions are completed. While undertaking a preferential issue in accordance with the terms of Section 42 of the Companies Act, 2013, the question that arises in the company’s compliance officer’s mind is, whether making of a fresh offer to a prospective investor by a company pending the issue of shares under an existing resolution is permissible or not.
For instance, ABC, is an existing investor who had agreed to invest in Company X by subscribing to certain convertible preference shares in 2 (two) or more tranches. For this purpose, Company X had filed the offer letter on July 01, 2019 in single Form PAS-4 with the Registrar of Companies, wherein the offer period for the issuance and allotment of the convertible preference shares was 180 days from the date of the offer. Subsequently, ABC entered into the definitive agreements sometime in August 2019 for the purpose of subscribing to the convertible preference shares in 2 (two) tranches.
ABC has in relation to the aforesaid subscription remitted the amount for the first tranche and in consideration thereof, Company X issued the pro-rata convertible preference shares for the first tranche to ABC as well as filed the return of allotment in Form PAS-3. Company X is still awaiting the balance tranche payment from ABC.
The question which stems from the above illustration is whether a proposed investment by a New Investor pending the completion of the allotments of the second tranche convertible preference shares by Company X to ABC would be permissible.
For this purpose, it is imperative to study the provisions of Section 42 of the Companies Act, 2013 and the Rules made thereunder in relation to issuance of securities on a preferential basis, particularly making of a fresh offer by a company pending issue of shares under an existing resolution (being the issue of remainder of the convertible preference shares to ABC). For this purpose, one needs to evaluate when is an offer under Section 42 is deemed to be complete.
Section 42 of the Companies Act, 2013 is silent on when an offer is construed to be completed. However, Section 42(5) of the Companies Act, 2013 states that "No fresh offer or invitation under this section shall be made unless the allotments with respect to any offer or invitation made earlier have been completed or that offer or invitation has been withdrawn or abandoned by the company."
Going by simple interpretation of the above provision in our present illustration, one may take a view that Company X shall not be permitted to make any fresh offer or invitation, unless "allotments" with respect to a particular previous offer have been completed or such offer has been withdrawn or abandoned by the company.
Therefore, by a literal reading of the provisions of Section 42(5) of the Companies Act, 2013, one may conclude that unless the allotments under the offer of ABC have been completed or withdrawn/abandoned by Company X, a fresh offer/ invitation by Company X to a prospective New Investor would not be permitted under the provisions of the Companies Act, 2013. It would then become important to consider what construes "allotment" as has been contemplated in this Section 42(5).
The Companies Act, 2013 does not define the term "allotment". In Sri Gopal Jalan and Company Vs. Calcutta Stock Exchange Association Limited (1963) 33 Comp. Cas. 862 (SC), it was held that the term "allotment" would be the appropriation out of the previously unappropriated capital of a company of certain number of shares to an identified person. Therefore, going by the interpretation of the same, it would imply allocation of share capital of the company to such identified persons upon an offer made by a company to a proposed allottee and as such, allotment would precede the actual issuance of shares upon payment by such persons.
Applying this to the current scenario, even though the issuance of the balance tranche of convertible preference shares is yet to take place, the "allotment" of all the convertible preference shares to ABC by Company X has deemed to have taken place (by virtue of the Form PAS-4 filed on July 01, 2019) and all the said convertible preference shares (albeit in 2(two) tranches) have been earmarked for issuance to ABC. The payment of subscription amounts for the balance tranche of the convertible preference shares (and when ABC makes such payment) and issue of the balance tranche of convertible preference shares is a procedural as well contractual process which will occur in due course.
To conclude, for the purpose of fulfilling the criteria mentioned in Section 42(5) for making a fresh offer to the New Investor, one can take the view that the ABC offer has been completed inasmuch as "allotment" of all convertible preference shares has taken place.