As per Section 62(1) of the Companies act, 2013 if the Company decides to issue fresh shares, these should be offered to existing shareholders in proportion to existing persons who are holders of equity shares. ‘Right Issue’ means offering shares to existing members in proportion to their existing share holding. The object is, of course, to ensure
equitable distribution of Shares and the proportion of voting rights is not affected by issue of Fresh shares.
Section 62(1) of the Companies Act, 2013 (‘CA, 2013’) to ‘Preference Shares’. First, it is necessary to know the scope of Section 62 of the CA, 2013 which provides for issue of rights shares to existing equity shareholders. It also provides for issuance of shares to employees under Employees Stock Option Scheme and issue of shares on Preferential Basis. Sub-section (4) to (6) relate to conversion of Loans granted/Debentures subscribed by the Central Government into shares of the company.
Overview of Section 62 of Companies Act, 2013
Section 62 of the Act deals with the further issue of share capital in the company. A company that is limited by shares can increase its capital by issuing new shares according to the Articles of Association of the company. The companies usually do not issue all of their shares at once. They do so whenever there is a need for additional funds for the expansion, diversification, or modernization of the company. However, the directors of the company cannot issue shares at their discretion. If this power is given to them, they may misuse it by issuing and allotting the shares to their family members and relatives. In order to curtail this misuse, the Act under Section 62 provides certain conditions for the issuance of shares.
This Section provides for the further issue of shares that are to be first offered to the existing members of the company. These are known as right shares, and this right of the members is known as the right of preemption.
Applicability of Section 62(1) of Companies Act, 2013
The meaning of Section 62 of the Companies Act, 2013, which provides for the issuance of rights shares to existing equity shareholders, must be understood. It also allows for the issuance of shares to employees through the Employees Stock Option Scheme and the issuance of shares on a preferential basis. Subsections (4) to (6) deal with the conversion of loans granted/debentures subscribed for by the Central Government into company shares.
By virtue of the provisions of clause (a) of section 62(1) of the Companies Act, 2013, which speaks to offer to holders of equity shares, it may be inferred that issue of preference shares falls outside the ambit of this section. The opening part of section 62(1) of the Companies Act, 2013 generally refers to an increase in the subscribed capital of the company by allotment of further shares, without restricting the same to the equity shares.
Since capital includes both Equity Share Capital and Preference Share Capital, it would appear that Section 62(1) of the Companies Act, 2013 would apply in the event of the issuance of additional shares (i.e., Preference Shares).
Increase in subscribed capital
According to Section 62(1), when a company having a share capital wants to increase its subscribed capital by issuing further shares, it can be done so following the procedure given therein. It provides a procedure for the issuance of rights shares, shares under the ESOP Scheme and shares that are given on the basis of preference.
Provisions related to right issue or rights shares
Whenever a company wishes to increase its subscribed capital, it can do so by offering the shares first to the existing members of the company or to its members holding equity shares in proportion to the paid-up shares. These are known as “rights shares” and are given under Section 62(1)(a). In order to do so, the following conditions must be satisfied:
- The offer must be made by issuing a notice which specifies the number of shares offered.
- It must contain a limiting time period which must not be less than 15 days and not exceed 30 days from the date of the offer. If the offer is not accepted within this time period, it will be deemed to have been declined.
- The existing shareholder has the right to renounce the shares that are offered to him in favour of any other person unless the articles otherwise provide and so the notice will also contain a statement regarding this right as mentioned under Section 62(1)(a)(ii) of the Act.
- After the expiry of the above-mentioned time period or if the shareholder declines to accept the shares offered to him, the board of directors will dispose of them in a manner which is not harmful or disadvantageous to the shareholder and the company. This is provided under Section 62(1)(a)(iii).
Exception
When 90% of the members of the private companies have given their consent either in writing or in electronic mode then the lesser periods shall be applicable than those which are mentioned under these provisions.
In the case of R. Khemka v. Deccan Enterprises (P) Ltd. (1998), it was held by the Andhra High Court that if a member or shareholder does not respond to the offers made by the company, it means that he is not inclined to subscribe to additional shares offered to him and thereby gives implied consent for the allotment of shares to others. Further, in the case of M.S. Madhusoodanan v. Kerala Kaumudi (P.) Ltd. (2003), the Supre Court held that if shareholders are not given the notice to apply for allotment of shares, then subsequent allotment of shares to others is invalid.
Benefits of Rights Issue
Making a rights issue, compared to raising capital through a preferential allotment or private placement, provides the company with two additional advantages. First, unlike a private placement or preferential allotment, a rights issue does not require shareholder approval by special resolution. Second, the board of directors has absolute discretion in determining the price of the securities, which need not be determined based on a valuation carried out by a registered valuer.
On the other hand, a preferential allotment of securities must comply with the pricing rules set out in the Companies (Prospectus and Allotment of Securities) Rules, 2014 (hereinafter referred to as the “PAS Rules”) and the Companies (Share Capital and Bonds) Rules. , 2014 (“Capital Rules”). In addition, listed companies seeking private placement/preferential allotment should comply with the pricing guidelines set out in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
Reason for Issuing Rights
As the company expands, it looks for avenues of capital expansion, so the company turns to issuing shares. Instead of issuing shares to the general public, which will cause an imbalance in the voting rights of existing shareholders, the company will resort to issuing additional shares to existing shareholders in proportion to its current holding. This solves the purpose of the additional capital and existing shareholders will retain their voting rights.
Issue of shares under ESOP Scheme
Section 62(1)(b) provides for the issuance of shares under the ESOP Scheme i.e., to employees under a scheme of employees’ stock option. This can be done by passing a special resolution in this regard or by fulfilling the prescribed conditions.
Issue of shares on preferential basis
Section 62(1)(c) provides for the issuance of shares to any persons authorised by a special resolution whether or not it includes those referred to in the above clauses. This is done either for cash or consideration other than cash. The price of such shares is determined with the help of a valuation report prepared by a registered valuer. This report is further subject to prescribed conditions under the Act. This is also provided under Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014.
Legal framework of Section 62(1) of the Act
According to Section 62(1) of the Act, if the company proposes to increase its subscribed capital by issuing additional shares, then these shares will be offered to the company’s shareholders in proportion to the paid-up share capital by sending a letter of the offer under the following conditions:
- The offer should state the number of shares offered and the acceptance period should be 15 to 30 (fifteen to thirty) days. If the offer is not accepted within this period, it will be considered rejected.
- Unless otherwise provided by the company’s articles of association, the offer is deemed to include a right of withdrawal.
- After the expiration of the period specified in the notice or after receiving earlier notice from the person that he refuses to accept the shares offered, the board of directors may dispose of the shares in a manner that is not disadvantageous to the shareholders and the company.
The conditions specified are exhaustive and rights can be issued without the prior consent of the shareholders. However, it should be noted that following Section 179(3) (c) of the Act, rights can only be issued with the approval of the board of directors, namely by a resolution from a board meeting.
Procedure for issuing rights
According to Section 62(1) of the Companies Act of 2013, the procedure for issuing shares is as follows:
- Sending notices of Board Meetings: According to Section 173(3) of the Companies Act 2013, notices of board meetings must be sent at least 7 days before the board meeting and must contain an agenda.
- Convene the first meeting of the Board of Directors: The meeting of the board of directors is held and a resolution is passed to issue legal shares. The rights issue does not require the approval of the shareholders and therefore the board of directors can proceed with the issue.
- Issuance of Letter of Offer: After the resolution is passed, the letter of offer is issued to all shareholders and is sent by registered post or speed post. There are 15-30 days for the shareholders to accept the offer, which means that the maximum period that the shareholders can accept is 30 days and the minimum period is 15 days. An offer shall be deemed rejected if not accepted before the expiration date. The offer must be opened at least three days after the issue of the offer letter.
- File MGT – 14: After the adoption of the resolution of the board of directors, the company is required to file MGT -14 within 30 days of the adoption of the resolution of the board of directors. Form MGT 14 is mandatory for a joint-stock company. A true certified copy of the board resolution must be attached to MGT 14.
- Receive Request Money: Shareholders must send the received request along with the requested money.
- Convene the 2nd meeting of the Board of Directors: The Company is obliged to convene the 2nd meeting of the board of directors, the notice of which must be sent 7 days before the meeting of the board of directors. The requisite quorum must be present and a resolution for the allotment of shares must be passed. When passing a resolution on the allotment of shares, the allotment of shares must be done within 60 days of receiving the request for money.
- File the forms with ROC: The Company must file Form PAS -3 within 30 days of allotment of shares with the Registrar of Companies. A certified copy of the board resolution and a list of authorized persons must be attached to the form. In addition, MGT – 14 has to be filed for both allotment and issue of shares.
- Issue of Share Certificates: Share certificates must be issued; if the shares are in Demat form, the company must immediately inform the depository about the allotment of shares. When the shares are in physical form, the share certificates must be issued within 2 months from the date of allotment of shares. It must be signed by a minimum of 2 directors. Share certificates must be issued on form SH-1.
Difference between right issue of shares and preferential allotment of shares
| S.no. | Right issue | Preferential allotment |
| It is given under Section 62(1)(a) of the Act. | It is given under Section 62(1)(c) of the Act. | |
| Shares are first offered to the existing members or the shareholders in the company according to their proportional interest in the company. | Shares are offered to both shareholders and people who are authorised by special resolution. | |
| Approval from the board is necessary. | A special resolution must be passed in this regard, and the approval of the board must be taken. | |
| The offer is given for a limited time period, which is minimum 15 days and maximum 30 days. | No such time period is specified. | |
| It is necessary to fill form PAS-3 with the registrar of the company. | Forms like PAS-3, MGT-14, GNL-2 are filled out and submitted to the registrar of the company. | |
| Shareholders can exercise their right to renounce or reject the shares offered to them. | No such right is available to them. | |
| There is no need to prepare a valuation report. | It is mandatory for companies to prepare a valuation report. |
Recent case laws
The Canning Industries Cochin v. SEBI (2020)
Facts of the case
The appellant in this case was an unlisted company known as Canning Industries Cochin. When the company suffered losses, it proposed to issue 1,92,900 unsecured fully convertible debentures to 1929 shareholders in its 68th Annual General Meeting by passing a special resolution under Section 62(3) and Section 71 of the Act. However, the shareholders were not given the right to renounce the offer to any other person. One of the shareholders raised objections to this proposal and filed an application before the Company Law Board, but no action was taken, and as a result, complaints were filed in SEBI and with the registrar of the company. SEBI issued directions against the directors and the company, which were discharged by another order that stated that the company had not violated any provisions of the Companies Act, 2013. This was, however, appealed by the shareholder.
Issues involved in the case
Whether the company in this case has complied with the provisions of Section 62 of the Act?
Judgement of the case
The appellate tribunal observed in this case that Section 62(1)(c) is applicable in the present case as the case is not related to the issuance of preference shares but deals with an increase in the subscribed capital of the company. The shareholders in the present case passed a special resolution that contained a condition that this right cannot be renounced. This shows that the increase in subscribed capital was caused by exercising an option by way of condition that the debentures issued cannot be renounced in favour of any third person. Thus, the company has complied with the provisions of Section 62(3) of the Act. Moreover, the prospectus clearly states that the said offer was made to the existing members or shareholders of the company. As a result of this, the impugned order passed by the Whole-time member cannot be sustained and so the order and directions issues against the company are quashed.
Proddaturi Malathi v. SRP Logistics Pvt. Ltd. (2018)
Facts of the case
The company or the respondent, in this case, is an incorporated private company having an authorised share capital of five lakh rupees. The appellant was inducted as assistant director in the company. In 2015, a notice was issued to convene a board meeting to further increase the share capital to forty lakh rupees. Further, in 2016 a general and board meeting was conducted to allot the shares. In 2017, a notice was served to conduct an extraordinary general meeting with an agenda to remove the appellant from the post of director in the company. As a result, she moved to a tribunal which passed an interim order against the appellant. Aggrieved by the order, the appellant challenged the allotment of shares on the grounds that Section 62 of the Act has been violated by the company.
Issues involved in the case
Whether there has been a violation of Section 62 of the Act and whether the order passed by the tribunal is correct?
Judgement of the court
While discussing the validity of the order passed by the tribunal, it was observed that earlier Section 62 was not applicable to private companies. But now it is applicable and requires that the offer of shares must be first made to the existing members or shareholders of the company holding equity shares in the company. They must be given time to either accept or reject the offer along with a right to renounce the offer in favour of another person as given under the section. The issuance of shares to any other person will be done at a fair value which is determined by the valuation report of the registered valuers.
In the present case, it was observed that the company was running into profits and increased its authorised share capital twice and paid capital thrice since the time it was incorporated. It was argued by the appellant that the funds were raised again to suppress her by reducing her shareholding to a minority in the company as there was no need to increase the share capital. The appellant has also objected that the order of the tribunal has not dealt with certain acts of the company. The meetings of the company have been challenged and the tribunal failed to deal with it. Further, it has only dealt with the removal of the appellant from the position of director and not any other contentions made by the appellant. The National Company Law Appellate Tribunal (NCLAT) observed that according to Section 62, shares must be first offered to the existing members and when they reject it or the offer declines then only they can be distributed among others. The appellate tribunal thus, ordered to remand back the matter to the tribunal to deal with the case on merits and also hear the other pending issues which have not been dealt with so far.
FAQs
What is Section 62(1) of the Companies Act, 2013 about?
Section 62(1) deals with the issuance of rights shares by a company, which are offered to existing shareholders in proportion to their current shareholding.
Is there any restriction on the issuance of rights shares?
Yes, there are certain conditions and procedures prescribed under Section 62(1) and related rules that need to be followed by the company.
Who can issue rights shares under Section 62(1)?
Any company registered under the Companies Act, 2013 can issue rights shares, subject to compliance with the provisions of the Act and relevant rules.
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