A Practical Guide to Convert Loan into Shares

Business loans are quite beneficial when it comes to fulfilling the funds requirement of the company whether it is to finance working capital, expansion of the business or otherwise.

However, the Company may not be able to repay the loans taken on due date which is not a new occurrence. Impact on the credit score, recovery proceedings against the Company, enforcement of charge by lenders in case of secured loans are some of the common outcomes of such failure of repayment.

To avoid such consequences, the Company may opt for Conversion of Loan into shares which has been recognized under the provisions of Section 62(3) of Companies Act, 2013.

Under Companies Act, 2013

As per the provisions of Section 62(3) of the Companies Act, 2013 the conversion of loan into the shares of the Company caused by the exercise of an option as a term attached to loan raised is allowed subject to its in-principle approval through a special resolution passed by the company in general meeting before raising of such loan.

Procedure:

BEFORE RAISING OF LOAN

STEP 1: Convene a board meeting to consider the following:

• Acceptance of Loan
• In Principle Approval to Convert Loan into Shares
• To fix day, date, time and place for convening Extraordinary General Meeting (EGM)  and approval of draft notice including the explanatory statement

STEP 2: Convene the EGM to pass the special resolution.

STEP 3: File Form MGT-14 within 30 days of passing the special resolution

STEP 4: Execution of Loan agreement containing such option of conversion

AT THE TIME TO CONVERSION:

STEP 5: Convene a board meeting to consider the following:

• Allotment of shares
• Authorize directors to file FORM PAS-3 and for making entries in register of members

STEP 6: Prepare list of allottees

STEP 7: File Form PAS-3 within 30 days of passing board resolution for allotment of shares

STEP 8: issuance of Share certificates

STEP 9: File Form MGT-14 for issue of shares against the conversion

STEP 10: Make necessary entries in register of members. 

Notes:

• Check the borrowing limit as per Section 180(1)(c).

Not applicable to private Company 

• Ensure that the Secretarial Standards I and II issued by the Institute of Company Secretaries of India have been complied with. 

• Ensure that the proper stamp duty has been paid on instruments as per the provisions of Indian Stamp Act, 1899 

• Ensure that the amount lent as loan is covered under the amount not treated as deposits under Rule 2 (c) Companies (Acceptance of Deposits) Rules, 2014 

• The requirement of filing resolutions in Form MGT-14 under section 179(3) is covered u/s 117 of the Companies Act, 2013 

Additional Requirements for Conversion of ECB (External Commercial Borrowings) into Equity

As per the Master Directions – External Commercial Borrowings, Trade Credits and Structured Obligations issued by RBI

Conversion of ECB, including those which are matured but unpaid, into equity is permitted subject to the following conditions:

• The activity of the borrowing company is covered under the automatic route for FDI or Government approval is received, wherever applicable, for foreign equity participation as per extant FDI policy.

• The conversion, which should be with the lender’s consent and without any additional cost, should not result in contravention of eligibility and breach of applicable sector cap on the foreign equity holding under FDI policy;

• Applicable pricing guidelines for shares are complied with;

• In case of partial or full conversion of ECB into equity, the reporting to the Reserve Bank will be as under:

For partial conversion, the converted portion is to be reported in Form FC-GPR prescribed for reporting of FDI flows, while monthly reporting in Form ECB 2 Return will be with suitable remarks, viz., “ECB partially converted to equity”.

For full conversion, the entire portion is to be reported in Form FC-GPR, while reporting in Form ECB 2 Return should be done with remarks “ECB fully converted to equity”. Subsequent filing of Form ECB 2 Return is not required.

For conversion of ECB into equity in phases, reporting through Form FC-GPR and Form ECB 2 Return will also be in phases.

• If the borrower concerned has availed of other credit facilities from the Indian banking system, including foreign branches/subsidiaries of Indian banks, the applicable prudential guidelines issued by the Department of Banking Regulation of Reserve Bank, including guidelines on restructuring are complied with;

• Consent of other lenders, if any, to the same borrower is available or at least information regarding conversions is exchanged with other lenders of the borrower.

• For conversion of ECB dues into equity, the exchange rate prevailing on the date of the agreement between the parties concerned for such conversion or any lesser rate can be applied with a mutual agreement with the ECB lender. It may be noted that the fair value of the equity shares to be issued shall be worked out with reference to the date of conversion only.

Frequently Asked Questions (FAQ):

Can the loan which has been already taken by the Company be converted into the shares of the Company by modifying the terms of the loan and providing such option of conversion?

No, Section 62(3) specifically provides that the option to convert loan into the shares of the Company has to be approved through special resolution by the company in general meeting before raising of such loan.

Can the loan be converted into preference shares?

Section 62(3) does not restrict the company to convert the amount raised as loan into a specific type of Share. The word “shares” is used therefore it can be construed that the option of converting the loan into the shares can be given for both type of shares, i.e. Equity and preference.

However, for approval of giving such option for preference shares, Section 55 read with Companies (Share Capital and Debentures) Rules, 2014 needs to be complied with in addition to the requirements of this section.

What will be the event to convert such loan into the shares of the Company?

The event on happening of which the loan raised by the company can be converted into the shares will be as per the mutual agreement between the parties reduced in writing through loan agreement.

Is Valuation required for conversion of Loan under the provisions of this Act?

The requirement of Valuation is applicable on conversion of Loan into shares.

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Disclaimer: The contents of this Article are for information purposes only and do not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up.

The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof.

Reference: Companies Act, 2013 and Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations