In a rights issue under Section 62(1)(a) of the Companies Act, 2013,, shares are offered to the existing shareholders in proportion to their shareholding. Since the offer is made uniformly to all shareholders, there is no question of unfair advantage or dilution for any particular group, and accordingly, there is no mandatory requirement of a valuation report under the Companies Act, 2013.
Section 62(1)(a) also provides shareholders a statutory right of renunciation in favour of any other person. Therefore, if a shareholder renounces their entitlement in favour of a non-member, the resulting allotment is still regarded as a rights issue under Section 62(1)(a) and not as a preferential allotment under Section 62(1)(c). The rationale is that the company’s obligation is limited to making the offer to existing members; once this is done, renunciation is purely an exercise of shareholder rights.
In practice and as supported by legal commentaries, renunciation in favour of outsiders does not alter the character of the rights issue. However, if the company were to directly offer shares to non-members without following the rights issue and renunciation route, such allotment would fall within the ambit of preferential allotment under Section 62(1)(c), requiring a special resolution and valuation. Further, where renunciation is made in favour of non-resident investors, FEMA pricing guidelines will apply, even though no valuation is mandated under the Companies Act.
A rights issue, even when renounced in favour of non-shareholders, continues to be governed by Section 62(1)(a) and does not constitute a preferential allotment under Section 62(1)(c). Valuation is not required under the Companies Act, 2013, though FEMA valuation norms may apply in case of non-resident allottees.
Purpose of a Rights Issue
It allows a company to raise additional capital from existing shareholders, who already have a stake, instead of approaching outsiders. Since shares are offered in proportion to existing holdings, shareholders can maintain their percentage of ownership and voting power. Compared to public issue or private placement, rights issues are procedurally less complex and more cost-effective. Shares are usually offered at a discount to market price (in case of listed companies) or at a fair price (in unlisted ones), making it attractive for shareholders.
Purpose of Right to Renounce in Favour of Third Person
If a shareholder does not wish to invest additional funds, they are not forced to; instead, they can renounce their entitlement. In listed companies, rights entitlements can be traded, allowing shareholders to monetize their rights instead of letting them lapse. By permitting renunciation to third parties, companies ensure better subscription of the issue, even if some shareholders cannot or do not want to participate. Renunciation allows entry of new investors (including strategic ones) without the company directly making a preferential offer. Since renunciation is a statutory right under Section 62(1)(a), allotment to outsiders through this route avoids being treated as preferential allotment.
Under Section 62(1)(a), a shareholder has the statutory right to renounce their entitlement in favour of any other person, including a third party who is not currently a shareholder. This means a non-shareholder can lawfully subscribe to a rights issue through renunciation. In practice, this allows the entry of new investors (even strategic investors) without the company directly offering shares to them under Section 62(1)(c) (preferential allotment).
The law does not prohibit a shareholder from renouncing their rights in favour of a chosen third party. The company itself cannot force or plan this; the statutory right of renunciation must be exercised voluntarily by the shareholder. If the company is seen as orchestrating renunciation solely to bring in a new investor, it may raise compliance questions, because preferential allotment rules (special resolution, valuation) are intended to prevent unfair allotment to select persons.
It is pertinent to mention that the renunciation must originate with the shareholder, not the company. The company can facilitate renunciation by informing shareholders of their rights and providing procedures, but cannot direct the choice of renouncee. If the company wants to directly allot shares to a strategic investor, it must follow preferential allotment rules under Section 62(1)(c), including passing a special resolution and obtaining a valuation report.
Ultimately, a rights issue with renunciation can legally result in new investors entering the shareholder list. The company cannot pre-plan or dictate the renunciation, because that would effectively be circumventing Section 62(1)(c), which could be treated as a preferential allotment. So, voluntary renunciation is allowed and recognized; deliberate orchestration by the company is not legally permissible.
Example: Rights Issue with Renunciation
Company X has 1,00,000 shares held by three shareholders: A (50,000 shares), B (30,000 shares), and C (20,000 shares). The company announces a rights issue of one new share for every two existing shares at ₹100 per share. Accordingly, A is entitled to 25,000 new shares, B to 15,000 shares, and C to 10,000 shares. Shareholder A, however, does not wish to subscribe to the additional shares and exercises the statutory right of renunciation under Section 62(1)(a), transferring the entitlement of 25,000 shares to D, a third-party non-shareholder. The company allots these shares to D, while B and C subscribe to their respective entitlements. As a result, the company successfully raises the intended capital, B and C maintain their proportional ownership, and D becomes a new shareholder. This illustrates that a rights issue allows the company to raise funds from existing shareholders while protecting their ownership rights, and that the right of renunciation provides flexibility for shareholders and facilitates participation by new investors without converting the transaction into a preferential allotment.
All shareholder agrees to renounce their rights in favor of third person.
Under Section 62(1)(a), shareholders have the statutory right to renounce their rights in favour of any person, including a non-shareholder. This right is vested in the shareholder and not the company, whereas Section 62(1)(c) governs direct allotments to selected persons through preferential allotment.
If all shareholders voluntarily agree to renounce their rights specifically in favour of a new strategic investor, each shareholder is exercising their statutory right, and such allotment is technically permissible under Section 62(1)(a), provided the company does not direct or coerce the renunciation. The company may facilitate the process by providing information or procedures but cannot predetermine or orchestrate the choice of renouncee.
While legally permissible when voluntary, any orchestration by the company could raise concerns of circumventing Section 62(1)(c), which requires a special resolution and valuation, and may attract regulatory scrutiny, particularly in listed companies, for fairness and disclosure compliance. To ensure compliance, shareholder consent should be documented explicitly, the decision must originate with the shareholders, and communication must avoid suggesting that the company is selecting the new investor. If certainty about including a strategic investor is required, the preferential allotment route under Section 62(1)(c) remains the safest and most transparent approach.
Example: Company Y has 1,20,000 shares held by three shareholders: A (60,000 shares), B (40,000 shares), and C (20,000 shares). The company announces a rights issue of one new share for every two existing shares at ₹100 per share, entitling A to 30,000 shares, B to 20,000 shares, and C to 10,000 shares. All three shareholders voluntarily agree to renounce their rights in favour of D, a third-party non-shareholder and strategic investor. The company allots the 60,000 shares to D, while the rights of A, B, and C lapse as they have renounced them. As a result, D becomes a new shareholder, the rights issue is fully subscribed, and the allotment continues to be treated as a rights issue under Section 62(1)(a) rather than a preferential allotment under Section 62(1)(c), since the company’s role was limited to offering shares to existing shareholders and D received shares solely through voluntary renunciation. Proper documentation of shareholder consent and careful communication ensure compliance and transparency, demonstrating that the process was fully voluntary and legally valid.
Discussion Note for Board Meeting
Subject: Ensuring Compliance for Rights Issue and Renunciation in Favour of New Investor
Background:
Under Section 62(1)(a) of the Companies Act, 2013, shareholders have the statutory right to renounce their rights in favour of any person, including non-shareholders. In practice, this allows new investors, including strategic investors, to participate in a rights issue through renunciation. It is important to note that the decision to renounce must originate solely with the shareholders, and the company cannot direct or predetermine the renouncee, as doing so could be viewed as circumventing Section 62(1)(c) (preferential allotment) requirements.
Discussion Points:
1. Ensure that shareholder consent for any renunciation is documented explicitly.
2. Confirm that the decision to renounce is voluntary and originates with the shareholders, without any influence or direction from the company.
3. Ensure that all communications related to the rights issue avoid suggesting that the company is selecting or promoting a particular new investor.
4. Consider whether the preferential allotment route under Section 62(1)(c) may be more appropriate if the company wishes to include a specific strategic investor directly.
Board Action:
The Board may discuss and approve the procedures for documenting shareholder consent, the mechanism for facilitating renunciation, and the compliance safeguards to ensure transparency and avoid any regulatory or legal concerns.
Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the author whatsoever and the content is to be used strictly for informational and educational purposes. While due care has been taken in preparing this article, certain mistakes and omissions may creep in. the author does not accept any liability for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon.
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