Compliances For Preferential Allotment of Securities Under Companies Act, 2013 & Rules

Preferential allotment under the Companies Act, 2013 allows companies to raise capital quickly by issuing securities to selected persons on a preference basis, often to manage financial constraints or restructure debt. Only equity shares, preference shares, and convertible securities or debentures can be issued through preferential allotment, while non-convertible instruments must follow the private placement route under section 42. The process is governed by sections 42, 55, and 62(1)(c) of the Act and the Companies (Share Capital and Debenture) Rules, 2014, requiring authorization in the Articles of Association, approval by special resolution, detailed disclosures, and completion within 12 months. Valuation by a registered valuer is mandatory for unlisted companies, including pricing of convertible instruments. Companies must comply with filing requirements such as PAS-3 and SH-7 and ensure no default in redemption of existing preference shares. Preference shares are redeemable within prescribed periods and require creation of a Capital Redemption Reserve to safeguard shareholders and creditors.

Preferential Allotment

The preferential allotment of shares is allotment of securities to selected persons on preference basis when the company is undergoing financial constraints or even otherwise wishes to increase its capital in a short time frame, or to decrease its debt without share capital dilution. A company limited by shares has three types of securities –

1. Equity Shares

2. Preference Shares (Convertible or non-convertible)

3. Debentures (Convertible or non-convertible)

Only convertible securities or debentures can be put up for preferential allotment. If a company wishes to allot non-convertible preference shares or non-convertible debentures on a preference basis, it has to adopt the route of private placement u/s 42 of the Companies Act, 2013 (hereinafter referred to as “the Act”).

A company not listed on stock exchanges can offer one kind of securities to maximum 200 members in a financial year via private placement. For example – a company can offer 200 convertible preference shares, and 200 convertible debentures. In this article we will talk about preferential allotment only.

As per section 23 of the Companies Act, 2013 a company can raise its capital by-

1. Public issue of security (IPO/FPO)

2. Right issue or bonus issue

3. Private Placement or Preferential Allotment of Shares

Preference Shareholders

The preference shareholders do not have any right accrued to them unlike equity shareholders who possess voting rights and ownership of company neither do they generally participate in the annual meetings. Preference shareholders are less prone to the risks associated with the bear and bull market because they receive fixed annual dividend from the company irrespective of its profit and loss. Convertible preference shares can be converted into the equity shares in times of market appreciation.  At the time of winding up of a company, preference shareholders are given preference over the equity shareholders.

Governing Provisions

For preferential allotment, section 42, 55, 62(1)(c) of the Companies Act, 2013 and Rule 9, 13, 14 of the Companies (Share Capital and Debenture) Rules, 2014, (hereinafter referred as “Rules”) and for public listed companies SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 also applies.

Securities offered on preferential basis

The equity securities, preference shares, debentures, fully or partly convertible or securities that can be converted to equity shares at a later date are offered in preferential allotment. The securities offered through public issue, rights issue, bonus issue, ESOP, Employee Stock Option Scheme, Sweat Equity, Depository Receipts, are not offered in preferential offer.

What is the process of offering preferential allotment?

1. The Articles of Association must authorise the company to issue preferential allotment of securities. [Rule 9 (1) of Rules]

2. A special resolution (advance notice + 3/4^th votes in favour) must be passed approving the allotment on preference basis in the general meeting of the company. The company must annex explanatory statement with notice for general meeting in accordance with section 102 of Companies Act setting out the objective of issue, number of preference shares, nature of shares, price at which such shares are proposed to be issues and how this price has been arrived at, redeemable period, etc. [Rule 9 (1) & (3) of Rules].

3. Within 12 months of passing the SR, the company must complete the issuance of preferential allotment or if it lapses pass another SR to complete the process. [Rule 13 (2) (e) of Rules].

4. The value of preference shares must be determined on the basis of valuation report of a registered valuer and issue price must not be less than what is determined by the regd. valuer. [Rule 13 (2) (g) and Rule 13 (3) of Rules]. However, such valuation is not required in case of a listed company. [Second Proviso to Rule 13 of Rules].

5. When convertible preference shares are issued, the price of resultant shares post conversion must also be pre-determined by registered valuer. [Rule 13 (2) (h) of Rules].

Other Compliances.

1. At the time of issuance of preference shares, the company must not have any subsisting default in the redemption of previously issued preference shares. [Rule 9 (1) (b) of Rules]

2. Company has to notify the ROC in written for alteration of share capital at the time it redeems its redeemable preference shares in Form No. SH.7 along with the fee within a period of 30 days. [Sec. 64 (1) and Rule 15 of Rules].

3. Defaulting company and its officer would be liable to penalty which is 500/- per day till the default continues subject to maximum 5 Lakh Rupees in case of company and Rs. 1 Lakh for officer-in-default. [Section 64 (2) of the Act].

4. Company must file return of allotment of securities with the ROC, within 30 days of its allotment in Form PAS-3 along with the fees specified in Companies (Registration Offices and Fees) Rules, 2014. [Section 39 (4) of the Act and Rule 12 (1) of Companies (Prospectus and Allotment of Securities Rules, 2014].

5. Defaulting company and its officers are liable to penalty which is 1000/- per day till the default continues or Rs. 1 Lakh whichever is less. [Section 39 (5) of the Act].

Redemption of Preference Shares

A company cannot issue unredeemable preference shares. Redemption of preference shares is governed by section 55 of the companies act, 2013. Redemption refers to buying back of allotted preference shares by the company at a pre-determined price out of its profits to return the capital to investors when the business starts taking pace, if it wishes to. It can either redeem shares within a period of 20 year or before, for the infrastructural companies, redemption period is 30 years.

The company has to create a Capital Redemption Reserve Account which has the amount equal to nominal value of shares which are proposed to be redeemed. The Capital Redemption Reserve Account is applied to pay unissued shares of the company to the existing shareholders as fully-paid bonus shares. The CRR acts as a capital base for the company to avoid any sudden capital reduction due to buying back of shares saving interest of shareholders and creditors.