Converting loans into equity shares offers companies a way to improve balance sheets and cash flow. Under Section 62(3) of the Companies Act, 2013, this conversion is permitted if the option was included in the original loan terms and approved by a special resolution before the loan was accepted. This provision applies only to the conversion into equity shares, not preference shares. The process involves several steps, including board and shareholder approvals, executing a loan agreement with the conversion clause, and subsequent board approval for allotment of shares upon the exercise of the conversion option. While a valuation certificate isn’t explicitly mandated at the time of loan acceptance, it becomes necessary at the time of conversion to determine the fair share price and comply with regulations. Post-conversion, the company sees changes in its capital structure, debt position, and potentially shareholding, necessitating ROC filings and adherence to tax and governance norms. Careful consideration of legal and financial implications is crucial for both companies and lenders undertaking this process.
Introduction
In the dynamic landscape of corporate finance, companies often resort to debt funding as a strategic tool for expansion or sustenance. However, in circumstances necessitating financial restructuring or in pursuit of investor alignment, the conversion of such debt into equity becomes both a practical and tactical recourse. Section 62(3) of the Companies Act, 2013, embodies this flexibility by enabling companies to convert loans or debentures into equity shares, subject to compliance with prescribed conditions. This provision not only facilitates capital restructuring but also ensures a balanced alignment of stakeholder interests through procedural safeguards and statutory oversight.
- Certain advantages for conversion of loans into equity share capital of the Company:
- No cash exchange occurs in the debt-to-equity swap.
- Increasing cash flow by decreasing liabilities.
- Avoidance to paucity of financial resources.
- Legal Provisions:
Section 62(3) of the Companies Act, 2013:
“Section 62 pertains to the further issue of share capital. Sub-section (3) specifically carves out an exception from the requirement of offering shares on a rights basis or under employee stock options, stating:
“Nothing in this section shall apply to the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to debentures issued or loan raised by the company to convert such debentures or loans into shares in the company: Provided that the terms of issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of the loan by a special resolution passed by the company in general meeting.”
Accordingly, the law permits conversion of loans or debentures into equity only where such option for conversion is entrenched in the terms of the instrument at the time of its issuance, and such terms are ratified by the shareholders through a special resolution.
I. Whether under this section 62(3) loan/ debentures can be converted into Preference Shares?
Section 62 addresses the issue of equity shares, including rights issues and ESOPs.
- Section 62(3) specifically refers to conversion of loan/debenture into shares — and by interpretation and intent of the provision, this means equity shares, not preference shares.
No, a loan cannot be converted into preference shares under Section 62(3).
√ It can only be converted into equity shares, subject to prior approval of a special resolution and the terms being embedded at the time of loan agreement or debenture issue.
Compliance Before Acceptance of Loan
STEP- I- Holding of Board Meeting
i. To pass a resolution for Acceptance of Loan or issue of debenture
ii. To pass board Resolution for conversion of such Loan / Debenture into Equity share Capital of the Company
iii. To issue Notice for holding of Extra Ordinary General Meeting of Shareholders.
STEP- II- Holding of Extra Ordinary General Meeting:
iv. Company shall pass Special resolution for conversion of such loan/ Debenture into Equity share capital of Company in Future.
v. File e-form MGT-14 within 30 days of passing Special Resolution with ROC.
STEP- III- Enter into Agreement:
vi. Company shall enter into an agreement of Terms of Loan or Debenture.
vii. Such Agreement should contain the term of conversion of such Loan or Debenture into Equity share capital of Company in Future.
II. If the company has not passed a special resolution at the time of loan acceptance. Is it possible for the company to convert this loan into equity by approving SR at the time of conversion?
Legal Reasoning:
Section 62(3) of the Companies Act, 2013 clearly states:
“…provided that the terms of issue of such debentures or the loan containing such an option have been approved by a special resolution passed by the company before the issue of such debentures or raising of the loan.”
This means:
- The option to convert must be part of the original loan agreement.
- A special resolution must be passed before the loan is raised.
Implication:
If the company:
- Accepted the loan without including the conversion clause, and
- I did not pass a special resolution at that time,
Then such a loan cannot be converted into equity under Section 62(3), even if the company now passes a special resolution at the time of conversion.
III. While accepting a loan with the stipulation that it be converted into equity in the future. Is it necessary for the company to adhere to the provision regarding the acceptance of loans under the Companies Act? if so, which provisions
Yes, absolutely — while accepting a loan with a convertible clause (i.e., convertible into equity in the future under Section 62(3)), the company must comply with the relevant provisions for acceptance of loan under the Companies Act, 2013 and other applicable laws like RBI directions (if applicable).
Acceptance of Loan – Applicable Provisions under Companies Act, 2013
Whether or not the loan is convertible, the acceptance of loan itself must comply with applicable provisions.
IV. Whether valuation certificate is mandatory for conversion of loan into equity u/s 62(3)
While Section 62(3) does not explicitly require valuation, however, there are practical, legal, and regulatory reasons why valuation is still necessary
Understanding Section 62(3):
Section 62(3) states:
“…the increase of subscribed capital by the exercise of an option attached to loan raised by the company to convert such loan into shares, provided the terms of such loan containing such an option have been approved by special resolution passed before raising the loan…”
It facilitates conversion of a loan into equity shares based on pre-agreed terms — like a contractual right, not a fresh offer.
However, it does not explicitly mention valuation.
V. When is Valuation Required: At the Time of Loan Acceptance or at the Time of Conversion?
Short Answer: Valuation is required at the time of conversion, not at the time of accepting the loan.
Reasoning:
1. Section 62(3) Requirements:
This section allows conversion of a loan into equity if:
- Conversion terms are included in the loan agreement, and
- Approved by a special resolution before loan acceptance.
But it does not prescribe valuation at the time of accepting loan, because:
- No shares are being issued yet.
- It is only a contingent right to convert in future.
2. Conversion is the Trigger for Share Allotment:
The actual issuance of shares (i.e., increase in subscribed capital) happens only at the time of conversion. Hence:
Valuation must be done as of the conversion date, to:
- Determine fair price per share.
- Justify the number of shares being allotted.
- Comply with tax, audit, and, if applicable, FEMA pricing norms.
Aspect Requirement of Valuation
Section 62(3) (Textually) × Not explicitly required
Practical / Regulatory Needs Yes, to justify conversion ratio
Tax and Audit Standards Advisable to avoid disputes
Compliance at the time of conversion of Loan into equity
STEP- I- Holding of Board Meeting
1. Confirm Fulfilment of Pre-conditions
- Ensure that:
- The loan agreement had a conversion clause.
- The special resolution was passed before accepting the loan.
- The conversion terms (price, ratio, time period) are being met.
2. Take Note of the Loan Conversion Request
- If conversion is initiated by lender (e.g. via notice), the board should:
- Take note of the written request or triggering event.
- Confirm that the lender is exercising its right of conversion.
3. Consider and Approve Valuation Report
- Take note of the valuation report (preferably as of date of conversion).
- Determine number of shares to be allotted based on:
- Outstanding loan amount.
- Agreed price per share.
4. Approve Conversion of Loan into Equity
- Pass board resolution to:
- Approve conversion of the loan into equity shares.
- Approve allotment of shares to the lender.
- Authorize filing of e-Form PAS-3 with ROC.
5. Allot Equity Shares
- Approve allotment of equity shares to the lender as per agreed terms.
- Update:
- Register of Members
- Register of Allotment
- Register of Charges (if loan was secured and now converted)
6. Authorize Filing of Statutory Forms
- PAS-3 – Return of Allotment (to be filed within 30 days).
- MGT-14 – Not required at this stage since no SR is passed at this meeting (was already passed earlier under 62(3)).
7. Issue Share Certificates
- Authorize issuance of share certificate in Form SH-1.
- Stamping of share certificate as per respective state stamp laws (e.g., in Delhi, ₹1 per ₹1,000 or part thereof of face value plus premium).
Post-Conversion Implications
Summary Table:
| Area | Post-Conversion Implication |
| Capital Structure | Increase in paid-up share capital |
| Debt Position | Reduction in liability |
| Shareholding | Dilution/change in control possible |
| ROC Filings | PAS-3, SH-1, CHG-4 (if required) |
| Tax | FMV to avoid Sec. 56(2)(x) |
| Financial Ratios | Improved net worth, lower leverage |
| Governance | New shareholders may gain influence |
| Disclosures | Financials, MBP-1 (if interested party) |
Process of Conversion of Loan into Equity in Tabular Form:
| Step | Activity | Statutory Reference / Guidance | Responsible Party |
| 1 | Draft loan agreement with conversion clause | Section 62(3) | Legal/Finance Team |
| 2 | Convene Board Meeting to propose special resolution | Section 173, SS-1 | Board of Directors |
| 3 | Issue notice and explanatory statement for General Meeting | Section 101 & 102 | Company Secretary |
| 4 | Pass special resolution approving loan terms with conversion option | Section 62(3) Proviso | Shareholders in General Meeting |
| 5 | Accept loan as per approved terms | Section 179(3), 180(1)(c) if applicable | Board of Directors |
| 6 | Initiate conversion upon exercise of option | Loan Agreement Terms | Company Management |
| 7 | Obtain Valuation Report | Not Mandatory | Registered Valuer / CA / MB |
| 8 | Convene Board Meeting for allotment of shares | Section 62 | Board of Directors |
| 9 | File Form PAS-3 for return of allotment | Section 39(4), Rule 12 of PAS Rules | Company Secretary |
| 10 | Update Register of Members and Register of Allotments | Section 88, Rule 5 of MGT Rules | Company Secretary |
| 11 | Issue Share Certificates within prescribed time | Section 56, Rule 5 of SH Rules | Company Secretary |
A business needs to be aware of the following operational and financial ramifications if loans are converted to equity:
Balance Sheet Improvement: The debt-to-equity ratio improves and the company’s financial risk is reduced when the loan is converted into equity since the liability portion of the balance sheet shrinks.
Possible Dilution of Current owners: When loans are converted into equity, new shares are usually issued, which may reduce the proportion of current owners that own shares. This may have an effect on voting rights and dividend distribution.
Enhanced Compliance: In order to adhere to corporate governance standards, there can be a rise in reporting and disclosure requirements with a new class of shareholders.
Tax Repercussions: There may be a number of tax ramifications when loans are converted to equity. For example, depending on the jurisdiction, the conversion can result in a taxable event. To comprehend these ramifications, speaking with a tax expert is advised.
Modifications to Decision-Making and Control: The decision-making process and the general course of the business may be impacted if the lender, who is now a shareholder, owns a sizable portion of the shares.
Increased Investor Confidence: A stronger balance sheet and lower financial risk can increase investor confidence and possibly attract more potential investors to the business.
Conclusion
Although it requires careful consideration and adherence to legal and regulatory frameworks, turning loans into shares is a calculated financial move. One must carefully consider the practicalities, seek professional advice, and understand the advantages and disadvantages in order to effectively embark on this trip.
Businesses and lenders can successfully manage the risks involved in loan-to-share conversions while gaining access to the special benefits that come with them by carefully navigating the complexity. To put it simply, it’s a delicate dance in which cautious movements lead to compliance and financial potential.
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Author – CS Divesh Goyal, GOYAL DIVESH & ASSOCIATES Company Secretary in Practice from Delhi and can be contacted at csdiveshgoyal@gmail.com).
Author Bio
At the time of conversion of loan to shares, Can company issue preference shares u/s 42 instead of Equity shares u/s 62(3) ???
If loan was taken when it was a partnership firm and after getting converted into company it want to convert its loan into equity. What can be done in this situation.
my query is that a company B hold the shares of Company A and company B took loan from third party on May 2018 now in respect of settlement of that loan company B wants to give shares of Company A……is it possible???
Can u tell me the citation of the NCLT judgement?
Dear Sir,
Is it mandatory to execute the contract in case of conversion of loan into equity.
Section 81 Further issue of share capital:
The existing requirement of section 81 of the 1956 Act in regard to further issue of capital would no longer be restricted to public companies and would be applicable to private companies also, since sub-section 3 of section 81 of the 1956 Act has not been acknowledged in the 2013 Act.
Section 81 of the 1956 Act has been repealed to the extent of its overlap with the notified provisions of Section 62(1) to (3) of the 2013Act, w.e.f. 01-04-2014. Since Section 62(4) to (6) of the 2013 Act are yet to be notified, the corresponding section 81(3) provision 81(4) and section 94A(3) are still in force.
The provisions for conversion of loan into equity have been significantly amended under Companies Act, 2013 in comparison to Companies Act, 1956. By plane reading the ‘Section 81(3)(a) or (b) not applicable on Private Company in respect of Conversion of Debenture or loan into Share of the Company’, but Section 81(4) of 1956 Act applies to private companies unconditionally ‘Notwithstanding Clause to subsection (3)(a) section 81 inter alia for the reason stated below:
(i) Sub-section (4), (5), (6) and (7) of section 81 were added by section 5 of the Companies (Amendment) Act, 1963 (53 of 1963). It is obvious therefrom that section 81(3)(a) which was in the status before the introduction of sub-section (4).
(ii) It is well known that “if two sections of the same statute are repugnant, the rule is that the last must prevail. Subsection (4),
(iii) “Section 81(3) Nothing in this section shall apply – (a) private company; or” (b) to the increase of the subscribed capital of a public company caused in the circumstances specified in the said clause.
Sub-section (4) of Section 81 deals with an entirely different subject. It is a well-known principle in interpretation of statutes that one way in which repugnancy can be avoided is by regarding two apparently conflicting provisions as dealing with distinct matters or situations.
(iiii) The opening words of sub-section (4) section 81, viz., ‘notwithstanding anything contained in forgoing provisions of this section refer to sub-sections (1), (2) and (3) of section 81 and as such sub section (4) section 81 prevails over sub-section (3)(a) section 81 and in premises, an order under section 81(4) can be made by central govt even in respect of private company.
Dear Sir,
please provide me draft of special resolution of acceptance of laon and convert into equity in future
Can the valuation of shares be done at the time of conversion of loan into equity?? Or it is required to do valuation of shares when approval from shareholders will be taken??
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