Convertible Notes in India: Companies Act Compliance, Private Placement, Deposits and Stamp Duty
Summary: A convertible note is commonly papered as though Section 62(3) and Form MGT-14 were the whole of the law. They are not. The instrument is a debenture within Section 2(30), it is issued by private placement under Section 42, and it bears stamp duty at a rate fixed by Parliament and not by the State. This article sets out the classification and what follows from it, the deposit exclusion in Rule 2(1)(c)(xvii) and the trap in its single-tranche condition, the sequence Section 42 and Rule 14 impose, the stamp duty position, and the remedial sequence where an offer has gone wrong.
- 1. Introduction
- 2. The instrument and its classification
- 2.1 The statutory definition
- 2.2 A convertible note is a debenture
- 2.3 It is not a SAFE
- 3. The deposit exclusion
- 3.1 The five conditions of Rule 2(1)(c)(xvii)
- 3.2 The single-tranche condition: a structural trap
- 3.3 The alternative exclusions
- 4. The private placement machinery
- 4.1 The sequence
- 4.2 Rule 14(8): the provision most often contravened
- 4.3 A separate special resolution for every offer
- 4.4 Section 42(5): the gate on the second tranche
- 4.5 The limit of two hundred persons
- 5. After allotment
- 6. Stamp duty
- 6.1 The rate is central; the revenue is the State’s
- 6.2 Who pays, and through whom
- 6.3 Timing decides the consequence, not the amount
- 7. Conversion
- 8. Where it has already gone wrong
- 9. Conclusion
- References
1. Introduction
The convertible note has become the default instrument of early-stage Indian fundraising. A company that cannot yet be valued takes money now and issues an instrument that converts into equity at a price the next priced round will fix, subject to a cap and a discount. The commercial logic is simple and the drafting is short, and both facts contribute to the compliance treatment being thinner than it ought to be.
Much of the available guidance addresses the note as a Section 62(3) borrowing with a Form MGT-14 attached, deals at length with the exchange control position where the subscriber is non-resident, and goes no further. On the domestic side that treatment is incomplete in four respects, each of which matters.
- It does not classify the instrument. A convertible note is a debenture, and a substantial part of the Act follows from that single proposition.
- It omits the private placement machinery of Section 42 and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014, which carry both a penalty regime and a mandatory sequence.
- It omits stamp duty on the note itself, treating stamping as something that happens to share certificates after conversion.
- It states the return of allotment as a thirty-day filing. Under Section 42(8) read with Rule 14(6) it is due within fifteen days, and until it is filed Section 42(4) forbids utilisation of the money.
What follows states the position as the author understands it, with the provisions relied upon identified so that the reader may take a different view with reasons. References appear at the end.
2. The instrument and its classification
2.1 The statutory definition
Explanation II to Rule 2(1)(c)(xvii) of the Companies (Acceptance of Deposits) Rules, 2014 defines a convertible note as an instrument evidencing receipt of money initially as a debt, repayable at the option of the holder, or convertible into such number of equity shares of the start-up company upon occurrence of specified events and as per the terms indicated in the instrument. Three features follow: the money is a debt when received, repayment is at the holder’s option and not the company’s, and the conversion terms are stated in the instrument itself. An instrument that leaves conversion to a future agreement does not answer the definition.
2.2 A convertible note is a debenture
Section 2(30) defines a debenture to include debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. A convertible note is an instrument of a company, issued against money received, which the company must either convert or repay. It evidences a debt. That it is unsecured is expressly immaterial, and a nominal coupon does not alter its character. The classification is not academic. It carries the following with it.
| Consequence | Provision |
|---|---|
| Special resolution for the issue of debentures | Section 71(1) read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 |
| Register of debenture-holders in Form MGT-2 | Section 88(1)(b) read with Rule 5(1) of the Companies (Management and Administration) Rules, 2014 |
| Certificate within six months of allotment | Section 56(4)(d) |
| Return of allotment in Form PAS-3 within fifteen days | Section 42(8) read with Rule 14(6) |
| Stamp duty at the rate prescribed for debentures | Section 2(10A) and Article 27(a) of Schedule I to the Indian Stamp Act, 1899 |
| Reporting in Form DPT-3 | Rule 16 of the Deposit Rules. An amount excluded from the definition of deposit remains a reportable transaction |
2.3 It is not a SAFE
The Simple Agreement for Future Equity has no counterpart in Indian company law, and two differences are decisive. A SAFE is not debt, whereas the Indian definition requires money received initially as a debt; and a SAFE may remain outstanding indefinitely, whereas the exclusion in Rule 2(1)(c)(xvii) applies only where the instrument converts, or is repayable, within ten years of issue, ten years having been substituted for five by G.S.R. 548(E) dated 7 September 2020. An instrument drawn on an imported template, under which conversion depends on a financing that may never occur and no outer date is given, fails that condition. The answer is an automatic conversion at a stated valuation well inside the period.
3. The deposit exclusion
If the amount received is a deposit, Chapter V and the Deposit Rules apply in full: credit rating, deposit insurance, the deposit repayment reserve, trustees and the circular in Form DPT-1. No early-stage private company can comply, and acceptance in contravention engages Section 73 with the consequences that follow for the company and every officer in default.
3.1 The five conditions of Rule 2(1)(c)(xvii)
The clause excludes from “deposit” an amount of twenty-five lakh rupees or more received by a start-up company, by way of a convertible note convertible into equity shares or repayable within a period not exceeding ten years from the date of issue, in a single tranche, from a person. Each limb is a separate condition.
| Condition | What it requires | |
|---|---|---|
| (a) | Twenty-five lakh rupees or more | A floor tested per note and per person. Two subscribers of fifteen lakh each do not aggregate to thirty lakh |
| (b) | Received by a start-up company | Recognition by the Department for Promotion of Industry and Internal Trade under G.S.R. 127(E) dated 19 February 2019, subsisting on the date of receipt. An application pending on that date will not do |
| (c) | By way of a convertible note | As defined in Explanation II: money received initially as debt, repayment at the holder’s option, conversion terms stated in the instrument |
| (d) | Convertible or repayable within ten years | An outer date on the face of the instrument |
| (e) | In a single tranche, from a person | The whole of the amount of the note must be received in one payment from one subscriber |
3.2 The single-tranche condition: a structural trap
Condition (e) is the one most often defeated, and it is defeated by a drafting habit rather than by any decision. Where the parties agree an aggregate to be drawn in instalments against milestones, the instinct is to issue one note for the aggregate and treat each receipt as a drawdown. That approach is sound for a subscription agreement in respect of shares. Here it is fatal.
A note issued for an aggregate against which only part has been received is not an amount received in a single tranche. It is a part-paid instrument, and the exclusion does not reach it. The company is in receipt of a deposit accepted without any of the machinery of Chapter V, and the position is not retrieved by the balance being received later: the contravention arises on the date of first receipt and does not depend on what follows.
The answer must be built into the documents before execution. The investment agreement fixes the aggregate, the instalments and the conditions precedent to each. Each instalment is then the subject of a separate convertible note of twenty-five lakh rupees or more, issued against a single payment, with its own offer letter in Form PAS-4, its own allotment and its own return in Form PAS-3. The subscriber’s commercial position is unaltered; the company’s compliance position is transformed.
3.3 The alternative exclusions
Two other clauses cover what clause (xvii) does not. Clause (xviii) excludes amounts received by a start-up company from an alternative investment fund, a venture capital fund or a mutual fund registered with the Securities and Exchange Board of India, and carries no single-tranche condition. Clause (ix) excludes amounts raised by bonds or debentures compulsorily convertible into shares within ten years. Where the amount is below the floor, or cannot come in one payment, compulsorily convertible debentures within clause (ix), or compulsorily convertible preference shares, which are share capital and were never deposits, achieve the same commercial result soundly. The choice between the three belongs before the term sheet; taken afterwards it requires something to be unwound.
4. The private placement machinery
A convertible note is almost invariably offered to an identified person, which brings the issue within Section 42 and Rule 14. Section 42 carries its own penalty in sub-section (9), the company, its promoters and directors being liable to a penalty which may extend to the amount raised or two crore rupees, whichever is lower, with refund within thirty days. It is drafted as a sequence, and the order of the steps is itself part of the obligation.
4.1 The sequence
| Step | Provision and point to watch | |
|---|---|---|
| 1 | Valuation | Not mandatory for a resident subscriber, but the report fixing the valuation cap is what the Board acts on and what the explanatory statement must disclose. For a non-resident subscriber, pricing is governed by the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 |
| 2 | Board meeting | Approval of the offer, the record of names of identified persons, the form of the instrument and the opening of the separate bank account. Section 179(3)(c) |
| 3 | Special resolution | Rule 14(1). The explanatory statement under Section 102 must carry the disclosures in the proviso, including the justification for the price. The same resolution should carry the authority under Section 71(1) and the approval required by the proviso to Section 62(3) |
| 4 | File Form MGT-14 | Within thirty days under Section 117(1) and, critically, before the offer letter issues. See paragraph 4.2 |
| 5 | Issue Form PAS-4 | Rule 14(3). Serially numbered, addressed to the person by name, sent within thirty days of recording the names, with an application form and no right of renunciation |
| 6 | Maintain Form PAS-5 | Rule 14(4). The complete record of the offer, maintained though no longer filed |
| 7 | Receive the subscription | Section 42(6): a separate bank account with a scheduled bank. Rule 14(5): from the subscriber’s own bank account, the company keeping the record of it. Cash is not permitted |
| 8 | Stamp, then execute | Duty at 0.005 per cent remitted and the certificate obtained before the instrument is executed. See paragraph 6 |
| 9 | Allot within sixty days | Section 42(6). Failing allotment, repayment within fifteen days thereafter, and after that with interest at twelve per cent per annum from expiry of the sixtieth day |
| 10 | File Form PAS-3 | Section 42(8) read with Rule 14(6): within fifteen days of allotment, with the list of allottees. Until filed, Section 42(4) forbids utilisation |
| 11 | Registers and returns | Entry in Form MGT-2 within seven days of the allotment resolution, Rule 5(1) of the Management and Administration Rules; certificate within six months, Section 56(4)(d); Form DPT-3 on or before 30 June each year, Rule 16 of the Deposit Rules |
4.2 Rule 14(8): the provision most often contravened
Rule 14(8) provides that a company shall issue the private placement offer cum application letter only after the relevant special resolution or Board resolution has been filed in the Registry. It is easily overlooked: it is a sequencing rule rather than a disclosure rule, and thirty days are available for the Form MGT-14 while the pressure is to issue the offer letter at once. Registrars have imposed penalties under Section 450 for this contravention in orders where every other step was in order. The Form MGT-14 is a gating item, not a post-completion formality.
4.3 A separate special resolution for every offer
Rule 14(1) requires the offer to have been previously approved by a special resolution. The relaxation permitting one special resolution a year for all offers is confined by the proviso to non-convertible debentures within the limit in Section 180(1)(c), and a convertible note is by definition not that. Two instalments therefore require two offers and two special resolutions. They may be passed at the same general meeting, and ordinarily should be; what they may not do is share one resolution.
4.4 Section 42(5): the gate on the second tranche
Section 42(5) prohibits a fresh offer unless the allotment under any earlier offer has been completed, or that offer has been withdrawn or abandoned. Read with Section 42(4), the practical rule is that a second offer letter may not issue until the first allotment is complete and its Form PAS-3 is on the record. Where two closings fall a short interval apart, the gating item is the company’s own filing and not the subscriber’s remittance, a point to be explained before the term sheet fixes dates that cannot be met.
4.5 The limit of two hundred persons
Rule 14(2) caps the offer at two hundred persons in the aggregate in a financial year, reckoned individually for each kind of security, the proviso excluding qualified institutional buyers and employees offered securities under a stock option scheme. The Explanation to Section 42 adopts the meaning given to a qualified institutional buyer in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, and Regulation 2(1)(ss) includes an alternative investment fund registered with the Board. A subscription by a registered AIF therefore does not consume a place in the count, and the exclusion should be recorded in the explanatory statement and the minutes.
5. After allotment
No form is prescribed for a debenture certificate. Form SH-1 is prescribed by Rule 5(2) of the Companies (Share Capital and Debentures) Rules, 2014 for certificates of shares, and issuing a convertible note on an SH-1 is an error apparent on the face of the document. The certificate is drawn to suit the instrument and issued under Section 56(4)(d) within six months of allotment.
The register in Form MGT-2 is required by Section 88(1)(b), and Rule 5(1) of the Companies (Management and Administration) Rules, 2014 requires the entry within seven days of the Board resolution, not of the certificate. It is authenticated under Rule 8, kept at the registered office unless the members resolve otherwise under Section 94, and preserved for eight years from redemption under Rule 15(2).
Three things do not apply: no debenture redemption reserve, Rule 18(7) confining the reserve to the non-convertible portion; no trust deed in Form SH-12, Section 71(5) and Rule 18(1) being engaged by an offer to the public or to more than five hundred members; and no charge, the instrument being unsecured. One further matter belongs on the critical path. Rule 9B requires every private company other than a small company to issue securities only in dematerialised form, the compliance date having been extended to 30 June 2025, so the ISIN must be in place before allotment rather than after.
6. Stamp duty
6.1 The rate is central; the revenue is the State’s
Section 2(10A) of the Indian Stamp Act, 1899 defines debenture in terms that track Section 2(30) of the Companies Act, including any other instrument of a company evidencing a debt. The classification in paragraph 2.2 therefore holds for the stamp law. Article 27(a) of Schedule I, as substituted by the Finance Act, 2019 with effect from 1 July 2020, fixes the duty on the issue of a debenture at 0.005 per cent of the consideration, and on transfer or re-issue at 0.0001 per cent.
Those rates are not open to the States. Entry 91 of List I reserves to Parliament the rates of stamp duty on, among other instruments, debentures; Entry 63 of List II confers rates on the States only for documents other than those in Entry 91. A State schedule therefore contains no article for the issue of a debenture, and that absence is not a lacuna to be supplied by stamping the instrument as an agreement. Doing so leaves it liable under the central article and unstamped for the purpose.
6.2 Who pays, and through whom
Where securities are issued through a stock exchange or a depository, Section 9A makes the depository the collecting agent, duty being collected from the issuer before any transaction is executed in the depository system. Where securities are issued otherwise than through a stock exchange or a depository, Section 9B places the liability on the issuer, the duty being payable at the place where its registered office is located.
The practical difficulty is that State e-stamping systems were not designed to collect a central rate on the issue of a debenture. The route now generally taken rests on S.O. 116(E) dated 8 January 2020, by which registrars to an issue and share transfer agents registered with the Securities and Exchange Board of India are notified as a depository for the limited purpose of acting as a collecting agent. Remitting through such an agent converts a payment by the issuer under Section 9B into a collection under Section 9A, and produces a stamp certificate identifying the instrument, the allottee, the consideration and the duty. Guidance issued by the Board has, however, been framed in the context of units of alternative investment funds, so a view must be formed on the width of the notification and recorded on the file with reasons.
6.3 Timing decides the consequence, not the amount
The sums are small, 0.005 per cent of one crore rupees being five hundred rupees, and the smallness is why the point is neglected. The consequence is not small. Every State stamp law requires an instrument to be stamped before or at the time of execution; Section 17 of the Karnataka Stamp Act, 1957 is in those terms and the provisions elsewhere are to the same effect. An instrument not duly stamped is inadmissible in evidence and liable to be impounded, the deficiency recoverable with penalty. A convertible note establishes the holder’s entitlement to shares and is produced years later, in a diligence exercise or a dispute, where the defect is least convenient. Remit the duty, obtain the certificate, and only then execute.
7. Conversion
Conversion is not a fresh issue of securities to a new person. It is performance of an obligation the company assumed when it borrowed. The proviso to Section 62(3) permits a company to convert debentures into shares where the terms of the issue have been approved before the issue by a special resolution passed in general meeting.
The approval must precede the issue. A company that passes its conversion resolution at the time of conversion, the point at which the question naturally presents itself, has lost the proviso and must bring the allotment within Section 62(1)(c), with a valuation report under Rule 13 of the Share Capital and Debentures Rules and a price no longer fixed by the instrument.
The resolution authorising the issue should therefore set out the conversion terms in full, the trigger events, the valuation cap, the discount, the formula and the outer date, and expressly approve conversion on those terms under the proviso. On conversion there follow a Board resolution allotting the shares, a return in Form PAS-3, entries in the register of members, certificates in Form SH-1 within two months under Section 56(4)(c), stamp duty on those certificates under the State Act, and the closing entry in the register of debenture-holders. The note is extinguished by conversion; nothing is repaid.
8. Where it has already gone wrong
A practitioner is as often asked to repair a private placement as to paper one, and the first task is to separate what can be cured from what cannot. Four things cannot: a note issued for an aggregate against which only part has been received, the contravention having arisen on receipt; money received before the offer letter issued or before the resolution was filed under Rule 14(8); an instrument executed before it was stamped, the duty being capable of being made good on impounding but the lateness not; and a conversion authority passed after the issue rather than before it, for the purposes of the proviso to Section 62(3).
Section 42(5) itself contemplates that an offer may be withdrawn or abandoned by the company, and that is the provision on which a remedial plan ordinarily rests. Where an offer has been made but the allotment under it is defective or incomplete, the orderly sequence is as follows.
| Step | What it requires |
|---|---|
| Abandon the offer | A Board resolution recording the facts as they are, the defect, and the decision to abandon under Section 42(5). A minute drawn to obscure the defect is worse than the defect |
| Rescind any purported allotment | The resolution rescinding the allotment and the consequential entries in the registers |
| Refund the subscription | From the separate account to the account it came from, the transaction reference recorded in the minutes |
| Amend the agreement | Where the agreement provided for the defective structure, an amendment executed and stamped in its own right |
| Fresh resolution and Form MGT-14 | Fresh approval, filed before the fresh offer letter. Rule 14(8) |
| Fresh Form PAS-4 and receipt | A new serially numbered offer letter and a fresh single-tranche receipt into the separate account |
| Stamp, allot and file | In the order set out in paragraph 4.1, with duty remitted before the instrument is executed |
This is not a device for rewriting history. It is a mechanism the statute provides, it works only where the facts recorded are the facts, and the refund must be genuine and must precede the fresh offer, Section 42(5) requiring the earlier offer to have been abandoned first.
9. Conclusion
Nothing set out above is obscure. Every provision relied upon is in the bare Act, in a rule that has been in force for years, or in a notification of 2019 or 2020. None of the steps is expensive, and none calls for judgment of a kind the ordinary practitioner does not exercise weekly. The difficulty is not one of law but of order.
Convertible notes go wrong because the instrument presents as informal. It is short, the parties are on good terms, the amounts are modest against what is expected to follow, and the paperwork is treated as something to be regularised once the money has moved. It is the one transaction in which that order does not work: by the time the file is examined the receipt has occurred, the date has passed and the instrument has been executed, and of the four failures described in paragraph 8 none can be corrected after the event.
Three habits dispose of most of the risk. Settle the instrument, whether a note, a compulsorily convertible debenture or a compulsorily convertible preference share, before the term sheet rather than after the money. Treat Form MGT-14 and Form PAS-3 as gating items rather than filings, because Rule 14(8) and Section 42(5) make them so. And remit the stamp duty before execution, however small the sum. The contribution a professional makes to a transaction of this kind lies less in the drafting than in the sequence.
References
- Companies Act, 2013: Sections 2(30), 42, 56, 62, 71, 73, 88, 94, 101, 102, 117, 179, 180 and 450.
- Companies (Prospectus and Allotment of Securities) Rules, 2014: Rules 9B and 14.
- Companies (Acceptance of Deposits) Rules, 2014: Rule 2(1)(c)(ix), (xvii) and (xviii), and Rule 16.
- Companies (Share Capital and Debentures) Rules, 2014: Rules 5, 13 and 18.
- Companies (Management and Administration) Rules, 2014: Rules 5, 8 and 15.
- Companies (Acceptance of Deposits) Amendment Rules, 2020, G.S.R. 548(E) dated 7 September 2020.
- Notification G.S.R. 127(E) dated 19 February 2019, Department for Promotion of Industry and Internal Trade.
- Indian Stamp Act, 1899: Sections 2(10A), 9A and 9B, and Articles 27 and 56A of Schedule I, as amended by the Finance Act, 2019.
- Notification S.O. 116(E) dated 8 January 2020, Department of Revenue, Ministry of Finance.
- Karnataka Stamp Act, 1957: Section 17.
- Constitution of India, Seventh Schedule: List I Entry 91 and List II Entry 63.
- SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: Regulation 2(1)(ss).
- Foreign Exchange Management (Non-debt Instruments) Rules, 2019.
- Secretarial Standards SS-1 and SS-2 issued by the Institute of Company Secretaries of India.
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About the author: CS Avil Rakshith Salins is a Company Secretary in practice (ACS 48442, CP 28369) and the proprietor of Salins & Co., Bengaluru.”
Disclaimer: This article states the law as the author understands it on 26 October 2026 and is intended for general professional information. It is not advice on any particular transaction, and no client matter is described in it. Readers should take advice on their own facts before acting.
