ESOP – All You want to know

The respective provisions of the Act and the Rules can be read in two perspectives i.e. provisions governing –

• Issue of ESOPs and
• Trust set-up, funding and operation for administration of ESOPs.

The provisions relating to issue of ESOPs are common for all the unlisted Companies irrespective of their status being Private or Public; whereas the provisions on Trust set-up, funding, etc. are relevant for an unlisted Public Company which is dealt with in the later part.

The provisions relating to issue of ESOPs applicable for all unlisted Companies are:

i. Employee under an ESOP Scheme – Rule 12(1) read with Section 2(37), 197(7) of the Companies Act, 2013 defines the term to mean any permanent employee or Director whether a whole-time or not and whether working in India or not. The employees and Directors of the Holding, Subsidiary and Associate Company are also covered. The specific exclusions are:

a) An Independent Director;

b) An employee who is a Promoter or belongs to the Promoter Group; and

c) A Director who directly or indirectly holds more than 10% of outstanding equity shares of the Company.

ii. Procedural requirements – Rules 12(1), 12(2) and 12(4) read with section 62(1)(b) of the Companies Act, 2013 require:

a) Approval of the ESOP Scheme by the members of the Company by way of a special resolution;

b) There shall be separate resolutions in case of grant of ESOPs to employees of the Subsidiary or Holding Company or in case of grant of ESOPs to identified employees equal to or exceeding 1% of the issued capital; and

c) The explanatory statement shall disclose prescribed details namely total number of ESOPs to be granted, appraisal process, requirements of vesting, exercise price or pricing formula, exercise period, lock-in period, method of accounting, etc.

iii. Other requirements – Rest of the Sub-rules of Rule 12 besides giving the flexibility to the Company to determine the exercise price and lock-in of shares, require:

a) Variation of terms of the ESOPs to be carried out by way of members’ approval by way of a special resolution provided it is not prejudicial to the interests of the employees;

b) Minimum vesting period of 1 year;

c) Non-transferability of the ESOPs;

d) Unvested ESOPs to vest in case of death or permanent incapacity of an employee;

e) Disclosure of prescribed details in the Directors’ Report; and

f) Maintenance of an ESOP Register.

In the context of ESOP, SEBI has notified on October 28, 2014, Securities and Exchange Board of India (Share Based Employee Benefits) Regulations, 2014.

It is to provide for regulation of all schemes by companies for the benefit of their employees involving dealing in shares, directly or indirectly, with a view to facilitate smooth operation of such schemes while preventing any possible manipulation and matters connected therewith or incidental thereto.

Applicability

Schemes:(i) employee stock option schemes;(ii) employee stock purchase schemes; (iii)stock appreciation rights schemes; (iv) general employee benefits schemes; and (v) retirement benefit schemes.

Any companyWhose shares are listed on a recognized stock exchange in India, and has a scheme:(i) for direct or indirect benefit of employees; and (ii) involving dealing in or subscribing to or purchasing securities of the company, directly or indirectly; and (iii)satisfying, directly or indirectly, any one of the following conditions: a.the scheme is set up by the company or any other company in its group; b.the scheme is funded or guaranteed by the company or any other company in its group; c. the scheme is controlled or managed by the company or any other company in its group.

Non- Applicability

Shares issued to employees in compliance with the provisions pertaining to preferential allotment as specified in the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009

Scheme may be implemented

• either directly
• By setting up an irrevocable trust(s) – the same has to be decided upfront at the time of taking approval of the shareholders for setting up the schemes.

Mandation for trust route, if the scheme involves secondary acquisition or gift or both

Single Trust

In case of a single trust, it shall keep and maintain –

• proper books of account,
• records and documents

for each such scheme so as to explain its transactions and to disclose at any point of time the financial position of each scheme and in particular give a true and fair view of the state of affairs of each scheme.

Trust Deed

• SEBI may specify the minimum provisions to be included in the trust deed
• Deed shall be mandatorily filed with the stock exchange in India where the shares of the company are listed.

Non-eligibility for being a trustee if the person

• is a director, key managerial personnel or promoter of the company or its holding, subsidiary or associate company or any relative of such director, key managerial personnel or promoter; or
• beneficially holds ten percent or more of the paid-up share capital of the company.

Trustee Type	Minimum such required
Individual or OPCs	2
Corporate Entity	1

Powers, Rights and Duties of Trustees

• Not entitled to vote in representative capacity.
• Trustees to ensure that appropriate approval has been obtained from shareholders.

Trust

• The trust shall not deal in derivatives.
• The trust shall undertake only delivery based transactions for the purposes of secondary acquisition.
• The company may lend monies to the trust on appropriate terms and conditions to acquire the shares either through new issue or secondary acquis ition, for the purposes of implementation of the scheme(s)

Acquisition Limits

• Secondary acquisition in a financial year < 2% of the paid up equity capital as at the end of the previous financial year
• The total number of shares under secondary acquisition held by the trust shall at no time exceed

S.No.	Particulars	Limits
A	for the schemes enumerated in Part A, Part B or Part C of Chapter III of these regulations	5%
B	for the schemes enumerated in Part D, or Part E of Chapter III of these regulations	2%
C	for all the schemes in aggregate	5%

*Above Limits shall include enhanced capital on account of bonus, rights or split.

*Limits shall be for aggregate of multiple trusts and schemes.

*Ceiling Limit not to apply where shares are allotted to the trust by way of new issue or gift from promoter or promoter group or other shareholders.

*If options, shares or SAR granted > number of shares that the trust may acquire through secondary acquisition, then such shortfall shall be made up by the company through new issue of shares to the trust.

• Un-appropriated inventory of shares which are not backed by grants, shall be appropriated within a reasonable period which shall not extend beyond the end of the subsequent financial year.

If not appropriated, then the same shall be disclosed to the stock exchange(s) at the end of such period and then the same shall be sold on the recognized stock exchange(s) where shares of the company are listed, within a period of five years from the date of notification of these regulations.

• Lock-in period – 6 months for such shares.

Off-market transfer of Shares

• transfer to the employees pursuant to scheme(s);
• when participating in open offer under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, or when participating in buy-back, delisting or any other exit offered by the company generally to its shareholders.

Compensation Committee Constitution

• For administration and superintendence of the schemes
• Committee of such members of the board of directors of the company as provided under section 178 of the Companies Act, 2013
• It shall, inter alia, formulate the detailed terms and conditions of the schemes which shall include the provisions as specified by Board.
• It shall frame suitable policies and procedures to ensure that there is no violation of securities laws

Approval of Shareholders

Approval of shareholders by way of separate resolution in the general meeting shall be obtained by the company in case of:

(a). Secondary acquisition for implementation of the schemes. Such approval shall mention the percentage of secondary acquisition (subject to limits specified under these regulations) that could be undertaken;

(b). Secondary acquisition by the trust in case the share capital expands due to capital expansion undertaken by the company including preferential allotment of shares or qualified institutions placement, to maintain the five per cent. cap as prescribed under sub-regulation (11) of regulation 3 of such increased capital of the company;

(c). Grant of option, SAR, shares or other benefits, as the case may be, to employees of subsidiary or holding or associate company;

(d). Grant of option, SAR, shares or benefits, as the case may be, to identified employees, during any one year, equal to or exceeding one per cent. of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option, SAR, shares or incentive, as the case may be.

Variation of terms of the schemes

• By Special Resolution in General Meeting
• The notice for passing special resolution for variation of terms of the schemes shall disclose full details of the variation, the rationale therefor, and the details of the employees who are beneficiaries of such variation

Non-transferability

• Not be transferable to any person
• No person other than the employee to whom the option, SAR or other benefit is granted shall be entitled to the benefit arising
• The option, SAR, or any other benefit granted to the employee shall not be pledged, hypothecated, mortgaged or otherwise alienated
• In the event of death of the employee, it shall vest in the legal heirs or nominees of the deceased employee
• In the event of permanent incapacity while in employment, as on the date of permanent incapacitation, shall vest in him on that day
• In the event of resignation or termination of the employee, all the options, SAR, or any other benefit, shall expire.

Certificate from auditors

The board of directors shall at each annual general meeting place before the shareholders a certificate from the auditors of the company that the scheme(s) has been implemented in accordance with these regulations and in accordance with the resolution of the company in the general meeting.

The above has been compiled by CS Reema Jain, an Associate Member of ICSI. Her areas of interest include Corporate and Allied Laws and advisory services. For any queries or suggestions, she can be approached at reemajaincs@gmail.com, 9953299308.

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