Issuance of OCD through Right issue is allowed ?

Issuance of OCD through Right issue is allowed ?

Question: Can the Company issue OCD/CCD through Right issues under Section 62(1)(a) of the Companies Act, 2013 (“Act”)?

Answer: No, a company cannot issue OCDs (Optionally Convertible Debentures) or CCDs (Compulsorily Convertible Debentures) through a rights issue under Section 62(1)(a) of the Companies Act, 2013.

Explanation:

1. Applicable Section:

OCDs and CCDs, being convertible debentures, fall under the broader category of “shares or other securities” as defined in Rule 13(1) of Companies (Share Capital and Debentures) Rule, 2014. Therefore, their issuance is governed by Section 62(1)(c) of the Act, which specifically deals with the preferential issue of shares or other securities.

2. Preferential Basis:

• To issue OCDs or CCDs, a company must follow the preferential allotment route under Section 62(1)(c) of the Act.
• This includes:
  • Obtaining a special resolution passed in a general meeting.
  • Complying with the conditions laid down in Section 42 of the Act read with Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014, which outline the procedural requirements for private placement of securities.

The basis of the Answer is on the order passed by RD Adjudication Orders in the case of Krishikan Krishikan Private Limited: Issue of OCDs on Right basis instead of Preferential basis: RD reduces Penalty

Facts of the Case:

The company has issued Optionally Convertible Debentures (OCDs) thrice i.e., on 24.07.2020, 10.12.2020 and 29.01.2021 respectively as per section 71 of the Act and allotted the same later. These OCDs have been issued as rights issued under section 62(1)(a) of the Act instead of preferential allotment under section 62(1)(c) of the Act. The company repaid the subscription amount to the debenture holders along with 12% interest.

The company has followed section 62 of the Act for the issue of OCDs in all 3 issues. The first issue is treated as a violation of section 42 of the Act, the remaining two issues may not fall under the ambit of violation of section 42 of the Act as the company has duly followed the method of rights issue of OCDs under section 62 of the Act while issuing the debentures in second and third instances which were offered to the friends of the shareholders-cum-directors after the renunciation of the offer made to them.

As per section 71 (1) of the Act, a company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption and as per the provisions of section 23(2) of the Act, a private company may issue securities (a) by way of rights issue or bonus issue in accordance with the provisions of this-Act or (b) through private placement by complying with the provisions of Part II of this Chapter (i.e. section 42 of chapter Ill of the Act).

Reference to Section 62(1)(c)

As per section 62(1)(c) of the Companies Act, 2013, where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered to any persons, if it is authorised by a special resolution, whether or not those persons include the persons referred to in clause (a) or clause (b) of section 62, either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer, subject to the compliance with the applicable provisions of Chapter II of Section 42 of the Act and any other conditions as may be prescribed. Further, as per Rule 13( 1) of Companies (Share Capital and Debentures) Rule, 2014, for the purpose of clause (c) of f sub-section ( 1) of section 62, if authorized by a special resolution passed in a general meeting, shares may be issued by any company in any manner whatsoever including by way of a preferential offer, to any persons whether or not those persons includes the persons referred to in clause (a) or clause (b) of sub-section ( 1) of section 62 and such issue on preferential basis also comply with conditions laid down in section 42 of the Act. The explanations provided for under this rule further clarify the scope of this section and rule and state that for the purposes of this rule,

(i) the expression ‘Preferential Offer’ means an issue of shares or other securities, by a company to any select person or group of persons on a preferential basis and does not include shares or other securities offered through a public issue, right issue, employee stock option scheme, employee stock purchase scheme or an issue of sweat equity shares or bonus shares or depository receipts issued in a country outside India or foreign securities;

(ii) the expression, “shares or other securities” means equity shares, fully convertible debentures, partly convertible debentures or any other securities, which would be convertible into or exchanged with equity shares at a later date.

As per section 42 of the Companies Act, 2013, a company may, subject to the provisions of this section, make a private placement of securities which shall be made only to a select group of persons who have been identified by the Board, whose number shall not exceed 200 in a financial year subject to such conditions as may be prescribed, which are provided for in Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014.

On the basis of the above summary RD conclude that the company ought to have issued OCDs under section 62(1 )(c) of the Act on preferential basis by complying with the conditions laid down in section 42 of the Act since OCDs fall under the definition of “shares or other securities” as provided for in the explanation to Rule 13( 1) of Companies (Share Capital and Debentures) Rule, 2014.

However, the company has issued OCDs wrongly under section 62(1)(a) as rights issue which is only meant for issue of shares (equity or preference) to the holders of equity shares in proportion to the paid-up share capital by sending a letter of offer.

Further, RD verified the minutes of the EoGM attached in the adjudication application that the shareholders have resolved to issue OCDs as rights issue and the company has failed to comply with the procedural requirements laid down in section 42 of the Act read with Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 viz. identifying the select group of persons to whom allotment of OCDs shall be made, issuing private placement offer and application form, receiving monies in a separate bank account, maintaining & filing the appropriate requisite records etc. Thus, the company has violated provisions of section 62( 1 )(c) of the Act by not following the appropriate method of issuing OCDs rendering the company and directors liable for action under section 450 of the Act and has violated provisions of section 42 of the Act for not following the procedure as mentioned above rendering the company, promoters and directors liable for action under section 42(10) of the Act for each of the three issues of OCDs.

The company in the adjudication application is not applicable in this case as this clause is applicable to the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to the debentures issued or loan raised by the company to convert such debentures or loans into shares in the company which is not the case.

The order passed by the RD

The RD has considered the following parameters before passing the order

a. The Company is engaged in Agriculture business and is a Startup and a Small company which is striving hard to scale up its business and to promote the ease of doing business which is the moto of the honourable Ministry of Corporate Affairs.

b. The company being closely held had issued optionally Convertible debenture to borrow money and to raise funds. If a higher penalty is levied, the company will face a higher borrowing cost which will substantially impede its ability to continue its operation.

c. The Company had no malafied intention in violating the sections mentioned above; the violation is due to the reasons mentioned in supra.

d. Considering various exemptions granted to a small company under the Companies Act, 2013, and due to the multiplicity of professional opinions on the applicability of the preferential allotment for the OCDs, the management has inadvertently failed to comply with sections 62 and 42 of the Act.

e. Due to the non-compliance, no injury to public interest is caused and this is the first time of default by the Company. No undue gain or unfair advantage is made due to the noncompliance and no loss is caused to anyone.

f. (a) Penalty of Rs. 45,000 to be paid by the company and each director (i.e. 2) under section 450 of the Act r/w Section 4468 of the Act for violation of Section 62( 1) (c) of the Act:

(b) Penalty of Rs. 3,00,000 to be paid by the company and each director (i.e.2) under section 42( 10) r/w Section 446B of the Act for violation of Section 42 of the Act:

Takeaways:

1. Understanding the nature of Securities and Issuance Processes: For professionals working with companies, it’s crucial to understand the nature of the securities being issued. This understanding guides the selection of the appropriate method and process for their issuance.

2. Professional Guidance and Verification: Companies and promoters should seek professional support before making decisions based on any advice, regardless of the source. This ensures a comprehensive understanding of the legal and regulatory landscape and minimizes the risk of relying on inaccurate or incomplete information.

3. Ignorance of the Law is No Defense: The legal principle of ignorantia juris non excusat, meaning “ignorance of the law excuses no one,” applies here. Neither directors nor companies can avoid liability for legal violations by claiming they were unaware of the relevant laws and regulations. It’s their responsibility to seek expert guidance and ensure their actions comply with all applicable requirements.