Issue of Employee Stock Options by Private Limited Companies

(A). Introduction: Section 62(1)(b) of the Companies Act, 2013 provides that 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 employees under a scheme of employees’ stock option, subject to special resolution passed by company and subject to such conditions as may be prescribed.

“Employees’ Stock Option” means the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price [Section 2(37)]

Section 42(2) of the Companies Act, 2013 provides that the offer of securities or invitation to subscribe securities, shall be made to such number of persons not exceeding fifty or such higher number as may be prescribed [200 persons in the aggregate in a financial year as per Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014], (excluding qualified institutional buyers, and employees of the company being offered securities under a scheme of employees stock option as per provisions of clause (b) of sub-section (1) of section 62), in a financial year and on such conditions (including the form and manner of private placement) as may be prescribed.

Explanation to Rule 13 of Companies (Share Capital and Debentures) Rules, 2014 also provides that ‘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 employee stock option scheme, employee stock purchase scheme.

Section 197(7) of the Companies Act, 2013 provides that notwithstanding anything contained in any other provision of this Act but subject to the provisions of this section, an independent director shall not be entitled to any stock option and may receive remuneration by way of fees provided under sub-section (5), reimbursement of expenses for participation in the Board and other meetings and profit related commission as may be approved by the members

(B). Procedure to be followed by private limited companies for offering shares under ESOS:

Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 provides that a company, other than a listed company, which is not required to comply with Securities and Exchange Board of India Employee Stock Option Scheme Guidelines [now SEBI (Share Based Employee Benefits) Regulations, 2014] shall not offer shares to its employees under a scheme of employees’ stock option (hereinafter referred to as “Employees Stock Option Scheme”), unless it complies with the following requirements, namely:—

(1) Scheme to be approved by passing special resolution: The issue of Employees Stock Option Scheme has been approved by the shareholders of the company by passing a special resolution.

Explanation: For the purposes of clause (b) of sub-section (1) of section 62 and this rule “Employee” means—

(a) a permanent employee of the company who has been working in India or outside India; or

(b) a director of the company, whether a whole time director or not but excluding an independent director; or

(c) an employee as defined in clause (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company

but does not include—

(i) an employee who is a promoter or a person belonging to the promoter group; or

(ii) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.

(2) Specified disclosures to be made in the explanatory statement:  The company shall make the following disclosures in the explanatory statement annexed to the notice for passing of the resolution—

(a) the total number of stock options to be granted;

(b) identification of classes of employees entitled to participate in the Employees Stock Option Scheme;

(c) the appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;

(d) the requirements of vesting and period of vesting;

(e) the maximum period within which the options shall be vested;

(f) the exercise price or the formula for arriving at the same;

(g) the exercise period and process of exercise;

(h) the Lock-in period, if any;

(i) the maximum number of options to be granted per employee and in aggregate;

(j) the method which the company shall use to value its options;

(k) the conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct;

(l) the specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee; and

(m) a statement to the effect that the company shall comply with the applicable accounting standards.

(3) Exercise price can be determined in accordance with applicable accounting policies: The companies granting option to its employees pursuant to Employees Stock Option Scheme will have the freedom to determine the exercise price in conformity with the applicable accounting policies, if any.

(4) Shareholders’ approval through separate resolution required in certain cases: The approval of shareholders by way of separate resolution shall be obtained by the company in case of—

(a) grant of option to employees of subsidiary or holding company; or

(b) grant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.

(5) Terms of ESOS not yet exercised may be varied only in non-prejudicial manner by passing special resolution: The company may by special resolution, vary the terms of Employees Stock Option Scheme not yet exercised by the employees provided such variation is not prejudicial to the interests of the option holders. The notice for passing special resolution for variation of terms of Employees Stock Option Scheme shall disclose full of the variation, the rationale therefor, and the details of the employees who are beneficiaries of such variation.

(6) Minimum one year shall exist between granting and vesting of options and companies to have freedom to specify lock in period: There shall be a minimum period of one year between the grant of options and vesting of option. However, where options are granted by a company under its Employees Stock Option Scheme in lieu of options held by the same person under an Employees Stock Option Scheme in another company, which has merged or amalgamated with the first mentioned company, the period during which the options granted by the merging or amalgamating company were held by him shall be adjusted against the minimum vesting period required under this clause. The company shall have the freedom to specify the lock-in period for the shares issued pursuant to exercise of option.

(6.1.) No right to receive any dividend or to vote till exercise of option: The Employees shall not have right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of option granted to them, till shares are issued on exercise of option.

(7) Amount payable at the time of grant of option may be forfeited or refunded, as the case may be, by the company: The amount, if any, payable by the employees, at the time of grant of option—

(a) may be forfeited by the company if the option is not exercised by the employees within the exercise period; or

(b) the amount may be refunded to the employees if the options are not vested due to non-fulfilment of conditions relating to vesting of option as per the Employees Stock Option Scheme.

(8) Transferability, etc. of options granted:

(a) The option granted to employees shall not be transferable to any other person.

(b) The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

(c) Subject to clause (d), no person other than the employees to whom the option is granted shall be entitled to exercise the option.

(d) In the event of the death of employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

(e) In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.

(f) In the event of resignation or termination of employment, all options not vested in the employee as on that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the Board.

(9) Disclosures in Directors’ Report: The Board of directors, shall, inter alia, disclose in the Directors’ Report for the year, the following details of the Employees Stock Option Scheme:

(a) options granted;

(b) options vested;

(c) options exercised;

(d) the total number of shares arising as a result of exercise of option;

(e) options lapsed;

(f) the exercise price;

(g) variation of terms of options;

(h) money realized by exercise of options;

(i) total number of options in force;

(j) employee wise details of options granted to:—

(i) key managerial personnel.

(ii) any other employee who receives a grant of options in any one year of option amounting to five per cent or more of options granted during that year.

(iii) identified employees who were granted option, 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.
(10) Company to maintain register of ESOS in prescribed Form:

(a) The company shall maintain a Register of Employee Stock Options in Form No. SH.6 and shall forthwith enter therein the particulars of option granted under clause (b) of sub-section (1) of section 62.

(b) The Register of Employee Stock Options shall be maintained at the registered office of the company or such other place as the Board may decide.

(c) The entries in the register shall be authenticated by the company secretary of the company or by any other person authorized by the Board for the purpose.

(The above article is contributed by CA Kamal Garg having professional and academic interests in IFRS, Accounts, Auditing and Corporate Laws arenas. He can be approached at cakamalgarg@gmail.com)