Pre-emptive rights of Existing Shareholders for further issue of shares under Section 62 of the Companies Act, 2013

Currently, Section 62 of the Companies Act, 2013 are in operation to increase subscribed capital of the company by issue of further shares. As per this section further shares can be issued in different mode as under-

-By way of Right Issue;

-Under Employee Stock Options;

-By way of Preferential Allotment;

pursuant to satisfaction of the conditions specified in the Section.

Right issue is not defined under the Companies Act, 2013. However, Right issue may be defined as, offer of further issue of shares to the existing shareholders of the Company in proportion to their current paid up shareholding on rights basis including right to renounce the shares offered to the shareholders in favor of any other person.

As per Section 179(3) of the Companies, Act, 2013 the Board has power to issue securities. The Board of Directors of the Company shall exercise the said power on behalf of the company by means of resolutions passed at the meeting of the Board.

Now, question arise herein whether the further/additional shares can be given to an outsider without offering the existing shareholders under section 62(1)(a) of the Companies Act, 2013?

Now, we would like to give the answer of this question in the context of the Companies Act, and judicial pronouncement in this regard.

It is pertinent to note that in India, the Companies Act has always found mention regarding the presumptive right of the existing shareholders to the new shares of the company. Section 105C of the Companies Act, 1936 had explicit mention relating to the presumptive right of the existing shareholders.  That section runs as follows:

“Where the directors decide to increase the capital of the company by the issue of further shares such shares shall be offered to the members in proportion to the existing shares held by each member (irrespective of class) and such offer shall be made by notice specifying the number of shares to which the member is entitled and limiting a time within which the offer if not accepted, will be deemed to be declined; and after the expiration of such time, or on receipt of an intimation from the member to whom, such notice is given that he declines to accept the shares offered, the directors may dispose of the same in such manner as they think most beneficial to the company.”

Moreover, the Hon’ble Supreme Court while, dealing with this provision in the landmark case of Nanalal Zaver v. Bombay Life Assurance Co. Ltd, AIR 1950 SC 172, laid down that the company must give the first option to the existing shareholders before favouring anyone else.

Later on, the Companies Act, 1956 also clearly provides for a pre-emptive right of the shareholders to the new shares of the company.  Under Companies Act, 1956 a company is obligated to follow the procedure prescribed in Section 81 (including pre-emptive rights of the existing shareholders) only if the company has been in existence for two years (or) at “any time after the expiry of one year of the allotment of shares”.

Hon’ble the Supreme Court also recently in the landmark case of Sahara India Real Estate Corporation v. SEBI, (2013) held that Section 81 of the Companies Act, 1956 postulates a pre-emptive right on the part of the existing shareholders to the new issue of shares. Thus, it is evident that a company which engages in the further issue of shares should offer it to its existing shareholders before favouring anyone else (i.e. through Preferential allotment).

The Board of Directors of the Company should ensure that the existing shareholder is not unfairly treated. If new shares are issued without offering to the existing shareholders in proportion to their existing holding, then their share of control over the company would substantially reduce.  Moreover, the further/ additional shares, which are issued at a lower price, would facilitate outsiders to enter into the company in an extremely flexible manner but on the other hand, existing shareholders who has paid a higher price to acquire shares would stand to lose unfairly. Therefore, the existence of pre-emptive rights ensures the existing shareholders as there is no financial dilution. We can say that the existence of pre-emptive rights acts as a serious check on the directors’ discretion to issue further shares and not granting a pre-emptive right would result in an inequitable treatment of the existing shareholders.

By perusal of the Section 81 of the Companies Act, 1956, it is found that a company is not required to comply procedure prescribed in Section 81 of the Companies Act, 1956 if company allot shares within two years of its formation. This would include a situation wherein a company could disregard the pre-emptive rights of the shareholders if it allotted shares within two years of its formation.

The Legislature realizing the loophole and has made some changes in relation to the aspect of the further issue of shares in the Companies Act, 2013. It now obligates any company who issues further shares at “any time” to be within the ambit of Section 62 of the Companies Act, 2013. Therefore, it can be stated that it is a great step by the Government to ensure complete compliance with the procedure prescribed in the Act.

Further, unlike the erstwhile companies act of 1956, Section 62 of the Companies Act, 2013 applies to private companies as well. All the Companies i.e. Private Companies, Public Companies, Listed Companies as well as Unlisted Companies, shall follow Section 62 (1) (a) for issuance of Shares on right basis. The Companies whose shares are listed on recognized Stock Exchange/Exchanges shall also follow Securities and Exchange Board of India, (Issue of Capital and Disclosure Requirements) Regulations, 2009.

Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the authors whatsoever and the content is to be used strictly for educative purposes only.

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One Comment

  1. Sr says:

    A promoter wants to dilute his holding. How can he do it such that existing shareholders are given shares on a preferential basis at discounted rate, before an open OFS at higher rate?

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March 2021