Rights Issue: No Valuation or Escrow Account Required

A rights issue made exclusively to existing resident shareholders under Section 62(1)(a) of the Companies Act, 2013, does not legally require a valuation report or the establishment of an escrow account for subscription money. This is because the offer is made uniformly to all current shareholders, eliminating the possibility of preferential treatment or selective dilution, which is a key statutory protection. However, the requirement for a valuation report becomes mandatory in specific scenarios: first, if the company issues shares to outsiders (non-shareholders) through private placement or preferential allotment under Section 62(1)(c), and second, if the company has Foreign Direct Investment (FDI) and the rights issue involves non-resident shareholders. In the latter case, FEMA and RBI pricing guidelines apply, requiring the issue price to be at or above fair value, certified by a SEBI-registered Merchant Banker or a Chartered Accountant. For the subscription money, unlike a preferential allotment, a rights issue is exempt from the statutory requirement to deposit funds into a separate escrow account. Existing shareholders are considered insiders, leading to a lighter compliance framework where the funds can be credited directly to the company’s regular bank account and utilized, subject only to filing the return of allotment.

A. Valuation Requirement

In a rights issue under Section 62(1)(a) of the Companies Act, 2013, shares are offered to the existing shareholders in proportion to their current shareholding. Since the offer is made on a uniform basis to all shareholders, there is neither any element of preferential treatment nor the possibility of selective dilution of ownership. For this reason, the Companies Act, 2013 does not mandate the preparation or submission of a valuation report in the case of a pure rights issue to existing shareholders.

This right is a statutory entitlement of shareholders, as recognized by the Supreme Court in Nanalal Zaver v. Bombay Life Assurance Co. Ltd. (1950 SCR 391). Since the offer is made uniformly to all shareholders, there is neither any element of preferential treatment nor the possibility of selective dilution of ownership. Accordingly, the Companies Act, 2013 does not mandate the preparation or submission of a valuation report in such cases.

However, where the company has foreign direct investment (FDI) and the rights issue extends to non-resident shareholders, the regulatory framework prescribed under the Foreign Exchange Management Act, 1999 (FEMA) and the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, as well as the directions of the Reserve Bank of India (RBI), come into play. In such cases, the issue price must not be lower than the fair value of shares. The fair value is to be determined in accordance with internationally accepted pricing methodologies, such as the Discounted Cash Flow (DCF) method, and must be duly certified by a SEBI-registered Merchant Banker or a Chartered Accountant.

It is pertinent to note that valuation assumes significance only in specific circumstances, namely:

1. Issuance to persons other than existing shareholders – If the company allots shares to outsiders (through private placement under Section 62(1)(c) read with Section 42 of the Companies Act, 2013), a valuation report from a Registered Valuer is mandatory to ensure fairness and compliance.

2. Issuance by companies with FDI – In case of companies having foreign investment, the FEMA and RBI pricing guidelines strictly apply. The objective is to safeguard against undervaluation of shares and to ensure that non-resident investors are issued securities at or above their fair value.

Accordingly, for a domestic rights issue made exclusively to resident shareholders, no valuation is required under the Companies Act, 2013. Valuation becomes mandatory only in cases where shares are allotted to outsiders (non-shareholders) or when the rights issue involves non-resident shareholders, thereby attracting FEMA and RBI pricing regulations.

Different Scenario-

B. Escrow Account Requirement

The treatment of subscription money under the Companies Act, 2013 differs for preferential/private placements and rights issues, primarily due to the nature of the investors involved and the level of regulatory safeguards required.

1. Preferential Allotment / Private Placement

Under Section 42 read with Section 62(1)(c) of the Companies Act, 2013, and the corresponding rules, a company inviting subscription from outsiders through preferential allotment or private placement is subject to stricter safeguards.

• Mode of payment: Subscription money must be received strictly through banking channels, such as cheque, demand draft, or electronic transfer, to ensure traceability and transparency. Cash transactions are prohibited.
• Mandatory escrow arrangement: Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014 and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 require that all money received on application be deposited into a separate bank account with a scheduled bank, commonly referred to as an escrow account.
• Restriction on use of funds: The subscription money cannot be utilized by the company until:

1. The allotment of securities is completed, and

2. The return of allotment (Form PAS-3) is duly filed with the Registrar of Companies (ROC).

• Purpose of safeguard: This requirement acts as a protection mechanism for investors, particularly since private placement and preferential allotment involve outsiders or select investors who are not necessarily existing shareholders. It ensures that the company cannot prematurely access or misuse the funds before meeting all legal and compliance formalities.

2. Rights Issue

In contrast, a rights issue under Section 62(1)(a) is governed by a lighter compliance regime, given the nature of the offer.

• No escrow requirement: There is no statutory requirement under the Companies Act, 2013 or its allied rules to maintain a separate escrow account for subscription money received in a rights issue.
• Rationale: A rights issue is offered only to existing shareholders, who are already part of the company’s ownership framework. Since they enjoy statutory pre-emptive rights and are considered insiders, the law presumes a lower risk of misapplication of funds compared to outsiders.
• Utilization of funds: Subscription money received on a rights issue may be directly credited to the company’s bank account and utilized in the ordinary course of business, subject only to compliance with filing requirements such as submission of the return of allotment (Form PAS-3) with the ROC.

Key Distinction

In the case of preferential allotments or private placements, the law requires stricter safeguards to protect investors. Subscription money must be received only through banking channels and deposited in a separate escrow account with a scheduled bank. The company cannot access or utilize these funds until the allotment of securities is completed and the prescribed return of allotment (Form PAS-3) is filed with the Registrar of Companies (ROC). This escrow mechanism ensures that funds are ring-fenced, prevents premature utilization or misapplication, and introduce confidence in outside investors who are not already part of the company’s ownership base.

By contrast, in a rights issue under Section 62(1)(a) of the Companies Act, 2013, there is no statutory obligation to maintain an escrow account. The offer is made only to existing shareholders in proportion to their shareholding, thereby safeguarding their pre-emptive rights and avoiding selective dilution. Since these shareholders are already part of the company’s ownership structure, the perceived risk of misuse of subscription funds is significantly lower. Consequently, the subscription amount received in a rights issue can be directly credited into the company’s regular bank account and applied for business purposes, subject only to procedural compliance such as filing the return of allotment (Form PAS-3).

This contrast underscores the legislative intent:

• When capital is raised from outsiders (through preferential allotments/private placements), additional safeguards such as escrow arrangements are necessary to protect investors, promote transparency, and enforce regulatory discipline.
• When capital is raised from existing shareholders (through a rights issue), the law treats it as essentially an internal matter of the company, and therefore subjects it to a lighter compliance framework with no escrow requirement.

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