It is important to note that the term “loan” is not explicitly defined under the Companies Act, 2013 or the rules framed thereunder. In financial parlance, a loan generally refers to the borrowing of funds that the borrower is under an obligation to repay. Under the Act, Section 180(1)(c) places restrictions on the powers of the Board of Directors with respect to borrowing, by requiring shareholders’ approval through a special resolution when the aggregate borrowings of the company exceed the aggregate of its paid-up share capital, free reserves, and securities premium (excluding temporary loans obtained from bankers in the ordinary course of business).
The pertinent question that arises is whether a loan or borrowing taken by a company can subsequently be converted into equity, if required, or whether there exists any restriction in this regard under the Companies Act, 2013. In this context, Section 62(3) of the Act becomes relevant, as it specifically permits the conversion of loans or debentures into share capital of the company, provided that the terms of conversion are approved by the shareholders through a special resolution at the time of borrowing or issuance. Once such approval is obtained, no further compliance under Section 62(1) is required at the stage of conversion. Thus, loans validly borrowed in accordance with Section 180 can later be converted into equity under Section 62(3), subject to adherence to the prescribed conditions, thereby ensuring both legal validity and transparency.
Purposes of conversion
The conversion of a loan into equity under the Companies Act, 2013, serves multiple purposes. Primarily, it helps strengthen the company’s capital structure by reducing debt and improving the debt-to-equity ratio. It facilitates debt restructuring, enabling companies to manage financial stress and avoid defaults, while also allowing lenders or debenture holders to participate in the company’s growth. Conversion eliminates the interest burden on the loan, improves cash flows, and provides a legal and transparent mechanism under Section 62(3) for issuing shares to creditors. Additionally, it enhances the company’s capital base, making it easier to raise further funds and a signal of financial stability to investors.
Under the provisions of Section 62(3) of the Companies Act, 2013, a loan taken or debentures issued by a company may be converted into the company’s share capital in accordance with the conversion option attached to such loan or debenture at the time of borrowing or issuance. Such conversion, however, is valid only if it has been approved by the shareholders.
The section itself provides as follows:
“(3) Nothing in this section shall apply to the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to the debenture issued or loan raised by the company to convert such debentures or loans into shares in the company:
Provided that the terms of issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of loan by a special resolution passed by the company in general meeting.”
In essence, Section 62(3) carves out an exception to the general provisions of Section 62. Where the conversion option is pre-approved by the shareholders through a special resolution at the time of borrowing or issuance, the company is not required to again comply with the requirements of Section 62(1)(a) (rights issue) or Section 62(1)(c) (preferential allotment) at the stage of conversion.
The provisions of Section 62(3) of the Companies Act, 2013 commence with a non-obstante clause, which clarifies that if the terms of a loan or debenture, specifying an option for conversion into share capital, have been approved by the shareholders through a special resolution in a general meeting, no further approval of members is required at the time of conversion. In other words, once such terms have been pre-approved, the conversion of the outstanding loan or debentures into equity can be effected without complying with the other procedural requirements of Section 62, since the shareholders’ consent has already been duly obtained.
Illustration: ABC Ltd. proposes to raise a loan of ₹50 crore from a financial institution. As a part of the loan agreement (term sheet), it is agreed that in case of default or at the option of the lender, the outstanding loan (in whole or part) may be converted into equity shares of the company. Before availing the loan, ABC Ltd. obtains shareholders’ approval through a special resolution in the general meeting for incorporating such a conversion option.
Subsequently, the company faces financial stress and is unable to repay the loan. The lender exercises its right to convert the outstanding loan into equity shares. Since the conversion terms were already pre-approved by shareholders under Section 62(3), ABC Ltd. is not required to again comply with the provisions of Section 62(1)(a) (rights issue) or Section 62(1)(c) (preferential allotment) at the time of conversion.
Purpose of pre-approval of shareholders
The purpose of obtaining pre-approval of shareholders at the time of raising a loan or issuing debentures under Section 62(3) of the Companies Act, 2013, is to ensure the legal validity of future conversion into equity. Such pre-approval allows the company to avoid fresh compliance with Section 62(1)(a) or 62(1)(c) at the time of conversion, providing certainty to lenders or debenture holders that their conversion rights cannot be later denied. It also promotes transparency and disclosure, as the terms of conversion are communicated to shareholders in advance, and safeguards their interests by authorizing potential dilution of shareholding upfront.
Timing of Shareholders’ Approval under Section 62(3) of the Act
In the case of conversion of a loan or debenture into equity, there is an inherent dilution of the existing shareholding pattern. Therefore, the purpose of obtaining shareholders’ approval by way of a special resolution is to protect the interests of the shareholders and ensure that no shareholder is prejudiced by the conversion. This approval provides transparency and safeguards the rights of existing shareholders while allowing the company to legally effect the conversion.
Under Section 62(3) of the Companies Act, 2013, the preferred approach is to obtain shareholders’ approval at the time of issuing the loan or debenture, as part of its term sheet. This is because the section begins with a non-obstante clause, which provides that if the conversion option is already approved by shareholders through a special resolution, the company is exempt from complying with other provisions of Section 62 at the time of actual conversion. Obtaining approval beforehand ensures that lenders or debenture-holders can exercise their conversion rights without any risk of shareholder refusal later, thereby providing certainty and legal enforceability.
The Companies Act, 2013, through Section 62(3), provides that shareholders’ approval should ideally be obtained at the time of issuing the loan or debenture, as part of its term sheet. This ensures that the conversion option is pre-approved, allowing the company to later convert the outstanding loan or debenture into equity without complying again with other provisions of Section 62.
However, the letter and spirit of the law can be distinguished:
- Letter of the law: Strictly, Section 62(3) mentions that the terms containing the conversion option should be approved before issuance. This is the textual requirement.
- Spirit of the law: The purpose of Section 62(3) is to provide certainty and legal enforceability for conversion while protecting shareholders’ interests. If approval is obtained after issuance but before actual conversion, it still achieves the same objective, shareholders authorize the conversion in advance of shares being allotted.
Therefore, while the preferred and legally safest practice is to obtain approval at the time of loan or debenture issuance, in practice, obtaining approval after issuance but before conversion can also satisfy the intent of the law, provided all procedural requirements under Section 62(1)(a) or 62(1)(c) are fully complied with.
In my view, the law does not prohibit companies from conducting their business activities; rather, it regulates them by prescribing compliance requirements to ensure transparency and accountability. The Companies Act, 2013 does not dictate how a company should run its business, nor does it restrict a company from engaging in lawful activities. Its primary objective is to ensure that, wherever specific provisions are prescribed, the company complies with them in the interest of shareholders and stakeholders, thereby making relevant information publicly available and upholding principles of good corporate governance.
In this context, the conversion of a loan or debenture into equity is a lawful business activity permitted under the Act. However, the Act requires shareholders’ approval through a special resolution when such a conversion may lead to dilution of shareholding. This ensures that the company exercises its business discretion within the regulatory framework, protects the interests of existing shareholders, and maintains transparency in corporate governance while effecting the conversion.
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Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the author whatsoever and the content is to be used strictly for informational and educational purposes. While due care has been taken in preparing this article, certain mistakes and omissions may creep in. the author does not accept any liability for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon.
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