On 27 October 2023, the Ministry of Corporate Affairs (“MCA”) inserted in Rule 9B (Prospectus and Allotment of Securities) Rules 2014 (“PAS Rules”). These new provisions mandate private companies to dematerialise all securities and issue them only in dematerialised form by 30 September 2024.
Under Section 29 of the Companies Act 2013 (“ACT”) and Rule 9A of the PAS Rules, public companies, including unlisted ones, must issue securities in dematerialised form and facilitate the dematerialisation of existing securities as per the Depositories Act 1996. By transforming physical share certificates into electronic form, dematerialisation increases transparency and reduces the risks associated with them.
According to the Securities Contract (Regulation) Act 1956, Securities includes bonds, debentures, and shares. Recognising the benefits of dematerialisation in improving transparency and reducing the risks associated with physical share certificates, MCA expanded this requirement to private companies excluding the small and government companies.
As of 31 October 2023, India had 25,86,341 registered companies, with 63% (16,28,791) being active. Of these active companies, 96% are private, leaving just 4% as public companies. Because there are so many private companies, the new rules require them to dematerialise all of their securities by 30 September 2024 and only issue them in dematerialised form.
It has been observed by company secretaries and legal professionals who work on company compliance that many private companies did not finish the dematerialisation procedure according to the MCA’s deadline. This article delves into the uncertainties and ambiguities surrounding these delays, examines the potential impact on the private companies involved, and explores the legislative clarity (or lack thereof) on addressing these issues.
Dematerialisation Deadlock: Unpacking the Issues Faced by Private Companies
Dematerialisation requires obtaining an International Securities Identification Number (“ISIN”). This involves appointing a Registrar & Share Transfer Agent (“RTA”), preparing a tripartite agreement with the company, RTA, and depository (National Securities Depository Limited or Central Depository Services Limited), and submitting necessary documents like Board Resolutions and financial records. After review and fee payment, the Depository issues the ISIN. A dematerialisation request must be made, a demat account must be opened, and physical certifications must be sent in to the RTA for validation. To simplify securities management, the dematerialised shares are credited to the demat account after validation. It takes a lot of time for private companies and depositories to process ISIN number issuance.
In the dematerialisation of securities procedure, obtaining the ISIN number is crucial. Companies are experiencing significant delays in obtaining the ISIN. Without an ISIN, the dematerialisation of securities is not possible, which has been hindering the process. These delays are partly due to processing bottlenecks within regulatory bodies. The task of organising documents for dematerialisation is also time-consuming for companies. Moreover, reviewing and processing the applications and documents submitted by Private Companies, which account for 96% of all registered companies in India, presents additional challenges for depositories.
Many private companies have yet to finish the demat procedure, despite the amendment’s deadline of 30 September 2024 being passed. There is a stalemate since some private companies haven’t even received an ISIN yet. Since private companies are unable to issue securities until their securities have been dematerialised, this delay now presents a serious challenge. This delay in the dematerialisation process has a particular impact on private companies that wish to raise funds by issuing securities. Managerial challenges may arise if this delay persists, especially for private companies with limited capital and market presence. These companies will be at a distinct disadvantage compared to those with stronger market positions.
The inability of shareholders who have not finished dematerialising their holdings to sell their shares or subscribe for new shares significantly restricts the company’s ability to raise funds. Private Companies now have very limited funding choices due to the dematerialisation process taking longer than expected.
Private Companies are in an uncertain state as a result of this circumstance. Nowadays, private companies have few options and mostly rely on bank loans rather than funding from securities. However, many private businesses find bank loans to be a less appealing and more onerous choice due to their high interest rates, strict terms, and requirement for collateral.
Penalties for non-compliance
Companies issuing securities without dematerialising them attract penalties under Section 450 of the ACT. Public companies, in particular, have faced penalties for failing to comply with Section 29 of the ACT, read in conjunction with Rule 9A of the PAS Rules. These provisions emphasise the mandatory requirement for dematerialisation before securities can be issued, and non-compliance can result in significant financial penalties.
Recently on 7 June 2024, MCA has imposed a penalty of ₹31.83 lakh on Biogenomics Limited for issuing shares in physical mode instead of dematerialised form, in violation of Section 29(1) of the Companies Act, 2013. On 1 April 2024, the MCA, through the Registrar of Companies in Telangana, imposed a penalty of ₹3.4 lakh on Premier Energies Limited and its officers for failing to transfer shares in dematerialised form, in violation of Section 29(1)(a) of the ACT.
Private companies could face heavy penalties if they fail to adhere to Rule 9B, as outlined in the provision. It can be inferred that Section 29 of the ACT mandates the dematerialisation of securities. However, the provision does not explicitly include private companies, which creates a reasonable doubt regarding penalties for private companies that need to be addressed by legislation. It is clearly implied that the penalties for non-compliance apply to private companies in the same manner as they do to public companies since Section 29 read combined with Rule 9 of the PAS Rules, which covers private companies as per the amendment. Nevertheless, clarity from the legislation is still needed.
Moreover, recent order from NCLT Mumbai in a public company matter of Amrex Marketing Private Ltd. V. Harinagar Sugar Mills Ltd further shows that non- issuance of securities in dematerialised form would be invalid and any subsequent transfers or transactions emanating out of it will be rendered void ab initio. The order clarified that the dematerialisation of securities is sin qua non for the companies.
Ambiguity in filing the PAS-6 form
According to the amendment, private companies must comply with filing the PAS-6 form for every half-year ending. This form is mentioned under Rule 9(A)(8) of the PAS Rules. Additionally, the rules under Rules 9(A)(4) to 9(A)(10) are applicable to Rule 9B, which means that private companies adhere to file PAS-6 form, as stated in Rule 9(B)(5). Form PAS-6, which provides a thorough breakdown of securities held in both physical and dematerialised form, is filed in order to guarantee the transparent and correct reconciliation of a company’s share capital audit. Enhancing corporate governance, simplifying securities monitoring, and guaranteeing regulatory compliance with the dematerialisation process are the intended objectives of this requirement.
It has been noted that a large number of private companies have failed to receive an ISIN number, which has prevented them from dematerialising their securities by the deadline of 30 September 2024.
Additionally, the compliance date for filing the PAS-6 form for the half-year ending on 30 September 2024, which was 28 November 2024, has already passed. Failure to file the PAS-6 form within the stipulated time attracts penalties. For a public company, the MCA issued an order on 29 October 2024, regarding the adjudication of penalties against Ispat Sheets Limited for Non-compliance in filing Form PAS-6, MCA imposed Rs. 3.5 lakhs Penalty. The penalties are levied as stipulated under section 450 of the ACT for not filing PAS-6 form. The same will be applicable for private companies if not adhered to.
Given that the majority of private companies have not yet obtained their ISIN numbers, which is an essential component of the information needed to submit the PAS-6 form, it would be irrational to apply penalties in this unclear circumstance. To prevent punishing companies for circumstances beyond their control, the law should clarify and resolve these uncertainties surrounding the compliance process.
For the half-year ending on 31 March 2025, the next potential deadline for submitting the PAS-6 form is 30 May 2025. Even this provisional date, nevertheless, cannot be regarded as obligatory in the absence of formal confirmation. The MCA needs to clarify this issue, just as it did for unlisted public companies in 2019. Such a clarification would provide specific guidance for compliance by confirming the PAS-6 form submission deadline for the half-year ending 31 March 2025. Ambiguities about the procedural requirements may only be resolved by an official notification from the MCA, ensuring companies are informed of their obligations.
Conclusion
The MCA must address the present uncertainty with precise rules and realistic guidelines in order to ensure successful implementation, particularly for private companies who are experiencing procedural delays. Strong awareness efforts can help stakeholders better understand their duties, and proactive collaboration between depositories and private companies can speed up the dematerialisation process. Penalties need to be administered fairly, taking into consideration justifiable delays that are beyond a company’s control.
Resolving these issues and uncertainties is crucial to accomplishing the more general goals of financial stability, corporate governance, and regulatory compliance.
Author: Chekkapally Prem Kumar Varma is a 4th year B.A., L.L.B (Hons.) student at NALSAR University of Law, Hyderabad.
