In the ever-evolving landscape of corporate governance in India, a notable transformation is taking place—one that impacts private limited companies, which constitute around 95% of the total number of companies registered in India. This edition provides an insight into the newly introduced requirement for mandatory dematerialization of securities and its implications on compliance costs, shedding light on the regulatory changes that are shaping the way companies operate.
Historical Journey of Dematerialization of Securities
The provision pertaining to Dematerialization of securities was initially confined to Listed public companies in India. Rule 9A of Companies (Prospectus and Allotment of Securities) Rules 2014 was introduced effective 2nd October 2018 which made dematerialisation of securities of an unlisted companies mandatory.
The Ministry of Corporate Affairs notified the Companies (Prospectus and Allotment of Securities) Rules, 2023 on October 27, 2023. Rule 9B has been inserted in the existing Companies (Prospectus and Allotment of Securities) Rules, 2023 (‘Rule 9B’) which pertains to mandatory dematerialisation of securities of a private limited company (except small companies as defined in Section 2(85) of Companies Act, 2013.
Section 9B: Unveiling Regulatory Nuances
Delving into the heart of the matter, we analyse the provisions of Rule 9B, which is applicable to ‘Securities’ of a private limited company. It is to be noted that the term Securities under Companies Act 2013 and Securities Contracts (Regulation) Act, 1956 not only refers shares but also includes debentures, stocks, bonds, convertible instruments, notes issued by a company.
As per Rule 9B:
- Mandatory Dematerialisation of Securities: Every private company (other than a small company) shall issue its securities only in dematerialised form and facilitate dematerialisation of its securities.
- Time Period For Dematerialisation: In case of companies (other than a small company) whose financial year ends on 31st March 2023, eighteen months from the close of such financial year. In case of companies following a different financial year, 18 months from the close of such financial year.
- Every private company shall after the date referred to above, making any offer for issue of securities or issue or bonus or rights offer after the date referred to above, shall ensure that before making such offer, entire holding of securities of its promoters, directors, key managerial personnel has been dematerialised in accordance with the provisions of the Depositories Act, 1996 and regulations made thereunder.
- Any person who intends to transfer his securities or intends to apply for a bonus issue, rights issue, private placement on or after the date referred to above, shall ensure that his securities are held in dematerialised form before such transfer or subscription.
- Exemption From This Provision:
- Small companies: A small company under Section 2(85) of the Companies Act, 2013 means a company which meets the following criteria:
- Paid up capital should not exceed INR 4 crore; and
- Turnover should not exceed INR 40 crore.
It is to be noted that the following companies are exempt from the definition of the term ‘Small company’ although they meet the criteria referred to above:
- Holding company
- Subsidiary company
- Company registered under Section 8 of Companies Act, 2013
- Company that is governed by any particular Act.
- Government Company
The regulatory landscape governing the dematerialization of securities is multifaceted, and at the core of this framework lies Section 9(B).
RATIONALE: While dematerialisation of securities is not a completely new phenomenon, the idea behind this move seems to be to improve transparency, curb benami transactions, reduce litigations related to fake share certificates and share transfers. This move would aid the Governmental agencies to identify and trace the owners of a private limited company and also ensure appropriate stamp duty is paid on securities subscription and transfers.
Impact on Compliance Costs: Striking a Balance
As we navigate these regulatory waters, a pertinent question arises: Does the mandatory dematerialization of securities not counteract the government’s initiatives to reduce compliance costs, more so when the Government had in the last decade come up with initiatives to reduce set up and compliance costs?
While we are of the view that the costs of setting up business and regulatory compliances would certainly increase, this move would also ensure that any further issuance of securities by a private limited company, buy back, rights issue, buy back would become a much faster and smoother process.
Balancing the virtues of transparency with the financial implications on businesses, especially smaller entities, becomes crucial.
Impact on Foreign Shareholders/Investors:
Since dematerialisation of securities has been made mandatory, the foreign shareholders/ foreign investors would need to open Demat accounts with depositories in India for the purpose of making/holding their investments in private limited companies in India. This could lead to an increase in time period for issue of securities/closing transactions since the opening of Demat account would require the foreign shareholder/investor to apply for a Permanent Account Number (PAN) with the tax authorities in India and fulfilling of KYC (Know Your Customer) norms of Depositories, notarisation and apostille of documents etc.
Conclusion:
The compulsory dematerialization of securities seems to be a move in the right direction since it would lead to transparency, accountability, efficient system of share transfer, reduction in frauds etc.