INTRODUCTION
In a significant move aimed at enhancing the security, efficiency, and transparency of shareholding management, the Ministry of Corporate Affairs (MCA) issued a notification on October 27, 2023, that requires private companies to dematerialize their shares. This notification introduces new rules under the Companies (Prospectus & Allotment of Securities) Second Amendment Rules, 2023, introducing Rule 9B, making the dematerialization of shares mandatory for private companies including wholly owned subsidiary private companies of foreign entities present in India.
THE PROCESS
This Amendment applies to Private companies, except for government companies and small companies and Companies that offer to issue securities via bonus issue or right issue after September 30, 2024. The MCA through Rule 9B, marks a substantial shift in how private companies manage their securities. The rule also applies to every private company which is not a small company as on March 31, 2023 (defined as those with a paid-up capital of less than Rs. 4 crore and a turnover of less than Rs. 40 crore), to have all its shares are in dematerialization form by September 30, 2024.
Further issuance of any new securities post September 30, 2024 by the private companies has to solely be undertaken in a dematerialization form. Further, the private companies which plan to buy-back its shares or issue bonus shares or undertake a rights issue, have to ensure that the holding of securities by their promoters, directors, key managerial personnel are in the dematerialization.
Upon the introduction of the New Rule, private companies are required to issue securities only in dematerialization form. Further all existing physical share certificates must be converted to electronic form. Companies must ensure that the shareholdings of promoters, directors, and key managerial personnel are dematerialized before issuing new securities and any transfer or subscription of securities must be done in dematerialized form.
For the purpose of dematerialization of the securities, the private company are required to follow certain compliances such as the followings:
- The Companies are required to amend the article of association in order to authorize the shareholder to hold the shares in dematerialized form.
- Thereafter, the companies shall appoint a Registrar and Transfer Agent (“RTA”) to manage the dematerialization process.
- The companies are required to obtain an International Securities Identification Number (ISIN) for each type of share your company has issued (e.g., common stock, preferred stock). This unique code identifies your company’s securities globally.
- Thereafter the company needs to open a Demat account with a Depository Participant (DP). DPs are usually banks or brokerage firms authorized to facilitate dematerialization.
- Lastly, dematerialization of existing shares by the conversion of physical share certificates held by shareholders into electronic form.
- Another compliance requirement is to ensure that all promoters, directors, and key managerial personnel hold their shares in dematerialization form.
- The companies after the completion of process of dematerialization shall be required to submit half-yearly returns in the form of PAS 6, notifying the MCA of the dematerialization details.
However, while dematerializing shares, it is essential that the foreign entities of the wholly owned subsidiary of private company in India are well aware about the compliance requirement.
On account of compulsory dematerialization, the foreign investors would need to open demat accounts with depositories in India for the purpose of making investments in private companies in India. This could lead to increase in the time period of deal closure as opening of demat account for foreign investors would involve obtaining a Permanent Account Number (PAN) with tax authorities in India, fulfilling of know your customer (KYC) norms of the depositories, payment of additional fees, apostille of documents etc.
The foreign entities being parent companies of the WOS of the private companies are required to provide certain documents such as Certificate of Incorporation of such parent companies, Memorandum of Association and Article of Association, bank introduction letter from the foreign entity, updated shareholding pattern of the foreign entity duly signed, list of promoters and list of directors duly signed by the directors, signature card as per the stated format and board resolution of the parent company authorizing such dematerialization of shares. The Parent entity shall also be required to provide for the balance sheet and profit and loss account for the last 2 financial year.
The notification clarifies that the private companies are required to dematerialized the share by September 30, 2024 and in the event of failure to comply with the same the company faces monetary penalties of INR 10,000 plus INR 1,000 for each day of continued violation, up to a maximum of INR 200,000. Officers in default also face similar penalties, with a maximum fine of INR 50,000. Further the company will be unable to issue or allot any securities, including bonus shares and buybacks and the shareholders who have not dematerialization their holdings will be unable to sell their shares or subscribe to new ones.
Conclusion:
The requirement of compulsory dematerialization of shares may have additional compliance costs for the private companies, however, in the long run, this move would only improve the ease of doing business in India as this would ensure that any further issuance by private companies, share transfer, buyback, rights issues etc., would become a much faster and smoother process.
