Rights Issue, Unsecured Loan Adjustment

In SRM Energy Limited v. SEBI, SAT has adjudicated upon the issue of adjustment of unsecured loans against the price to be paid for the shares allotted in the rights issue. The brief facts of the case are as follows. The appellant company borrowed a certain sum of money from the promoter group upon an oral understanding that if and when the appellant company came out with a rights issue, the unsecured loans would be adjusted against the share price. Subsequently, the appellant company came out with a rights issue and further sought to give effect to the aforementioned oral understanding entered into with the promoter group.

SEBI objected to such an adjustment on the ground that the unsecured loan advanced by the promoter group did not comply with the conditions prescribed u/s 81(3) of the Companies Act, 1956 [hereinafter “the Act”]. On the other hand the appellant company argued that shares were proposed to be allotted in accordance with the provisions of S. 81(1) of the Act and that the conditions incorporated in S. 81(3) were not applicable to the dispute in question. Before discussing the ruling of SAT, it is only appropriate to discuss the relevant provisions of the Act.

S. 81(1) of the Act empowers the Board to issue shares to the existing body of shareholders of the company in the same proportion in which they already hold shares of the company, without any special resolution or government approval. S. 81(1A) further empowers the Board to issue shares to non existing shareholders. However, as a condition precedent, such an issue has to approved by the shareholders vide a special resolution. S. 81(3) stipulates that S. 81 would not apply (a) to a private company (b) when the loans/debentures have a stipulation attached thereto that the lender will be entitled to exercise an option to convert the loans/debentures into shares at a future date. Such a conversion is however subject to two conditions (a) the terms of the loan has to be approved by the central government or is in conformity with the rules made in this behalf; and (b) a special resolution has to passed by the shareholders sanctioning the terms of the loan. 

SAT, while taking a pragmatic view allowed the adjustment. The reasoning adopted by SAT was that the entire transaction fell within the purview of S. 81(1) of the Act in that the additional shares were sought to be issued to the existing body of shareholders in the same proportion and that the transaction was not a mere conversion of debt into equity in the strict sense. Additionally, SAT noticed that as per the terms of the loan it was open for the promoter group to demand the immediate payment of the loans from the appellant company and hence, it was meaningless for the promoters to first demand the payment of the loan and then forward the very same amount towards the price of the shares allotted in the rights issue.