Convertible Debentures: New Rules

The MCA has recently released the Draft Public Companies (Terms of Issue of debenture and of raising loans with option to convert such debentures or loans into shares), 2011. The rule if and when becomes effective will supersede the Public Companies (Terms of Issue of debenture and of raising loans with option to convert such debentures or loans into shares), 1977. 

The 2011 rules are more or less similar to the 1977 rules albeit one significant difference. As per the 2011 rules a public financial institution or a bank can now only convert all or any part of the debentures, if (a) the company has defaulted in the repayment of, or payment of interest on, such loans and debentures; and (b) the bank or public financial institution has given the company a notice of its intention to convert the debentures at least 30 days prior to the intended date of conversion.     

Preferential Allotment/Private Placement, New Rules

Recently the MCA released the Draft Unlisted Companies (Preferential Allotment) Rules, 2011. The draft rules seeks to substitute the Unlisted Companies (Preferential Allotment) Rules, 2003. The Draft rules inter alia requires more disclosures and also mandates the securities to be kept in a demat form. Here is a comparative table of both the rules:

Point	Current 2003 Rules	Proposed 2011 Rules
Applicability	Applies only to unlisted public companies in respect of preferential issue of equity shares, fully convertible debentures, partly convertible debentures or any other financial instrument which would be convertible into or exchanged with equity share at a later date.	Identical
Special Resolution	The issue of shares can be only made, if (i) the AoA of the company authorizes to do so and (ii) a special resolution is passed at the general meeting authorizing the allotment. The special resolution has to acted upon within a period of 12 months.	Additional Requirements The company has to make disclosures in the offer document as prescribed. The offer document has to be approved by way of a special resolution. Both the copy of the special resolution and the offer document has to be filed with the RoC.
Condition for the issue of Private Placement	Does not prescribe any such condition.	The following conditions are prescribed: Not more than 30 day gap between opening and closing of the issue. Minimum 60 days gap between two issues. Any financial instrument which is convertible into equity shares at a later date and resulting into a cumulative amount of Rs. 5 Crores or more will require the prior approval of the central government. After the issue, the company has to file a return of allotment with the RoC within 30 days.
Dematerialization of Securities	No such requirement	All securities issued under preferential allotment or private placement has to be kept in a demat form.
Compliance Certificate	A Similar audit certificate was only required to be placed before the shareholders.	The compliance certificate has to be filed with the RoC.
Disclosures in the offer document	Not applicable. However disclosures are to be made in the explanatory statement to the notice for the general meeting.	The 2003 rules only prescribed that the object of the issue had to be disclosed. The 2011 rules requires disclosures with regard to the object of the issue, brief detail of the project and statutory clearances required and obtained for the project. Apart from this the two rules are more or less the same in this regard.

It is quite clear that the new rules, if they become operational, would increase the compliance burden on the companies. It will also increase the paper work and possibly the transaction cost. Moreover, fund raising through the issue of convertible financial instruments would be hit severely as now all such transactions resulting into a cumulative amount of Rs. 5 Crores or more will require Central Government approval.

The rationale for these new rules is unclear. However, initial reports suggest that the rules are a fallout of the Sahara-Sebi Controversy.