PENALTY FOR CONVERSION OF LOAN INTO EQUITY SHARES

Dhiomics Anallytics Solutions Private Limited filed an application on 20.03.2023 citing default/violation of Section 62(3) of the Companies Act, 2023 (‘Act’ for short)  before the Adjudicating Officer.  The said application was filed by the promoters-cum-directors.  The company was non-compliant in certain requirements with respect to conversion of loan into equity shares.  The company has received Rs.17 lakhs from the founder directors and share holders.  The two directors contributed Rs.8.50 lakhs each.  The company allotted equity shares to the said directors adjusting the loan given to the company.  The applicants further submitted that while passing a resolution for this purpose they have wrongly indicated as a rights issue instead of conversion of loan into equity shares under Section 62(3) of the Act.  Subsequently the company filed PAS - 3 for allotment of shares.

The applicants submitted before the Adjudicating Officer that there was no mala fide intention for non compliant with the requirement of getting the terms of loan approved by the shareholders by a special resolution before raising the loan. 

On receipt of the application the Adjudicating Officer issued  notices to the applicants for personal hearing.  The authorized representatives attended the hearing.  In the hearing the representatives submitted that the default was intentional and occurred inadvertently and without any mala fide intention.

The Adjudicating Officer observed that Section 62(3) provides that nothing in this section shall apply to the increase of subscribed capital of a company caused by the exercise of an option as a term attached to the debentures issued or loan raised by the company to convert such debentures or loans into equity shares in the company, provided that the terms of such debentures or loan containing such a option  have been approved before the issue of such debentures or raising of loan by a special resolution passed by the company in annual general meeting.

The Adjudicating Officer further observed that Section 62(1) provides that where at any time, a company having share capital proposes to increase its subscribed share capital by the issue of further shares, such shares shall be offered to persons who, at the date of offer, are the holders of equity shares of the company in proportion, as nearly as circumstances admit to the paid up share capital on those shares by sending a letter of offer subject to certain prescribed conditions.  Further 62(1) (c) provides where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered to any  person, if it is authorized by a special resolution, whether or not those persons include the persons referred to in clause (a) or (b), either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation done by the registered valuer, subject to the compliance with the applicable provisions in Chapter III and any other conditions as may be prescribed.

The Adjudicating Officer further analyzed the provisions of Rule 13(1) of Companies (Share Capital and Debentures) Rules, 2014.   For the purpose of section 62(1)(C), if authorized by a special resolution passed in a general meeting, shares may be issued by any company in any manner whatsoever including by way of a preferential offer, to any persons whether or not those persons includes the persons referred to in section 62(1)(a) and (b) and such issue on preferential basis should also comply with conditions as laid down in Section 42 of the Act.

The Adjudicating Officer, then, analyzed the provisions of Section 42 of the Act.  According to this section a company may make a private placement of securities which shall be made only to a select group of persons who have been identified by the Board, whose number shall not exceed 200 in a financial year.  The conditions for the same are prescribed under Rule14.  The monies received for this purpose shall be kept in a separate bank account in a scheduled bank.  This amount shall not be utilized for any purpose other than allotment or repayment where the company is unable to allot securities.

The Adjudicating Officer observed that the company ought to have issued shares for consideration other than cash on preferential basis by complying with the conditions  under section 42 of the Act since the company did not get the terms of loan approved by the share holders, in a general meeting by a special resolution.  The applicant company issued shares in lieu of loan wrongly under section 62(1)(a) as rights issue which is only meant for issue of shares.  Further the company failed to comply with the procedural requirement laid down in Section 42 of the Act read with Rule 14.

The Adjudicating Officer, on the basis of the above said observation, held that the applicant company contravened the provisions of Section 62(1)(c) by not following the appropriate method of issuing shares for a consideration other than cash.  Therefore the directors are liable under section 450 of the Act.  The Adjudicating Officer further held that the applicant company has violated the provisions of Section 42 of the Act and the company, its directors and promoters are liable for action under section 42(10) of the Act.

The Adjudicating Officer observed that the applicant is a small company.  Therefore the lesser punishment under section 446B shall be applicable to the applicant company.  The penalty is @ 50% of the original fine subject to a maximum of Rs.2 lakhs.  The penalty for officer-in-default is Rs.1 lakh.

The Adjudicating Officer imposed penalty under section 450 read with section 446B of the Act for violation of section 62(1)(c) as detailed below-

• Company - Rs.5000/-;
• Directors - Rs.10000/- @ Rs.5000/- each.

Penalty under Section 42(10) of the Act read with section 446B of the Act for violation of Section 42 of the Act as detailed below-

• Company  - Rs.2 lakhs;
• Directors  - Rs.1,50,005.

The Adjudicating Officer directed that the said penalty amount shall be payable within 90 days from the date of receipt of the order and also directed to file INC - 28 attaching a copy of the order and payment challans.