Ensuring Compliance with Fundraising Provisions of Companies Act, 2013: Insights from ROC Adjudication Order - MMJC

Introduction

The fund-raising sections under the Companies Act 2013 (‘the Act’) are crucial because they involve an investment of public funds in the company and, as a result, are concerned with public interest. This is probably why all the regulators are extremely cautious about the non-compliance of sections relating to fundraising. The caution exercised by the Registrar of Companies (‘ROC’) can be seen from the recent adjudication orders passed by ROCs under section 42 relating to private placement. In this article, we shall delve deep into one such ROC adjudication order passed by ROC Delhi under section 42 of the Act¹.

Background

This order was passed in the matter of Mayasheel Retail India limited (‘Mayasheel’). Mayasheel issued equity shares worth of Rs. 5,04,80,000 to Planify Capital Limited (‘Planify’). These shares were further sold by Planify on its platform to multiple investors, totalling around 1800 members. As per information on Planify platform, Planify sold the said shares for an amount of Rs 40 crore. ROC issued show cause notice to Mayasheel alleging it violated sub-section 2 of section 42 by allotting shares to more than 200 persons at a time and also violated section 42(7) of the Act by giving public advertisement for subscribing to shares of the company through Planify platform. Mayasheel argued before ROC that it did not make any public advertisement for subscribing to the issue of shares, and neither did it allot shares to more than 200 persons. It had allotted shares only to Planify, and Planify sold shares to other investors and the company was not involved in or interested in these secondary transactions. Planify argued that, as per its object clause, it is its business to buy and sell listed and unlisted shares. Therefore, it did not do anything in violation of the Act. From the documents submitted by Mayasheel and the arguments made during the personal hearing, ROC held that, Mayasheel had entered in to an agreement with Planify wherein it was clearly mentioned that Planify shall sell the allotted shares to interested investors, which means that Mayasheel was fully aware of intentions of Planify to sell the shares to the public at large. Also, it was observed by ROC that there was a pitch video uploaded on the website of Planify, which gave information about the company and its future prospects to the investors. ROC held that this video was a part of a public advertisement.Looking at both these factors, ROC held that the transaction of issuing shares to Planify was just a smokescreen. The original intention of the company was to issue the shares to the public. Therefore, ROC imposed a penalty of RS. 48,15,000 each on the company and its four directors (officers in default).

Analysis of ROC’s order in the context of the principle of ‘Nemo Dat Rule’ under Sale of Goods Act, 1930

‘Nemo dat quad non habet’ commonly known as Nemo Dat Rule comes from sections 27 to 30 of Sale of Goods Act 1930. This is a Latin phrase that means, “no one can transfer a thing which they do not possess.” This principle states that the person who does not have proper ownership of any goods cannot transfer the said goods to anyone else. In other words, the person having proper title to the goods/property, is authorized to sell the same to anyone else.In the given case, the transaction that has been held to be in violation of section 42 is that, Mayasheel issued shares through private placement to PLANIFY and the PLANIFY in turn sold the shares to other outsider persons. In this case, the name of PLANIFY is entered in the register of members of the company and therefore, it is rightful owner of the shares and hence authorised to sell the shares as per its own wish.Therefore, there arises a question that is the order passed by ROC not in violation of principle of Nemo dat quad non habet? The answer to this question requires a judicial interpretation.

Is Offer for sale governed under the Act – Can sale of shares by Planify be considered as ‘Offer for Sale’.

As per Palmer’s Company Law [23rd edition], an offer for sale occurs where a company allots shares or debentures to allottees normally an issuing house which will publish an invitation to the public offering these shares or debentures for sale on application by a member of public. The concept of ‘offer for sale’ is also discussed in section 28 of the Act. As per section 28(1), ‘offer for sale’ is when an existing shareholder of the company in consultation with the board of directors of the company, offers his shares partly or fully to general public for subscription. Further, as per the explanation in section 23(1), an offer for sale is considered a public issue of securities.We may now compare the provisions of section 28(1) of the Act pertaining to offer for sale with facts of the present case in order to find out whether or not an offer for sale has been given in this case, and if yes, then whether the provisions relating to the same have been complied with or not?

Looking at this table, it is clear that the transaction covered in the given case, is an offer for sale given by Planify, the shareholder of Mayasheel, to the general public. However, this offer for sale is in non-compliance with sub-sections 1 and 3 of section 28, read with relevant provisions of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements), Regulations, 2018.

Non-compliance with section 42 or 28 of the Act.

Section 42 of the Act states that, while making a private placement of securities, a company should make an offer for subscription and allot securities to a selected group of persons not exceeding 200 persons. Further, allotment should be made only after shareholder approval, and the allotment money should be kept in a separate bank account and should not be used before filing returns of allotment with ROC.Mayasheel has not violated any of these conditions. It made an allotment to PLANIFY only after obtaining shareholder approval through a special resolution and valuation report. Also, it duly filed a return of allotment in form PAS-3.However, as discussed above, the transaction in the given case falls in the category of offer for sale, but that too is not in complete compliance with provisions relating to offer for sale. Considering all the above-mentioned factors, its prima face appears that this transaction violates section 28 and not section 42 of the Act because the transaction relating to an offer for sale is not covered in the provisions of section 42.

Jurisdiction for adjudication.

Suppose it is assumed that the sale of shares by issue of shares by Mayasheel and onward sale by Planify amounts to an offer for sale and not private placement, and offer for sale is considered a public offer as per section 23(1) of the Act. In that case, there arises a question that who has the authority to adjudicate the non-compliance relating to offer for sale? Is it the ROC or Securities and Exchange Board of India [‘SEBI’] for the reason the offer for sale is a public offer?To answer this question, reference can be made to section 24 of the Act. It states that SEBI has jurisdiction over the issue and transfer of securities of listed companies and the companies who intend to list their securities on the stock exchange. It means if a company is issuing or a shareholder is transferring securities of the company to the public at large and the company intends to list on stock exchanges, then the SEBI will have jurisdiction. However, it does not talk about a situations where an issue or transfer is made to the public, but the listing is not intended.So, to find out the correct authority having jurisdiction in such a situation, we will have to refer to judicial pronouncements. Reference can be made to an adjudication order passed by SEBI in the matter of Sun Techno International Limited². In this case, unlisted company had issued preference shares to public at large (i.e. to 322 allottees) without obtaining making a public offer. SEBI directed Sun Techno International Ltd to refund the money with interest. In its adjudication order SEBI quoted judgment of Hon’ble Supreme Court of India in the matter of Sahara India Real Estate Corporation Limited v. SEBI [2012] 26 taxmann.com 176/116 SCL 160 wherein the Hon’ble Supreme Court of India held that, “any offer of securities by a public company to fifty persons or more will be treated as a public issue under the Companies Act, even if it is of domestic concern or it is proved that the shares or debentures are not available for subscription or purchase by persons other than those receiving the offer or invitation.” As per this decision of Hon’ble Supreme Court, it appears that SEBI had jurisdiction over the offer for sale made by Planify and the ROC may have referred the matter to SEBI.

Conclusion

Private placement to a single investor and the sale of shares by the same shareholder to the public at large are now being viewed seriously. Companies need to revisit fundraising plans in the context of this order. This order sets a precedent wherein private placements are seen through.