Section 23 of Companies Act, 2013 states that a company may issue securities to public in following manner:
i) through prospectus (“public offer“) by complying with the provisions of Part I of Chapter 3 on Prospectus and Allotment of Securities; or
ii) through private placement by complying with the provisions of Part II of Chapter 3; or
iii) through rights issue or bonus issue by complying with the provisions of Section 62 of the Act.
Out of the above-mentioned methods, private placement is the most common and effective method of raising funds. Section 42 of the Act stipulates what constitute a private placement and also determines when private placement can become a public offer. Therefore, it becomes most important to comply with all the provisions of Section 42 of the Act if the company does not want its offer to fall under the ambit of public offer and its compliances.
Private placement means any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of public offer) through private placement offer-cum-application, which satisfies the conditions specified in section 42 of the Act. [Explanation II to Section 42(3) of the Act]
Two key features which makes an offer a Private Placement offer
Private placement is an offer of securities or any invitation to subscribe to securities to (i) select group of persons identified by the Board; (ii) not exceeding 200 in number (excluding qualified institutional buyers and employees to whom stock options are issued) [Section 42 of the Act read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014]. This dual condition makes an offer a private placement offer.
(i) Select group of persons
The phrase has not been defined in the Companies Act, 2013. Therefore, reference may be made to Companies Act, 1956. Section 67 of the erstwhile Companies Act, 1956 contains a provision similar to private placement. Section 62(1) provides that an offer to the public shall include a reference to offering them to any section of the public whether selected as members or debenture-holders of the company, subject to the provisions of Section 62 (3) and (4).
Section 62(3) states that no offer or invitation shall be treated as made to the public by virtue of Section 62 (1) or (2), as the case may be, if the offer or invitation can properly be regarded as-
(a) not being calculated to result, directly or indirectly, in the shares or debentures becoming available for subscription or purchase by persons other than those receiving the offer or invitation provided the offer is made to less than 50 persons; or
(b) otherwise as being a domestic concern of the persons making and receiving the offer or invitation.
In simple words, if the offer is not made available to people other than those who received the invitation, it is not a public offer.
(ii) not exceeding 200 in number
Companies Act, 1956 recognizes the term ‘domestic concern’ instead of ‘select group of persons’. The Hon’ble Supreme Court in the matter of Sahara India Real Estate Corporation Limited and Ors. vs. Securities and Exchange Board of India and Anr. (2013) 1 SCC 1 while examining Section 67 of the Companies Act held that:- “Section 67(1) deals with the offer of shares and debentures to the public and Section 67(2) deals with invitation to the public to subscribe for shares and debentures and how those expressions are to be understood, when reference is made to the Act or in the articles of a company. The emphasis in Section 67(1) and (2) is on the “section of the public”. Section 67(3) states that no offer or invitation shall be treated as made to the public, by virtue of subsections (1) and (2), that is to any section of the public, if the offer or invitation is not being calculated to result, directly or indirectly, in the shares or debentures becoming available for subscription or purchase by persons other than those receiving the offer or invitation or otherwise as being a domestic concern of the persons making and receiving the offer or invitations. Section 67(3) is, therefore, an exception to Sections 67(1) and (2). If the circumstances mentioned in clauses (1) and (b) of Section 67(3) are satisfied, then the offer/invitation would not be treated as being made to the public. The first proviso to Section 67(3) was inserted by the Companies (Amendment) Act, 2000 w.e.f. 13.12.2000, which clearly indicates, nothing contained in Sub-section (3) of Section 67 shall apply in a case where the offer or invitation to subscribe for shares or debentures is made to fifty persons or more. … Resultantly, after 13.12.2000, 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.”
In light of the forgoing, is the offer is made to more than 200 persons as per Section 42 of 2013 Act it shall be treated as public offer and will thus attract compliances of a public offer.
When private placement becomes public offer
Explanation III to Section 42(3) explicitly states that If a company, listed or unlisted, makes an offer to allot or invites subscription, or allots, or enters into an agreement to allot, securities to more than 200 persons, whether the payment for the securities has been received or not or whether the company intends to list its securities or not on any recognised stock exchange in or outside India, the same shall be deemed to be an offer to the public and shall accordingly be governed by the provisions of Part I of Chapter III. To reiterate, if securities are offered to more than 200 persons, irrespective to any other fact or terms and conditions, it shall be treated as public offer.
The intention of the law maker of strictly keeping it a private placement also becomes clear from Section 42(7) which clearly prohibits a company from releasing any public advertisements or utilise any media, marketing or distribution channels or agents to inform the public at large about such an issue.
In the matter of Zenith Highrise Infracon Ltd. Vs. Securities and Exchange Board of India [Appeal No. 459 of 2018], Securities Appellate Tribunal, Mumbai observed that the expression “offer to the public” is not a technical expression but has to be understood in its ordinary popular sense of indicating an approach to the general public by advertisement, circular etc. as distinguished from an offer made privately such as to friends and relatives or a selected set of customers. The objects and reasons for insertion of the first proviso to Section 67(3) of the Companies Act was that in order to keep an issue outside the arena of public issue and make it a “domestic concern” of the issuer and the offeree, would not apply in cases where the offer or invitation is made to fifty persons or more. The effect is, that an issue would remain in the category of a “domestic concern” only when the offer is confined to less than fifty persons. As offer extending to fifty or more persons will tantamount to a public issue.
In the said matter Securities Appellate Tribunal, Mumbai held that merely because three allottees had made the complaints indicates that the offer or invitation falls in the category of one which is calculated to result directly or indirectly in the shares, debentures becoming available to persons other than those receiving those offer or invitation is based on surmises and conjectures. No evidence has come forward by these complainants or otherwise to show that the company had made a public offer other than these 49 persons. Once allotment is made to less than fifty allottees by way of private allotment the first proviso to Section 67(3) clearly makes it a private issue and not a public issue.
To summarize the intention of law makers, when persons other than those invited cannot subscribe, it is the case of private placement and in contrast to it, when anyone and everyone is allowed to subscribe without any restriction, it is the case of public offer.
Further, in the matter of Canning Industries Cochin Ltd. Vs Securities and Exchange Board of India [Appeal No.115 of 2019], Securities Appellate Tribunal, Mumbai gave a controversial judgement wherein the Company had passed a special resolution under section 62(3) and 71 of the Companies Act, 2013 read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 to issue Unsecured Fully Convertible Debentures (FCDs) each to its 1929 shareholders with no right to renounce the offer to any other person. Here, it is apparent that resolution has not been passed neither in Section 42 nor Section 62 which prescribes basic mode of issuance of any securities. No issue of security is made only under Section 62(3) as it is clearly not an independent mode of issue. Section 62(3) is extracted hereunder for ease of reference:
“(3) Nothing in this section shall apply to the increase of the 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 shares in the company:
Provided that the terms of issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of loan by a special resolution passed by the company in general meeting.”
The pre-condition of above mentioned sub-section is that debentures has already been issued or loan has been raised. Therefore, no issue is made under this sub-section. It only provides that it at the time of issuing debentures, the terms of conversion were approved by way of special resolution, the increase in capital at the time of conversion will not require any further approval.
Therefore, Securities and Exchange Board of India in its order held that FCDs are covered under the expression “Shares or other securities” as per the Explanation (ii) to Rule 13 of the Companies (Share Capital and Debentures) Rules 2014 and hence Explanation ii to Rule 13(1) which mandates compliance of conditions stipulated in Section 42 of the Companies Act, 2013 is applicable to the said issue of FCDs on preferential basis to existing members of the Company. As the Offer of FCDs made by the Company was more than 200 persons, the same is a deemed to be “public issue” as envisaged under Section 42(4) of the Companies Act, 2013 read with Rule 14(2) (b) of the Companies (Prospectus and Allotment of Securities) Rules 2014. Since the Offer of FCDs is deemed to be public issue the Company was mandated to comply with the ‘public issue’ norms as prescribed under the SEBI Act and Companies Act, 2013 which it failed to do.
However, rejecting the above rationale, Securities Appellate Tribunal, Mumbai opined that-
“13. The term “select group of persons” though not defined under the Act indicates a specified number of persons. In the instant case, the offer of FCDs has been made only to the shareholders of the Company and to none else. The offer of shares to the Company’s shareholders cannot be termed as an offer to a ‘select group of persons’. The expression “select group of persons” is not a technical expression but has to be understood in its ordinary popular sense, namely, an offer made privately such as to friends and relatives or a selected set of customers distinguished from approaching the general public or to a section of the public by advertisement, circular or prospectus addressed to the public. Thus, the restriction of subscription of shares to 200 persons or more is not applicable in the instant case as it is not a private placement. Thus, section 42 read with Rule 14(2)(b) of the Securities Rules are not applicable in the instant case.
14. Section 62 of the Act is attracted only when a Company wants to increase its subscribed capital by allotment of further shares. The said section provides for issue of rights issue to existing equity shareholders. It also provides for issuance of shares to employees under employees stock option scheme and issue of shares on preferential basis…..
15. If a company having a share capital at any time wishes to increase its subscribed capital by the issue of further shares, then the Company has to comply with the provisions of Section 62 of the Act. Section 62 of the Act is not applicable to a private Company. This means that any such Company may offer its further issue of capital to any person or in any manner as it thinks best in its own interests.”
Further it stated that the offer of FCDs was made to the existing shareholders of the Company. Consequently, the Company was not required to ensure compliance with the limit of allottees as applicable in the case of private placement of securities. Once Section 62(2) is applicable which is an exception to the issuance of share capital under Section 62, the same is not a public offer and, therefore, the provisions of part I of Chapter III of the Companies Act are not applicable.
This judgement has been criticized on the ground that Section 62(3) was treated as an independent mode of issuance of securities without considering the Section 42 and Section 62(1)(c). With support of this interpretation and judgement, we come across a huge number of non-compliances of deemed public offer in future. Hence, an appeal to High Court could be a next step in this case.
In a nutshell, the basic condition is that if the offer is made to more than 200 persons as per Section 42 of 2013 Act it shall be treated as public offer and will thus attract compliances of a public offer. Any other interpretation related to ‘select group of persons’ etc. may result in non-compliances. Therefore, compliance with all the provisions of Section 42 of the Act is of utmost importance if the company does not want its offer to fall under the ambit of public offer and its compliances.