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Mandatory Dematerialization Of Private Company Shares: MCA Guidelines

The Ministry of Corporate Affairs through a notification dated 27 October, 2023 introduced a significant amendment particularly Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules 2014 (PAS Rules), via the Companies (Prospectus and Allotment of Securities) Second Amendment Rules 2023 (PAS Amendment Rules). This new rule requires every private company (except for small companies and a government company) to dematerialize issue and transactions in securities. In simple terms, the concept of dematerializing requires a company to convert the physical share certificates into digital or electronic form.  This step by the MCA is not only a positive advancement towards the digitisation trend but also further enhancement of transparency and efficiency in the corporate market.

POSITION PRIOR TO THE AMENDMENT

Prior to the 2023 amendment, the Companies Act 1956 vide Section 68B required initial offer of securities to be in dematerialization form in certain cases. However, it was Section 29 of the Companies Act 2013 (successor to Section 68B) that brought in the requirement for a public offer of securities by listed public companies and other companies to be in a dematerialised form. Section 29 which was notified on 12th September 2013 highlighted the shift from physical to electronic records. Subsequently the PAS Rules was promulgated on 1st April 2014 which provided a detailed explanation for the implementation of Section 29. A further expansion occurred when an amendment was brought into the PAS Rules, which came into force on 2nd October 2018 vide the MCA Notification dated 10th September 2018 wherein all unlisted public companies were brought within the ambit of Section 29 of the Companies Act. Now, with the amendment through which Rule 9B has been introduced, all private companies (except for small companies and government companies) have also been brought within the purview of Section 29 of the Act.

Rule 9B states that private company shall ‘(a) issue the securities only in dematerialised form; and (b) facilitate the dematerialisation of all its securities, in accordance with provisions of the Depositories Act, 1996 (22 of 1996) and regulations made thereunder.’

AN OVERVIEW OF THE MCA’S MANDATE

  1. Applicability of Rule 9B:

Rule 9B applies to private companies as defined under Section 2(68) of the Companies Act 2013. However, an exception to this has also been brought in wherein two specific categories are exempted from its purview;

  1. First, the amendment does not apply to small companies, that is defined as private companies with a paid-up share capital of INR 4 crores or below and a turnover of INR 40 crores or below.
  2. Secondly, the amendment excludes government companies from its scope.
  3. Timeline for Compliance:

Wherein every private company which is not a small company as on or after 31st March 2023 shall be required to comply with the provisions of the new amendment within eighteen (18) months from the date of closing of that financial year wherein such companies as specified are mandated to convert their existing physical securities to a dematerialized (demat) form. Consequently, the compliance date for every private company which is neither a small company nor a government company as on 31st March 2023 shall be 30th September 2024. 

  • Compliance Requirement
  • The amendment states that the Private Company will be required to
  • Issue securities only in a dematerialized form.
  • Facilitate dematerialization of all existing securities.
  • Every private company that engages in making an offer for issue of any securities or buyback of securities or issue of bonus shares or rights offer, must ensure that before such offer is made, the securities of the Private Company as held by its promoters, directors, key managerial personnel have been dematerialised prior to making such offer.
  • Upon the event that any person who holds any securities in a private company intends to transfer such securities, then such person has the obligation to dematerialize such securities before undertaking such transfer. This also requires the buyer to receive such securities in a dematerialized manner. Thereby, ensuring that both parties involved in the transaction, the seller, and the buyer, adhere to dematerialisation norms.
  • Upon the event that any person who holds securities in a private company subscribes to any securities of the Private Company, by way of private placement, bonus shares or rights offer, then such person is obliged to dematerialize all such securities held prior to such subscription.
  • Further, every private company shall also be required to adhere and comply to Depositories Act, 1996 (Depositories Act), the Securities and Exchange Board of India (Depositories and Participants) Regulations, 2018 (SEBI D&P Regulations) and the Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agents) Regulations, 1993. 
  • With respect to the regulatory obligations, every private company is also mandated to ensure the punctual payment of fees to both the depository and the registrar to an issue and share transfer agent, as indicated in the agreement executed between the parties involved.
  • Further, every private company is also required to submit the Form PAS – 6 which is a half yearly return form for reporting of shares held in Demat form. This submission should be made to the Registrar of Companies (ROC) within a period of 60 days from the conclusion of each half year and should be accompanied with a relevant fee and must be duly certified by a qualified professional, either a company secretary in practice or a chartered accountant in practice.
  • Consequences in case of Non – Dematerialization of securities on or before the due date would include.
  • On the Private Company

In the event wherein the Private Company fails to undertake dematerialization of its securities on or before the specified due date, then in those circumstances such companies shall not be able to make any offer for the issuance of any securities or buyback of securities or issue of bonus shares or rights offer after such due date unless entire holding of securities of its promoters, directors, and key managerial personnel has been as per the provisions of the Depositories Act, 1996

  1. On the Security Holder

In the event wherein the security holders of the private company fails to undertake the dematerialization of its securities on or before the due date, and wherein such security holder intends to transfer such securities on or after the due date shall not be able to transfer, purchase, subscribe to any securities of the applicable company by way of private placement or bonus shares or rights offer, unless such securities are dematerialized before transfer, purchase or subscription.

PROCEDURE FOR DEMATERILIZATION OF SECURITIES

  1. Procedure to be complied with by a Private Company;

Step 1: Passing of a Board Resolution

The board of directors shall pass a resolution authorizing the dematerialization of its securities and must ensure that the power of dematerialization must originate from the Articles of Association of the Company.

Step 2: Select the Depository Participant (‘DP’) and open the Demat Account

The Company must select a depository participant (DP) providing demat services to initiate and facilitate the entire dematerialization process. The DP then shall assist in opening its demat account for the purpose of dematerialization on obtaining the relevant documents and facilitate this process.

Step 3: Appointing the Registrar and Share Transfer Agent (RTA)

The Company is to appoint an RTA from the list of registered RTAs, who shall facilitate the dematerialization process and manage the administrative and record-keeping aspects of securities held in electronic form.

Step 4: Executing a Tripartite Agreement

A Tripartite Agreement is required to be entered between the Company and the depository, thereby governing the relationship between the parties and outlining the scope of the dematerialization process.

Step 5: Activate International Securities Identification Number (“ISIN”).

After submission and verification of all documents with the DP and RTA, the depository shall issue and activate the International Securities Identification Number (ISIN) which is a unique code that differentiates one security from another.

Step 6: Informing the Shareholders.

Intimation must be given to the shareholders of the Company on the decision to dematerialize such shares and the processes involved within.

Step 7: Ensure the Completion of the Processes.

The Company is to cooperate with the DP as well as the RTA for smooth facilitation of dematerialization and ensure that all the shares have been successfully dematerialized and further update its records upon the change.

  • Procedure to be complied with by a Shareholder of a Private Company;

Step 1: Selection of a Depository Participant (DP)

A registered Depository Participant must be selected from the list of registered DPs as available on the National Securities Depository Limited (‘NSDL’).

Step 2: Opening a Demat Account

The Shareholders shall provide their Know Your Customer (‘KYC’) documents along with other specified documents as prescribed by the DP for the purpose of opening a demat account.

Step 3: Submit the Dematerialization Request

The shareholder must submit a Dematerialization Request Form (‘DRF’) to the DP along with the physical share certificate and any other prescribed documents.

Step 4: Verification of the DRF

All the information and details provided in the DRF must be verified by the DP and ensure that they are authentic and comply with the regulatory standards.  Upon verification, the DP must forward the request to the respective depository.

Step 5: Confirmation and Record Update.

Upon verification and approval of the request by the depository, the electronic shares upon cancellation of the physical shares, shall be credited to the shareholders’ demat accounts.

To sum up, this recent initiative by the Ministry of Corporate Affairs mandates a private company to convert its physical shares into electronic form. This initiative of dematerialization of shares of private companies is expected to be advantageous from both regulatory and cost perspective. From a regulatory viewpoint, it brings in transparency in share transfers and from a cost perspective it mitigates significant paperwork costs. It aims to simplify and manage securities and its transfers in a more efficient manner, thereby reducing transaction costs and streamlining the securities market. Further, the dematerialization process will also contribute to the significant reduction in paperwork and eliminate the risk of loss or damage of physical share certificates thus making the entire process transparent and eco-friendly. Holding dematerialized shares not only modernises India’s corporate governance and creates operational efficiencies but also addresses and eliminates the challenges faced by institutions in foreclosure of physical certificates. Dematerialization of shares held by private companies is a stepping stone to enable a secure and efficient backbone for private company transactions in India.