1. LEGAL NOTE
ISSUE OF SHARES IN LIEU OF SERVICES AND TECHNICAL KNOW-HOW
Facts
An Indian company limited by shares (the “Company”) has received certain services in the form
of technical know-how and expertise for its business operations from certain advisors residing in
and outside India (“Advisors”). In recognition and in exchange of their advisory services, the
Company is desirous of issuing certain shares in the Company to such Advisors.
Query
In the given context, what are the ways in which the Company can issue and allot shares to the
Advisors for consideration other than cash?
Opinion
As per the provisions of the Companies Act, 2013 (the “Act”) and the Companies (Share Capital
and Debentures) Rules, 2014 (the “2014 Rules”), the Company can issue its shares to a person for
non-cash consideration by the following means:
(i) Employee Stock Options1
. Employee stock options can be issued by a company to its (a)
permanent employees; (b) directors (excluding independent director); and (c) such
employees as under (a) and (b) of a subsidiary (in or outside India), holding company or
associate company2
. A minimum period of one year is mandatory between the grant of
options and the vesting of options, so the options can be exercised and thereupon be
issued only after a minimum period of one year. Furthermore, in cases where the equity
shares of a company are listed on a recognized stock exchange, the Employees Stock
Option Scheme shall be issued in accordance with the SEBI (Share Based Employee
Benefits) Regulations, 2014.3
(ii) Issue of Sweat Equity4
. A company may issue sweat equity shares at a discount or for
consideration other than cash, for their providing know how and making available rights in
the nature of intellectual property rights or value additions, only to its (a) a permanent
employee working for at least last one year; (b) a director; (c) such employees as under (a)
and (b) of a subsidiary or a holding company5
. However, such sweat equity shall not be
issued for more than 15% or the existing paid up equity share capital in a year or shares of
the issue value of more than five crores, whichever is higher. Also, a company cannot issue
sweat equity shares for more than 25% of it’s paid up share capital at any time6
.
1
Companies Act, 2013, Section 62 (1)(b).
2
Companies (Share Capital and Debentures) Rules, 2014, Rule 12(1).
3
Ibid, Rule 12(11).
4
Companies Act, 2013, Section 54.
5
Companies (Share Capital and Debentures) Rules, 2014, Rule 8(1).
6
ibid, Rule 8(4).
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2. (iii) Preferential Allotment7
. A company can issue its shares or other securities on a preferential
basis to any person irrespective of whether such person is an existing equity shareholder,
an employee of the Company or otherwise, if such issue is authorized by a special
resolution passed in a general meeting. Such issue on preferential basis can be made either
for cash or for consideration other than cash.
Based on the above, it can be stated that issue of shares by way of preferential allotment is not
as restrictive and regulated as opposed to stock options and sweat equity shares. More
importantly, as explained above issue of shares can be made by the Company to its Advisors, who
are not employees or directors of the Company, whether resident in or outside India, only by way
of preferential allotment of shares since stock options and sweat equity shares cannot be issued
to persons other than employees and directions.
As stated above, Section 62 (1)(c) of the Act and Rule 13 of the corresponding 2014 Rules form
the legal framework for issue of shares to any person on a preferential basis under the
Companies Act. However, in case any such person is a resident outside India, then applicable
guidelines issued by the Reserve Bank of India under the Foreign Exchange Management Act,
1999 will also be applicable and have to be complied with. For purposes of explanation and
clarity, this Note has hereafter been divided into two parts: (A) Preferential Allotment under
Companies Act, 2013; and (B) Issue of shares in lieu of services as per the extant foreign
investment guidelines.
(A) Preferential Allotment under Companies Act, 2013
Allotment of shares or other securities (including equity shares, fully or partly convertible
debentures or other securities convertible or exchangeable with equity shares) can be
made by a private or unlisted public company in any manner including that on ‘preferential
basis’, and the same can be made subject to the following conditions:
(i) the price of such shares or other securities to be issued, for cash or consideration
other than cash is determined by the valuation report of a registered valuer, except in
case of preferential issue by listed companies8
, in which case SEBI (Issue of Capital
and Disclosure Requirement) Regulations, 2009 have to be followed;
(ii) the issue of shares (or other securities) complies with conditions prescribed under
the 2014 Rules. However, in case of listed companies, SEBI Regulations in this behalf
shall have to be complied with as well.9
(iii) the issue of shares (or other securities) is authorized by its articles of association;
(iv) the issue of shares (or other securities) is authorized by special resolution passed in a
general meeting;10
(v) the allotment of shares (or other securities) shall be completed within a period of 12
months from the date of passing of the special resolution;
7
Companies Act, 2013, Section 62(1)(c).
8
Companies (Share Capital and Debentures) Rules, 2014, Rule 13 (1).
9
A. Ramaiya, Guide to the Companies Act, 1193, (2015);
10
Companies Act, 2013, Section 62(1)(c).
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3. (vi) where shares or other securities are to be allotted for consideration other than cash,
valuation should be done by a registered valuer who shall submit a valuation report
to the company giving justification for the valuation.
For issue of shares (or other securities) by the Company to its Advisors, the value of
services and technical know-how provided may be determined by the Company based on
any agreement or unwritten arrangements between the Company and the Advisor. The
justification for the valuation to be given by the registered valuer can therefore be based
on the value of services provided, as determined by the Company.
Further, issue of shares on a preferential basis should also comply with conditions laid
down in Section 42 of the Act (Private Placement)11
. An offer under this Section has to be
made through issue of a private placement offer letter. Private placement can be made by a
company only when approved by its shareholders by a special resolution and the value of
such offer or invitation per person has to be with an investment size of not less than
twenty thousand rupees of face value of securities.12
For the purposes of this rule, it is
advisable that the services provided by the Advisors should be of such value or should be
valued in a manner such that at least 2,000 shares are issued to each of the Advisors
(assuming face value of the shares or securities to be issued is Rs. 10/-), irrespective of the
premium on such shares which is determined by valuation by the registered valuer.
Alternatively, assuming the class of shares (proposed to be issued) in the Company’s
authorized capital has a face value of not more than Rs. 10/-, a separate class of shares
(proposed to be issued) may be created with a face value higher than Rs. 10/-. For instance,
if equity shares of face value Rs. 50/- are to be issued, then in such case only 400 shares will
be required to be issued to comply with the above mentioned private placement rule of
Rs.20,000/- face value.
For a listed company however, to make a preferential allotment, the provisions of Chapter
VII of the SEBI (Issue of Capital and Disclosure Requirement) Regulations, 2009 are to be
complied with.
(B) Shares in lieu of services as per the Master Circular on Foreign Investments in India.
As per the extant guidelines issued by the Reserve Bank of India on July 01, 201513
, Indian
companies can issue equity shares, fully and mandatorily convertible debentures, fully and
mandatorily convertible preference shares and warrants subject to the pricing guidelines /
valuation norms and reporting requirements amongst other requirements as prescribed
under FEMA Regulations.
Pricing Guidelines: The guidelines specifically provide that, a company issuing
shares/convertible debentures to persons resident outside India may receive the amount of
consideration required to be paid for such shares or securities, among other ways, by
11
See supra note 8.
12
Companies (Prospectus and Allotment of Securities) Rules, 2014, Rule 14.
13
Master Circular No. 15 / 2015-16.
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4. conversion of lump sum technical knowhow fee due for payment. For such issue of shares
or securities to persons resident outside India, the price shall have to be:
• in case of listed companies, determined on the basis of SEBI guidelines;
• for other companies, not less than fair value of shares determined by a SEBI registered
Merchant Banker or a Chartered Accountant as per any internationally accepted pricing
methodology on arm’s length basis14
.
As per the guidelines, Foreign Direct Investment in India can be made through in different
manners including by way of: (i) Issue of fresh shares; (ii) Acquisition by way of transfer of
existing shares by person resident in or outside India; (iii) Issue of Rights / Bonus shares; (iv)
Issue of shares under Employees Stock Option Scheme; and (v) Conversion of ECB /
Lumpsum Fee / Royalty / Import of capital goods by units in SEZs in to Equity/ Import
payables / Pre incorporation expenses.
General permission has been granted for issue of shares/preference shares against lump-
sum technical knowhow fee, under automatic route or government approval route
(approval of Secretariat of Industrial Assistance / Foreign Investment Promotion Board),
subject to the pricing guidelines as mentioned above and payment of applicable taxes15
.
Reporting of Foreign Investment: As per the guidelines, reporting of such issue of shares,
for technical know-how fee, has to be done in Form FC-GPR16
. Form FC-GPR has to be
submitted by the Company not later than 30 days from the date of issue of shares along
with a certificate from (a) a Company Secretary certifying that (i) all the requirements of
the Companies Act have been complied with; (ii) terms and conditions of the Government
approval, if any, have been complied with; the company is eligible to issue shares under
these Regulations; and (b) from Statutory Auditors or Chartered Accountant indicating the
manner of arriving at the price of the shares issued to the persons resident outside India.17
Conclusion
As enunciated above, the Company may issue shares to its Advisors, both residents in and
outside India on a preferential basis by complying with all necessary rules and regulations under
the Companies Act, 2013, corresponding rules there under and the extant guidelines on foreign
investments, as detailed in the Opinion. Based on the Opinion, it can be concluded that the best
possible manner in which the Company may issue shares to its Advisor, whether resident in or
outside India, by way of preferential allotment under Section 62(1)(c) of the Act and the rules
prescribed there under.
14
ibid, Section 1 (5).
15
ibid, Section 1 (8E)(ii).
16
ibid, Section 1 (9)(iv).
17
Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India)
Regulations, 2000, Regulation 9.
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