Clause 49 of the Listing Agreement

1
Presentation on Preferential Allotment (71st
SMTP September 16, 2006) - By Mahavir Lunawat

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Outline

• Introduction
• Regulatory Framework in India
• Time Frame
• Regulatory Framework in US
• Specific Cases
• Preferential Allotment of Debt Securities
• Preferential Allotment of Shares / Deb to
  NRIs/FIIs
• QIP
• Back Office Preparation

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Different Types of Issues
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What is Preferential Allotment

• Issue of shares other than to the public at large
  or existing shareholders proportionately is
  commonly referred to as preferential allotment.
  
• As per DIP Guidelines, Preferential Allotment
  means an issue of capital made by a body
  corporate in pursuance of a resolution passed
  under Sub -section (1A) of Section 81 of the
  Companies Act, 1956.

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Preferential Allotment-Regulatory Framework

• Listing Agreement
• SEBI (DIP) Guidelines, 2000 - Chapter XIII
  Guidelines for Preferential Issues
• SEBI Circular on private placement of debt
  securities by listed companies and clarification
  thereon
• SEBI (Substantial Acquisition of Shares and
  Takeovers) Regulations, 1997
• SEBI (Prohibition of Insider Trading)
  Regulations, 1992
• SEBI (Delisting of Securities) Guidelines, 2003
• Depositories Act, 1996
• Companies Act, 1956
• Companies (Issue of Share Certificates) Rules,
  1960
• CARO and Rules under section 383A
• Unlisted Public Companies (Preferential
  Allotment) Rules, 2003
• Stamp Act
• Guidelines issued by GOI/SEBI/RBI for
  preferential allotment if made to Foreign
  Institutional Investors/ Overseas

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Preferential Allotment Listing Agreement

• Clause 24(a) In-principle approval
• Issuer to obtain in-principle approval for
  listing before issuing further shares or
  securities.
• Clause 40A (iii)
• No preferential allotment can be made, if such
  allotment or offer result in reducing the
  non-promoter holding below the limit of public
  shareholding specified under DIP Guidelines
• Clause 43 Quarterly statement
• Issuer to furnish a statement on a quarterly
  basis indicating the variations between projected
  utilisation of funds and/ or projected
  profitability statement made by it or object/s
  stated in the explanatory statement to the notice
  for the general meeting for considering
  preferential issue of securities and the actual
  utilisation of funds and/ or actual
  profitability.

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Preferential Allotment Listing Agreement

• Clause 43 Quarterly statement (Contd.)
• The statement shall be given for each of the
  years for which projections are provided in the
  explanatory statement shall be published in
  newspapers simultaneously with the quarterly
  financial results as required under clause 41.
• If there are material variations between the
  projections and the actual utilisation/
  profitability, the company shall furnish an
  explanation therefor in the advertisement and
  shall also provide the same in the Directors
  Report.
• Clause 49
• Quarterly disclosure of uses/application of funds
  raised by Preferential Allotment
• Annual Statement of funds utilised for purposes
  other than stated purposes certified by
  statutory auditors
• to the Audit Committee till such time, money
  raised is fully spent.
• Other General Clauses like Clause 22, 31, 36 etc.

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Preferential Allotment DIP Guidelines

• Provisions of Chapter XIII
• Pricing
• Currency of Shareholders Resolution
• Lock-in Requirements
• Situations where preferential allotment is
  prohibited
• Other Requirements
• Exemptions

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Preferential Allotment DIP Guidelines

• Pricing (13.1.1)
• Price not less than the higher of the following
• The average of the weekly high and low of the
  closing prices of the related shares quoted on
  the stock exchange during the six months
  preceding the relevant date OR
• The average of the weekly high and low of the
  closing prices of the related shares quoted on a
  stock exchange during the two weeks preceding the
  relevant date.
• "relevant date" means the date thirty days prior
  to the date on which the meeting of general body
  of shareholders is convened
• Stock Exchange means a stock exchange in which
  the highest trading volume in respect of the
  shares of the company has been recorded during
  the preceding 6 months.

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Preferential Allotment DIP Guidelines

• Pricing (Contd)
• Pricing of Shares arising out of warrants
  (13.1.2)
• While pricing shall be calculated in the same
  manner, the relevant date at the option of the
  issuer could be
• 30th day prior to date of shareholder meeting
• 30th day prior to the date when the person
  becomes entitled to apply for the shares.
• Pricing of shares on conversion of PCDs/FCDs
  (13.1.3)
• Pricing shall be calculated in same manner as
  determined for allotment of shares in lieu of
  warrants
• becomes entitled to apply for the shares Nath
  Seeds Ltd. v. SEBI (2005) 59 SCL 363 (SAT-Mum)

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Preferential Allotment DIP Guidelines

• Currency of Shareholders Resolution (13.4)
• Shareholders resolution for preferential issue
  of shares/ other instrument is to be implemented
  (by making allotment and despatch of
  certificates) within 15 days from the date of
  passing of the resolution (from the date of
  regulatory or government approval, if required)
• If allotment and despatch of certificates are not
  completed within 15 days from the date of
  shareholders resolution fresh consent will be
  necessary consequently the relevant date will
  also change.

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Preferential Allotment DIP Guidelines

• Lock-in Requirements (13.3)
• Lock-in of 1 year from the date of allotment
  shall be applicable for all preferential
  allotments made to all categories of allottees
  including promoters
• Shares allotted on preferential basis to
  promoters/promoter group shall be locked in for 3
  years from the date of allotment
• Overall lock-in of 3 years for promoter holding
  shall not exceed 20 of the post issue capital
• Lock-in already complied shall be reduced while
  calculating lock-in on shares arising upon
  conversion, etc.
• Pre-preferential allotment holding of the
  allottee shall also be kept under lock-in from
  the relevant date up to 6 months from the date of
  making preferential allotment
• Locked in securities can be transferred inter se
  amongst Promoters / Promoter Group or to a new
  promoter or person in control of the Company
  subject to SAST and subject to continuation of
  lock-in the hands of the transferees for the
  remaining period

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Preferential Allotment DIP Guidelines

• Situations where Preferential Issue cant be made
  (13.3)
• Conditions for continuous listing not complied
  with
• Partly paid-up securities
• Pre-allotment Shareholding of the allottee not in
  demat form
• To those shareholders who have sold their shares
  during 6 months prior to the relevant date
• When any public / rights issue is going on (8.7)

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Preferential Allotment DIP Guidelines

• Other Provisions
• Currency of instruments (Warrants/PCDs/FCDs/Others
  ), with a provision for the allotment of equity
  shares at a future date, shall not exceed beyond
  18 months from the date of issue of the relevant
  instruments. (13.2)
• If warrants are allotted, at least 10 of the
  price fixed shall be payable on allotment of
  warrant/ PCD such amount to be adjusted on
  exercising option. In case option is not
  exercised, amount will be forfeited. (13.1.2.3)
• The statutory auditors of the Company shall
  certify that the issue is being made in
  accordance with these Guidelines the Certificate
  shall be laid before the general meeting convened
  to consider preferential issue. (13.5)

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Preferential Allotment DIP Guidelines

• Other Provisions (Contd)
• In case preferential allotment is to promoters,
  their relatives, associates/related entities for
  consideration other than cash, valuation of
  assets shall be done by an independent qualified
  valuer and the valuation report submitted to the
  exchanges on which shares of the Issuer Company
  are listed. (13.5.1.c)
• Details of money utilised / non-utilised out of
  the preferential issue proceeds shall be
  disclosed under an appropriate head in the
  Balance Sheet of the Company. (13.5A)

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Preferential Allotment DIP Guidelines

• Exemptions (13.7) -
• Guidelines will not be applicable, where shares
  are issued
• In pursuance to the merger and amalgamation
  scheme approved by High Court
• In accordance with the provisions of
  Rehabilitation package approved by BIFR
• To All India Public Financial Institutions in
  accordance with the provisions of Loan Agreements
  signed prior to 4th August, 1994.

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Preferential Allotment DIP Guidelines

• Changes proposed by PMAC, SEBI (Dec04)
• Guidelines to be extended to issues made by
  non-company issuers (eg. SBI), allotments under
  Section 81(3) etc.
• Pricing
• Instead of the weekly high low of the closing
  prices of shares, the weighted average price of
  the shares based on all transactions on the
  exchange to be reckoned.
• The concept of 130 trading days and 10 trading
  days to be introduced, in place of 6 months and 2
  weeks, respectively.Valuation of infrequently
  traded shares to be done as per the relevant
  provisions of SAST.
• No preferential issue at a price lower than face
  value except in terms of the provisions of
  Section 79 of the Companies Act
• IRR on preferential issue of convertibles not to
  exceed PLR of SBI as on the relevant date.

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Preferential Allotment DIP Guidelines

• Changes proposed (contd..)
• Choice of relevant dates for warrants to be done
  away with.
• Time limit for completion of all formalities to
  be extended to 21 days from 15 days.
• Lock-in
• Current reference to 20 lock-in to be removed
  any preferential issue to promoters, therefore,
  to be locked-in for 3 years.
• The condition of pre-allotment lock-in of 6
  months to be extended to relatives of promoters
  (i.e., spouse, parents, brother, sister or
  children) too.

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Preferential Allotment - SAST

• Preferential Allotment was exempted from the
  Takeover Regulations
• Justice Bhagwati Committee (May 02) recommended
  to lift the exemption and accordingly on 9th Sep
  02, such exemption was removed.
• As per latest amendment effective 3rd Jan 05, no
  acquirer shall acquire shares, through market
  purchases / preferential allotment, which entitle
  such acquirer to exercise more than 55 of the
  post-allotment voting rights in the target
  company.
• Other Provisions as to disclosures, public offer
  etc.

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Preferential Allotment As a method to acquire
Voting Rights

• Preferential allotment route was dominant
  method used to avail exemptions till September
  02. Thereafter, this route became a less used
  one. (SEBI W.P. 10)

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Preferential Allotment Companies Act

• General provisions e.g. Sections 67, 81, 173 etc.
  
• Return of allotment of Shares in Form 2 to be
  filed with ROC
• Issue of Certificate Rules
• CARO 383A Rules
• Rules for unlisted companies
• Applicability In respect of preferential issue
  of equity shares, fully convertible debentures,
  partly convertible debentures or any other
  convertible financial instruments.
• Conditions
• Authorisation in articles of the company.
• A special resolution to be passed in a General
  Meeting empowering the BOD for such issue the
  special resolution to be acted upon within 12
  months.

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Preferential Allotment Companies Act

• Conditions (Contd.)
• Explanatory statement to the notice will contain
  the prescribed information like the price at
  which the allotment is proposed, the relevant
  date on the basis of which price has been arrived
  at, the object(s) of the issue through
  preferential offer etc.
• A Certificate from the statutory auditors /
  company secretary in practice stating that the
  issue is being made in accordance with these
  Rules.
• The Certificate will be laid before the meeting
  of the shareholders convened to consider the
  proposed issue.

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Preferential Allotment Other Regulatory
Provisions

• Prevention of Insider Trading / Fraudulent
  Unfair Trading in Securities Generally.
• Delisting Guidelines
• If preferential allotment has the effect of
  reducing public shareholding below the minimum
  level, the provisions of the delisting guidelines
  will become applicable.
• Depositories Act, 1996
• Person subscribing to securities offered by an
  issuer has an option to receive the securities in
  physical or Demat Form
• All securities held by a depository to be
  dematerialised and in fungible form.
• Stamp Act
• Requisite stamp duty as per Central / relevant
  State Stamp Act should be paid on the securities
  issued under preferential allotment. (Issue of
  share certificates is a Central subject, while
  issue of debentures is a State subject)

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Preferential Allotment - Time Table
15 days
30 days
25 days
Acceptance
Allotment of Shares
Offer
Despatch of Individual Notices
In-principle Approval from Stock Exchanges
Board meeting
General Meeting
Relevant Date
Completion of formalities
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Preferential Allotment Norms in US

• Regulated by the Securities Exchange Commission
  (SEC).
• Section 5 of Securities Act, 1933 No offer may
  be made public unless a registration statement
  has been filed with SEC or the offer is exempt.
• Privately placed securities termed as restricted
  securities and are subject to re-sale
  restrictions, unless exempted.
• Private Placement Exemptions available
• At first instance Sec 4(2), Reg. D (Rules 504,
  505, 506), Reg. S
• On re-sale Sec 4(11/2), Rule 144, Rule 144A,
  Reg. S

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Preferential Allotment Norms in US

• Sec 3(b) read with Reg. D (Exempted Securities)
• Rule 504 505 Exemption for small offerings
  limited to 1 5 mn., respectively, during any
  12-month period
• Rule 506 Unlimited amount of securities to an
  unlimited no. of accredited investors and 35-
  non-accredited but sophisticated investors.
• No general advertising or solicitation
• Absence of re-distribution
• Sec 4(2) Private Placement Exemption
  (Transactions by Issuer not involving any public
  offering)
• Reg. S offshore distribution of securities of
  US foreign issuers

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Preferential Allotment - Norms in US

• Resale of restricted securities - Rule 144
• Securities are to be fully paid up.
• Ordinary Brokerage Transactions The sales must
  be handled in all respects as routine trading
  transactions, and brokers may not receive more
  than a normal commission. Neither the seller nor
  the broker can solicit orders to buy the
  securities.
• Volume Restriction The number of shares that
  may be sold (after the holding period) during any
  three-month period can't exceed the greater of 1
  of the outstanding shares of the same class being
  sold, or the average reported weekly trading
  volume during the four weeks preceding the filing
  a notice of the proposed sale in Form 144.
• Holding (Lock-in) Period One Year. If the
  shares are held for 2 years, the above conditions
  are exempted.
• Issuer must have complied with the periodic
  reporting requirements (e.g. Form 8K Disclosure
  of material events including private placement
  Form 10Q Quarterly financial Reports Form 10K
  Annual Report)
• Filing Notice With SEC At the time of placing
  the order for sale involving more than 500 shares
  or the aggregate amount is greater than 10,000
  in any 3-month period, a notice in Form 144 needs
  to be filed with SEC. The sale must take place
  within 3 months of filing the Form, otherwise, a
  fresh Form needs to be filed.

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Preferential Allotment Norms in US

• Rule 144A permits financial institutions with
  more than 100 mn. invested in securities to
  trade unregistered privately placed securities
  among themselves freely without re-sale
  conditions
• Sec 4(11/2)
• Established by practice and confirmed by the
  regulator
• Reliance on 4(1) based on the procedure applied
  under 4(2)
• One private placement investor holding restricted
  securities privately negotiates and sells to
  another, if the buyer agrees to hold them subject
  to the same restrictions as those that bind the
  seller.
• Reg. S offshore re-sale of securities of US
  foreign issuers

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Preferential Allotment Specific Cases

• Preferential Issue of Debt Securities
• SEBI Circular on private placement of debt
  securities by listed cos. (30th Sep. 03)
• Securities to carry a credit rating as specified
• To appoint Debenture Trustee registered With SEBI
• Securities to be issued traded in Demat form
• Issuer to sign a separate listing agreement
• Trading in privately placed securities shall take
  place between QIBs and HNIs in standard
  denomination of Rs. 10 L
• Above conditions Not Applicable for
  private placement of securities having a maturity
  of less than 365 days. SEBI Clarification of Dec
  03)
• Companies Act
• Creation of DRR - In terms of DCA Circular
  (9/2002 dt. 18/04/02) issued u/s 117C, creation
  of DRR is not mandatory in case of privately
  placed debt by NBFCs 25 in case of
  manufacturing / infrastructure cos.
• Creation of Security / Charge - Non-NBFC by
  mortgage of immovable property only NBFC by
  mortgage of immovable property or any other asset
  (so that it doesnt fall into public deposits
  category).
• Other Provisions as applicable to issue of
  debentures.

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Preferential Allotment Specific Cases

• Preferential Allotment to NRIs / FIIs
• Issue of Shares / Convertibles / NCDs to NRIs /
  FIIs is regulated under the the FEM (Borrowing
  and Lending in Rupees) Regulations and FEM
  (Transfer or Issue of Securities by a Person
  Resident Outside India) Regulations. in terms of
  these Regulations
• NCDs to NRIs is treated as borrowing and covered
  under the FEM (Borrowing and Lending in Rupees)
  Regulations. These Regulations permit automatic
  route on satisfaction of the conditions
  stipulated therein. One of the conditions is
  issue must be through public offer. Therefore,
  private placement of NCDs to NRIs would require
  RBI approval.
• FEM (Transfer or Issue of Securities by a Person
  Resident Outside India) Regulations
• Purchase of Shares / Convertibles by FIIs
  Subject to limits under Schedule 2 (PIS)
• Purchase of Shares / Convertibles by NRIs on
  non-repatriation basis - No limit (Schedule 4).
  Therefore purchase on repatriation basis would
  require RBI approval.
• Purchase of NCDs by FIIs on repatriation basis
  Permitted under Schedule 5 on satisfaction of
  certain conditions like allocation of total
  investment between equity and debt in the ratio
  of 7030, etc.

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Preferential Allotment Specific Cases

• Q I P
• Eligible Issuer A company listed on a stock
  exchange having nation wide trading terminals and
  which is in compliance with the prescribed
  minimum public shareholding requirements.
• Eligible Investor QIBs other than any QIB who
  is a promoter or related to promoter(s) cannot
  participate in QIP.
• Eligible Securities
• equity shares
• any securities other than warrants, which are
  convertible into or exchangeable with equity
  shares within 5 years.

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Preferential Allotment Specific Cases

• QIP Issue Structure
• Maximum Limit 5 times the net worth of the
  issuer in any year.
• Minimum Placement to Mutual Funds Minimum of
  10 of securities issued pursuant to QIP will be
  allotted to mutual funds, if agreeable.
• Minimum Number of Allottees
• (a) 2, where the issue size is up to Rs.250 cr.
• (b) 5, where the issue size is more than Rs.250
  cr.
• No single allottee can be allotted more than 50
  of the issue size.  
• There will be a gap of at least 6 months between
  each placement in case of multiple placements
  pursuant to the same resolution.

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Preferential Allotment Specific Cases

• QIP Pricing and Lock-in
• Pricing Minimum price to higher of the average
  of the weekly high and low of the closing prices
  quoted during 6 months or 2 weeks preceding the
  relevant date. Price to be subject to adjustment
  for corporate actions such as stock splits,
  rights, bonus etc.
• Lock-in of securities issued under QIP No
  lock-in. Only, off-market transactions are
  prohibited for a period of 1 year from the date
  of allotment.

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Preferential Allotment Specific Cases

• QIP - Other Requirements
• Merchant Banker
• Placement Document
• to contain information specified in Schedule
  XXIA.
• being a private document can be provided only to
  select investors.
• to be placed on the website of the stock
  exchange(s) and of the Issuer
• a copy to be filed with SEBI for record purpose
  within 30 days of the allotment.
• Securities to be fully paid-up at the time of
  allotment.
• The resolution approving QIP, passed under
  Section 81(1A) of the Companies Act, to remain
  valid for 12 months from the date of passing.

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Preferential Allotment - Back
Office Preparation

• Compilation of Share Prices and calculation of
  appropriate price.
• Drafting of Shareholders Resolution containing
  relevant details as specified
• Calculation of Lock in Shares
• Taking of Auditors Certificate
• Disclosures in Balance Sheet / Directors Report

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Preferential Allotment - Back
Office Preparation

• Projection of funds to be raised, utilisation of
  funds, variation if any, reasons for material
  variation etc.
• Preparation of Quarterly / Annual Statement
• Obtaining Audit Committees Views, if any
• Appointment of Valuer, if required
• Allotment and Issue within time

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Preferential Allotment - Back
Office Preparation

• Internal and External Interactions
• Shareholders
• Stock Exchanges
• Internal Accounts, Finance Department
• Audit Committee
• Statutory Auditors
• Valuer - Merchant Banker / CA
• Press

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• Disclosure Limits under SAST
• Acquisition of 5 or 10 or 14 or 54 or 74
  shares in the target company and purchase or sale
  of shares aggregating 2 or more if the acquirer
  is holding more than 15 but less than 55 of
  shares in the target company Regulation 7
• Acquirer to disclose his aggregate shareholding
  to the target company the Stock Exchanges,
  within 2 days of receipt of intimation of
  allotment of shares or acquisition of shares, as
  the case may be.
• Target company to disclose the aggregate number
  of shares held by the acquirer to the Stock
  Exchanges, within 7 days of receipt of
  information as above.
• Yearly Disclosures The following persons to
  make yearly disclosures, in respect of their
  holdings as on 31st March, to the target company
  
• every person holding more than 15 shares, within
  21 days from the financial year ending 31st
  March. Regulation 8(1)
• a promoter or every person having control over
  the company, within 21 days from the financial
  year ending 31st March as well as the record date
  of the company for the purpose of declaration of
  dividend. Reg. 8(2)
• The target company to make disclosures, of
  the changes in holdings of the aforesaid persons,
  to the Stock Exchanges within 30 days from the
  financial year ending 31st March as well as the
  record date for the purpose of declaration of
  dividend. Regulation 8(3)

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• Triggers re. Public Announcement
• On acquisition of 15 or more of the shares in
  the target company Regulation 10
• On acquisition of additional shares entitling to
  exercise more than 5 of the voting rights in any
  financial year ending on 31st March by an
  acquirer who has acquired 15 or more but less
  than 55 of the shares in the target company.
  Regulation 11(1)
• On acquisition of additional shares by an
  acquirer who has acquired more than 55 but less
  than 75 of the shares in the target company.
  Regulation 11(2)
• On acquisition of control over the target
  company, in any manner, irrespective of whether
  or not there has been any acquisition of shares.
  Regulation 12

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AND DONT FORGET, ALL THIS HAS TO BE DONE BY US

COMPANY SECRETARIES
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