Amendment to Rule 18 of Companies (Share Capital and Debentures) Rules, 2014

The Companies (Share Capital and Debentures) Rules, 2014 (“Rules”) lays down the procedure for issuance of shares and debentures, disclosures, filing requirements and other compliances under the Companies Act, 2013 (“Act”).

The following post seeks to analyse a key change introduced to Rule 18 vide an amendment notified by the Ministry of Corporate Affairs on 19^th July, 2016 to the Rules (“Third Amendment”).

Rule 18 stipulates the term for redemption of debentures, appointment of a debenture trustee, creation of security to secure the issue of debentures and creating a reserve in the company’s books of accounts for repayment of debentures on maturity and the interest payable thereon.

The rules inter alia imposed an obligation on companies (private and public) to secure an issue of debentures with their own assets having a value which is sufficient for due repayment of the amount of debentures.

The Third Amendment has introduced revisions to the above obligations as reproduced below:

Rule 18 (1) (b) is revised to read as, “Such an issue of debentures shall be secured by the creation of a charge on the properties or assets of the company or its subsidiaries or its holding company or its associates companies, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon.”

Further, Rule 18 (d) which provides for creation of security on “any specific movable property of the company” is now amended to read as, “any specific movable property of the company or its holding company or subsidiaries or associate companies or otherwise.”

The amendment has now relaxed the earlier position wherein a company could create a charge only on its property or assets. The amendment will now allow a company’s subsidiary or its associate company to provide security for issue of debentures. In the Indian scenario, the companies which often seek to raise capital for financing its projects resort to debt funding by issuance of secured Non-Convertible Debentures (“NCDs”) are real estate developers or infrastructure companies. Due to the lack of consolidation, adherence to GAAP and its asset pool being apportioned amongst its group companies, most businesses often find it difficult to comply with conditions stipulated in Rule 18. Add to that, it is not uncommon to find such group companies having common directors on its board which leads to a dead end in the form of Section 185 of the Act. In light of this, how will the changes brought in by the Third Amendment come to the rescue of these businesses?

For starters, the revision in sub-rule (b) of Rule 18 will allow a subsidiary to provide its immovable property and assets as security for securing the issue of NCDs by its holding company. The term “subsidiary” has been defined under the Act in Section 2 (87) as, “in relation to any other company (that is to say the holding company), means a company in which the holding company-

(i)        Controls the composition of the Board of Directors; or

(ii)      Exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies”

It’s explicit that for the purposes of the Act, a subsidiary shall mean a company which owns not less than 51% of total share paid-up capital and/or it controls the composition of board of directors.

As for associate companies, there is an absence of clarity owing to the definition provided in Section 2 (6) of the Act, which reads as follows:

“In relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.

For the purpose of this clause the Explanation provides, “significant influence” means control of at least twenty per cent of total share capital, or of business decisions under an agreement.”  

The term “control” is also defined under the Act which reads as follows:

“control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person of persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders’ agreements  or voting agreements or in any other manner”

The above definition is exhaustive and it’s identical to Regulation 2 (e) of SEBI (SAST) Regulations, 2011. Therefore it can be concluded that the term “associate company” shall also include companies with majority of common directors or persons who have the right to control a company’s management or its operational policies directly or indirectly, by virtue of an agreement or in any other manner.

Though the conditions under Rule 18 have been relaxed, Section 186 (2) and (3) of the Act will continue to apply as the latter forbids a company from advancing any kind of loan, guarantee or security to any other body corporate exceeding 60% of its paid-up capital and free reserves or 100% of free reserves, whichever higher, except upon complying with the provisions of the section and relevant rules which inter alia entails passing of shareholder resolutions.

Conclusion

Henceforth, this key change introduced to Rule 18 would be  looked at as a positive change within the industry, especially for companies desirous of raising capital by issuance of NCDs. In other words, this change would prove to be beneficial for companies that would want to raise capital by issuance of NCDs.