Rights Issue of Fully Convertible Debentures: The Canning Industries Case

[Guest Post by Gaurav Pingle]

The author is a practicing Company Secretary and runs his own CS firm, Gaurav Pingle & Associates, Pune.


Section 23 of the Companies Act, 2013 (“the Act”) relates to ‘public offer and private placement’. According to the said provision, a public company may issue securities to public through prospectus (i.e. Initial Public Offer/Further Public Offer) or through private placement[i] or through rights issue[ii] or bonus issue[iii]. In addition to this, a public company can also issue ESOPs or debentures[iv]. However, the question for interpretation arises when a public company issues securities and such issue falls under two or more provisions of the Act. The requirement of valuation is different for rights issue, private placement or public offer of securities. In addition to this, the Act read with the Companies (Share Capital and Debenture) Rules, 2014 has significantly enhanced the compliances, disclosures, documentation and reporting for such issue of securities.

Section 42 of the Act, which relates to issue of shares on private placement basis was entirely substituted by the Companies (Amendment) Act, 2017[v]. However, irrespective of substitution, the underlying theme has not changed i.e. offer and issue of securities to certain investor(s) only i.e. ‘select group of persons’. In the recent case of Canning Industries Cochin Ltd. v. SEBI[vi], decided on 28 January 2020, Securities Appellate Tribunal (“SAT”) has interpreted the provisions relating to private placement of securities. This article analyses Section 42 of the Act along with the said SAT judgment.

Facts of the case

Canning Industries Cochin Ltd. (“Company”), an unlisted public company (having 1,929 shareholders) passed a special resolution[vii] for issuing 1,92,900 unsecured Fully Convertible Debentures (“FCDs”) of Rs. 250/- each to its 1,929 shareholders at the rate of 100 FCDs, with no right to renounce the offer to any other person. The debentures were issued for a period of 5 years i.e. every FCD would be compulsorily converted into equity shares on maturity or earlier if the call option is exercised by the Company itself. However, the Company was able to raise funds only from 335 members. One disgruntled shareholder filed complaints before SEBI and NCLT alleging that the Company has made public issue of securities without complying with the provisions of the Act. The Company contended that the same was neither rights issue as issue was not made on a proportionate basis, nor was it private placement as no ‘select group of individuals’ were identified for the issue in question. It however claimed the issue to be made on preferential basis under Section 62(1)(c) of the Act.

Issue for consideration

Whether the said issue of FCDs would be deemed public issue under Section 42 of the Act?

Observations of SEBI

SEBI in its Order dated 18 March 2019[viii], observed that an offer to 335 persons is a ‘deemed public issue’ as it violates the provisions of Section 42(1) of the Act. SEBI also observed that the Company was required to comply with the relevant IPO related provisions and was required to make an application to one or more of the stock exchanges for listing, which the Company failed to comply.

Observations of SAT

On appeal, SAT observed that Section 42 of the Act is not applicable to the offer of FCDs as it is not ‘private placement’ of securities. SAT observed that ‘private placement’ means an offer to subscribe securities to a ‘select group of persons’ by a company. The term ‘select group of persons’ though not defined in the Act, indicates a specified number of persons limited to aggregate 200 in a financial year. It was observed that since the offer was made to 1929 shareholders, the offer of said FCDs cannot be termed as an offer to a ‘select group of persons’. SAT observed that “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.” SAT further observed that restriction of subscription of shares to 200 persons or more is not applicable in the instant case as it is not a ‘private placement’. SAT also observed that section 62(1)(c) of the Act is not applicable as it is not a case of issuance of shares/securities on preferential basis.

Analysis of SC Order in the Sahara case

Before we analyse the said SAT order, let us refer to some important and relevant observations of Supreme Court (“SC”) in Sahara India Real Estate Corporation v. SEBI[ix]. In this case, an offer was made to public under the garb of private placement of securities[x]. SC observed that Section 73(1) of the Companies Act, 1956[xi] casts an obligation on every company intending to offer shares or debentures to the public to apply to recognised stock exchange for listing its securities. SC further observed that if an unlisted company expresses its intention, by conduct or otherwise, to offer its securities to the public by the issue of a prospectus, there arises a legal obligation on the company to make an application on a recognized stock exchange for listing. Even though the overall principle was laid down by SC under the Companies Act, 1956, it is still noted and referred by SEBI in many cases dealing with public issue of shares or securities, and stands valid under the provisions of Companies Act, 2013. Interestingly, provisions relating to private placement of securities have been introduced with an objective to avoid Sahara-like events in future i.e. offer to public under the garb of private placement of securities.

Analysis of SAT Order

  • FCDs were offered to 1,929 persons, however all the offerees were existing shareholders. Also, the right of renunciation was not part of the offer. Issue is whether such offer is rights offer or public offer or an offer that violates the provisions of private placement of securities? As discussed above, SAT observed that such issue is neither rights issue nor public issue nor private placement. The difference between Sahara case and the said case is the recipients of the offer and intention of the companies. In the said case, the offer of FCDs was made to existing shareholders and funds were raised a genuine purpose[xii]. Also, the offer was limited to shareholders only as there was no right of renunciation offered. The intention was clear by documents and conduct that the offer was to only shareholders and not public. In Sahara case – quite a few provisions of the Companies Act, 1956 and the SEBI Act, 1992 were flouted for raising monies through Optionally Fully Convertible Debentures (“OFCDs”).
  • Whether Section 62(3) of the Act creates an exception to Section 62 of the Act? Section 62(3) of the Act creates an exception to the provisions of rights issue interms of procedure for further issue of shares, and only prior approval of shareholders is required for increasing its subscribed capital by exercising option attached to the debentures or loan raised to convert such loans or debentures into shares. Here, there is no limitation to whom the offer can be made. Furthermore, such conversion of debentures/loans into shares does not fall under Section 23 of the Act.
  • Interpreting ‘select group of persons’: SAT has interpreted the expression ‘select group of persons’ and such interpretation makes a direct distinction between ‘all shareholders’ and ‘select group of persons’. Since the offer was made to all shareholders, there cannot be non-compliance with respect to offer to ‘select group of persons’. SAT’s interpretation would be helpful for quite a few listed and unlisted companies in structuring the issue of securities and accordingly complying with only the relevant provisions of the Act. Interestingly, Section 62(1) of the Act relating to ‘rights issue’ has reference to only ‘shares’ and not ‘securities’. With an objective to regulate such issues and to protect the interest of shareholders, it would be desirable to amend Section 62(1) of the Act to cover rights issue of ‘securities’.


The said offer of FCDs has some features of rights issue i.e. offer to all shareholders on proportionate basis. It also had some features of public issue i.e. by number of persons to whom offer is made. Though, it has all the features, such FCD issue is neither rights issue nor public issue nor private placement of securities. Such issue falls under the provisions of Section 62(3) of the Act read with debenture-related provisions – which is not part of the basic provision relating to issue of securities (i.e. section 23 of the Act).

End Notes

[i] u/s 42 of the Act.

[ii] u/s 62 of the Act.

[iii] u/s 63 of the Act.

[iv] u/s 71 of the Act.

[v] Amendment effective from August 7, 2018.

[vi] Appeal No. 115 of 2019, January 28, 2020.

[vii] Under section 62(3) and 71 of the Companies Act, 2013 read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014.

[viii] SEBI Order dated March 18, 2019.

[ix] Civil Appeal Nos. 9813 & 9833 of 2011.

[x] i.e. optionally fully convertible debentures (OFCDs).

[xi] Corresponding to section 40(1) of the Companies Act, 2013.

[xii] i.e. for automation of packing drinking water projects, advertisements, sales promotion of this project and for working capital requirements.


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