Mandatory Dematerialisation of Securities (Shares) by Private Companies : Latest Amendment

The landscape of corporate finance and securities management in India is on the cusp of a significant transformation. In line with the progressive strides in digital technologies and the push for enhanced corporate governance, the Ministry of Corporate Affairs (MCA) has embarked on a journey to align the operating frameworks of private companies with those of their public counterparts. The recent notification dated October 29, 2023, heralds a new era where private companies, with the exception of small companies, are mandated to enter the domain of dematerialised securities, thus abandoning the age-old practice of tangible share certificates.

Understanding Dematerialisation

Dematerialisation, often abbreviated as ‘demat’, refers to the process by which physical share certificates are converted into electronic format and maintained in an account with a Depository Participant (DP). To the uninitiated, this might seem like an inconspicuous change, but its implications on security, share transferability, and overall market practices are profound. Put simply, dematerialisation is akin to the transition from cash to digital banking; it doesn’t change the value or ownership but drastically enhances the way transactions are conducted.

Background of the Amendment

Previously, private companies in India had the discretion to issue and manage shares either in physical or dematerialised form, while their public counterparts were bound to adhere to stricter regulations mandating demat shares.

This discrepancy not only created an uneven playing field but also posed challenges in the transparency, efficiency, and fluidity of transactions involving private company shares. The MCA, in a bid to standardize practices across the board, introduced the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023, designed to modernise the securities landscape of private companies.

This trailblazing move is set to secure transactions, streamline processes, and safeguard the interests of shareholders and companies alike. The dematerialisation of shares promises to mitigate risks of loss, theft, or forgery of physical certificates and enables a seamless transfer of ownership, which is more in tune with contemporary business practices.

Who Is Affected by This Amendment?

The amendment primarily targets private companies, with provisions that exempt those falling under the definition of a ‘small company’ as per the Companies Act. This is an intentional carve-out, made in consideration of the scale of operations and the administrative burdens this might impose on these smaller entities. For all other private companies that eclipse the qualifying threshold of paid-up capital and turnover, dematerialisation of shares is not just a forward leap but a new operational mandate.

To ensure that companies are ready for this transformative change, it is essential that they stay abreast of the filing due dates to remain compliant with the ROC, as failure to comply could complicate the dematerialisation process.

Why Is This Amendment Important?

By bringing private companies into the fold of mandatory dematerialisation, the MCA aims to fortify the securities market against malpractices and to provide a consolidated platform for regulating securities in India. As transparency becomes a critical attribute in corporate dealings, dematerialisation will ensure that every transaction, be it transfer or buy-back of shares, is duly recorded and easy to track.

In the forthcoming parts of this article, we shall delve into the specifics of this amendment, including the definitions of private and small companies per the Companies Act, the timeline for compliance, and the processes involved in the transition. Whether you are a company seeking to file your annual return, contemplating a company strike-off, or simply a shareholder aiming to understand what lies ahead, this article will pave the way for a smooth transition into the dematerialised regime. Stay tuned for more insights as we continue to dissect this pivotal change in India’s corporate finance environment.

Compliance Requirement and Definition of Small Companies

To ensure a smooth transition towards the dematerialisation of shares, it is crucial to understand the compliance requirements and the distinction between private and small companies under the amended Companies Act.

Compliance Requirement

Private companies play a significant role in the Indian corporate landscape. With the recent amendment, the MCA aims to align their practices with those of their public counterparts, emphasizing transparency and accountability. The compliance requirement introduced by the amendment mandates the issuance of shares in dematerialised form for private companies, excluding small companies.

Definition of Private and Small Companies

To determine whether a private company needs to comply with the dematerialisation requirement, it is important to understand the definitions provided by the Companies Act. A private company is characterized by certain restrictions, including limitations on share transferability, a maximum of two hundred members, and a prohibition on public invitations to subscribe for its securities.

On the other hand, a small company is defined based on specific criteria, including the paid-up share capital and turnover.

According to the Companies Act, a small company has:

1. A paid-up share capital not exceeding four crore rupees (or a prescribed higher amount, but not more than ten crore rupees).
2. A turnover that does not exceed forty crore rupees (or a prescribed higher amount, not exceeding one hundred crore rupees), as per the profit and loss account of the immediately preceding financial year.

It is important to note that certain companies, such as holding companies, subsidiary companies, those registered under section 8, or companies governed by special acts, fall outside the scope of the small company definition.

Compliance Threshold

Under the new amendment, private companies (excluding small companies) with a paid-up share capital of four crore rupees or more and a turnover of forty crore rupees or more are required to comply with the dematerialisation requirement. This threshold ensures that larger private companies, which typically have a greater impact on the securities market, adhere to the new regulations.

Small companies, as defined by the Companies Act, are exempt from the mandatory dematerialisation requirement. This exemption recognizes the relatively smaller scale of operations and aims to reduce the administrative burden on these entities.

By imposing the compliance threshold, the MCA aims to strike a balance between ensuring strong compliance measures for larger private companies and providing relief to smaller entities.

Compliance Timeline and Specific Transactions

To facilitate a smooth transition to dematerialised securities, private companies subject to the new amendment are provided with a compliance timeline. Additionally, specific transactions require immediate compliance with dematerialisation requirements. Let’s explore these aspects in detail.

Compliance Timeline

Private companies falling under the purview of the new dematerialisation requirement must ensure the dematerialisation of all their securities within eighteen months of the closure of the financial year ending on March 31, 2023. This implies that by September 30, 2024, these companies should have completed the transition to dematerialised securities.

The timeline allows companies sufficient time to undertake the necessary steps to comply with the dematerialisation requirement. It is advisable for companies to begin the dematerialisation process well in advance to avoid any last-minute challenges or non-compliance issues.

Compliance for Specific Transactions

In addition to the general compliance timeline, private companies planning specific transactions must also consider dematerialisation requirements. The following transactions require compliance with the dematerialisation requirement, even if they occur after the compliance due date (September 30, 2024):

1. Buyback of Securities: If a private company plans to conduct a buyback of its securities after the compliance due date, it must ensure that the securities held by promoters, directors, and key managerial personnel are dematerialised as per the provisions of the Depositories Act, 1996.
2. Issuance of Bonus Shares: When issuing bonus shares after the compliance due date, private companies must confirm that the holdings of securities by promoters, directors, and key managerial personnel have been dematerialised in accordance with the Depositories Act, 1996.
3. Rights Offers: Similar to buybacks and bonus share issuance, private companies conducting rights offers after the compliance due date are required to ensure that the securities held by relevant individuals are dematerialised as per the provisions of the Depositories Act, 1996.

It is crucial for companies to be aware of these specific compliance requirements when engaging in such transactions, as non-compliance may have legal implications and impact the validity of the transaction. By adhering to the dematerialisation requirements for these transactions, companies can ensure transparency, traceability, and compliance.

Dematerialisation Process for Private Companies

As private companies embark on the journey to comply with the new dematerialisation requirements, it is important to understand the process involved in transitioning from physical to dematerialised securities. Let’s explore the steps companies should take to comply with the new rules.

Engage with a Depository Participant (DP)

To initiate the dematerialisation process, private companies need to engage with a Depository Participant (DP). A DP is an intermediary registered with the Securities and Exchange Board of India (SEBI) and acts as an interface between the company and the depository.

The DP will guide companies throughout the dematerialisation process, including setting up the necessary accounts and facilitating the conversion of physical share certificates into dematerialised form.

Educate Shareholders and Ensure Compliance

Private companies must proactively educate their shareholders about the dematerialisation process and the new requirements. This communication should provide clear instructions and guidance on how shareholders can dematerialise their shares.

Companies should also ensure that shareholders are aware of the deadline for compliance and the consequences of non-compliance. Maintaining open lines of communication and offering assistance will help facilitate a smooth transition for all stakeholders involved.

Follow the Process

The dematerialisation process generally involves the following steps:

1. Shareholders submit their physical share certificates to the DP.
2. The DP verifies the documents and processes the request for dematerialisation.
3. Once verified, the DP updates the shareholder’s account with the dematerialised shares.
4. Shareholders receive their dematerialised shares in electronic form, which are held in a demat account linked to their unique Demat Account Number (DAN).
5. Shareholders can then manage their securities electronically, including buying or selling shares, receiving dividends, and participating in corporate actions.

It is crucial for private companies to ensure that shareholders comply with the dematerialisation process. Shareholders who intend to transfer their shares on or after the compliance due date must first dematerialise those securities before initiating the transfer. Individuals subscribing to securities from a private company through private placement, bonus shares, or rights offers after the compliance due date must also ensure that all their securities are held in dematerialised form.

Importance of Compliance

Compliance with the dematerialisation requirement is not just a legal obligation; it is a crucial step towards enhancing transparency, streamlining processes, and safeguarding the interests of shareholders and companies alike. By complying with the new rules, private companies demonstrate their commitment to robust corporate governance practices and investor protection.

In the final part of this article, we will summarize the key points discussed and emphasize the significance of proactive measures for private companies as they work towards the compliance deadline. Stay tuned for the conclusion of this comprehensive guide to the mandatory dematerialisation of securities for private companies in India.

Importance of Proactive Measures

As the compliance deadline for the mandatory dematerialisation of securities approaches, private companies must take proactive measures to ensure a smooth transition and full compliance with the new regulations. Let’s summarize the key points discussed and emphasize the significance of these measures.

Importance of Proactive Measures

1. Early Initiation: Private companies should initiate the dematerialisation process as early as possible to allow ample time for shareholders to comply. Starting the process well in advance can help avoid any last-minute challenges or non-compliance issues.
2. Educating Shareholders: Companies must proactively educate their shareholders about the dematerialisation process, deadlines, and consequences of non-compliance. Clear communication and assistance in the dematerialisation process will ensure smooth compliance.
3. Engaging with Depository Participants: Private companies should engage with registered Depository Participants (DPs) to facilitate the dematerialisation process. Working with DPs will ensure proper guidance and assistance throughout the transition.
4. Timely Compliance for Specific Transactions: Private companies planning specific transactions such as buybacks, bonus share issuances, and rights offers must ensure immediate compliance with the dematerialisation requirement, even if these transactions occur after the compliance due date.

Conclusion

The recent amendment to the Companies Act, mandating the dematerialisation of securities for private companies (excluding small companies), marks a significant step towards enhancing transparency, efficiency, and investor protection in the securities market. By transitioning to dematerialised securities, private companies align themselves with the practices of their public counterparts.

The compliance requirements, defined thresholds, and specific timelines outlined in the amendment ensure a smooth transition and create a level playing field for private companies. The Dematerialisation process provides increased security, easy transferability, and streamlined management of securities.

Private companies must understand the importance of compliance, not only as a legal obligation but also as a means to improve corporate governance practices. By proactively initiating the dematerialisation process, educating shareholders, engaging with DPs, and complying with the requirements for specific transactions, private companies can successfully navigate the transition and contribute to a more robust and transparent securities market in India.

As the compliance deadline of September 30, 2024, approaches, private companies must prioritize the necessary measures to meet regulatory milestones. Seek professional advice, refer to the relevant resources, and ensure full compliance with the Companies Act and the provisions of the Dematerialisation process.

In conclusion, the mandatory dematerialisation of securities for private companies signifies a progressive shift towards an efficient and secure securities market. With timely action and diligent compliance, private companies can navigate this regulatory change successfully, ultimately contributing to a more streamlined and transparent corporate ecosystem in India.

FAQs

What is dematerialization?

Dematerialization is the process of converting physical shares into electronic form, which is safer and more convenient.

Who is affected by the amendment to the Companies Act?

All private companies with a paid-up share capital of four crore rupees or more and a turnover of forty crore rupees or more, excluding small companies as defined by the Companies Act.

What is a small company, and why is it exempt?

A small company has a paid-up capital less than four crore rupees and turnover less than forty crore rupees. They are exempt due to their smaller scale and lesser public impact.

What is the timeline for companies to comply with dematerialization?

The compliance deadline is September 30, 2024, eighteen months after the financial year ending on March 31, 2023.

Are there any transactions for which dematerialization is immediately necessary?

Yes, specific transactions such as buybacks, bonus issues, and rights offers require immediate compliance if they occur after the compliance due date.

How will transferring shares work post-compliance due date?

All transfers of shares after the compliance due date must only be done if the securities are held in dematerialized form.

What are the benefits of dematerializing shares?

Benefits include enhanced transparency, better security against fraud, easier handling, and improved efficiency in securities management.

What should a company do to comply with the new amendment?

Companies must engage with a Depository Participant (DP) to initiate the dematerialization process for their securities and ensure that all shareholders are aware of and comply with the new requirements.