Understanding the Rights Issue Process
The rights issue is a method for raising additional capital by offering existing shareholders the opportunity to purchase additional shares in proportion to their current holdings. A rights issue is a corporate finance strategy employed by companies to raise capital without diluting the existing shareholder base.
This method of raising capital presents a range of benefits for companies seeking to raise capital. In an event that the shareholders wish to participate in the rights issue process, this method offers a straightforward and rapid way to generate funds by allowing existing shareholders to purchase additional shares. This approach enables the company to quickly secure the necessary capital to support initiatives like expansion, research, debt reduction, or other strategic projects. By engaging with shareholders who are already committed to the company, it also strengthens the relationship with these stakeholders.
If the shareholders wish to participate in the rights issues process, this method offers a cost-effective alternative to other fundraising methods. By opting for a rights issue, the company can bypass underwriting fees and other related expenses, making it a more economical choice without having the need to increase its liabilities. This approach allows the company to maintain greater control over its capital structure by reducing the need for external investors. By offering shares first to existing shareholders, the company ensures that ownership remains within the current shareholder group. This helps preserve the company’s independence and avoids increasing its liabilities, aligning with its immediate financial needs while safeguarding its autonomy.
This process is primarily governed by Section 62 of the Companies Act, 2013, which outlines the legal framework and procedural requirements that companies must adhere to while raising funds through this method.
While the rights issue process is straightforward in many cases, complications often arise when one or more shareholders are foreign entities or individuals. This article aims to explore the rights issue process under Section 62 and highlight the specific challenges encountered when dealing with foreign shareholders.
The primary steps involved in the rights issue process are as follows:
Brief Process of Rights Issue:
Step 1- Obtain Valuation Certificate- Secure a valuation certificate of the company from a chartered accountant, SEBI-registered merchant banker, or practicing cost accountant.
Step 2- Prepare Draft Offer Letter: Draft the offer letter for rights issue considering the size of the issue, valuation of equity shares, offer period, etc. Further, issue a notice of the board meeting with the agenda including the rights issue of shares and approval of the offer letter.
Step 3- Conduct Board Meeting: Approve the record date (which refers to the number of shareholders of the company on the date of the board meeting), offer letter, offer period, and the ratio of the shares to be issued in the Board Meeting. Thereby passing a resolution of raising further capital via the rights issue process.
Step 4- Send Offer Letter to Shareholders: Send the offer letter to all shareholders as of the record date decided by the Board of Directors. The offer period shall open 3 days after the issuance of the offer letter.
Offer Period- Per Section 62(1)(a) of the Companies Act, 2013, the offer period must be at least 15 days but not more than 30 days.
Renunciation of Shares- Under Section 62(1)(c) of the Companies Act, 2013, if existing shareholders choose not to participate in the rights issue, they are required to formally communicate their decision of non-participation to the company before the closure of the offer period. Additionally, shareholders who opt not to partake in the rights issue have the option to renounce the shares offered to them in favour of other existing shareholders, thereby enabling the reallocation of such shares within the current shareholder base.
The Application Form and Receipt of Money – In an event that the shareholders wish to participate in this process, the shareholders have to submit the application form along with the application money. The application money should be received in the company’s bank account after the offer opens and before it closes.
Step 5- Post-Offer Actions: After receiving the money and the closure of the offer period, the company has to issue a notice for the next board meeting. The agenda for this board meeting shall include the topic of allocation of shares through a rights issue.
Step 6- Board Meeting for Allotment of Shares: Conduct the board meeting and pass the resolution for the allotment of shares on a rights issue basis to the applicants.
Step 7- Submission of Returns:
- FORM PAS-3: This form is to be submitted to the Registrar of Companies within 30 days from the date of allotment i.e., the board meeting for allotment of shares.
- FORM FC-GPR: This form has to be submitted to the Reserve Bank of India within 30 days from the date of allotment. The company raising the funds shall obtain a copy of the Foreign Inward Remittance Certificate (FIRC) and Know Your Customer (KYC) documents for submitting FORM FC-GPR with the RBI. These should be provided by the bank where the foreign investment has been received. Further a Company Secretary (CS) certificate will be required at the time of submitting FORM FC-GPR.
Challenges When Dealing with Foreign Shareholders
While the process outlined above is relatively simple when dealing with domestic shareholders, complications arise when one or more shareholders are foreign entities. The involvement of foreign shareholders introduces a layer of complexity due to the interplay of various regulations, including the Foreign Exchange Management Act (FEMA), 1999, and the Foreign Direct Investment (FDI) policy. One has to ensure that the FDI is coming through the Automatic Route or the route by which governmental approvals are required. In the automatic route no prior approvals are required from the Government for the investment.
- Pricing Guidelines: FEMA regulations impose specific pricing guidelines for shares issued to foreign shareholders and it should be offered at the same price as Indian resident shareholders. Furter, the issue price must be determined based on the valuation guidelines provided by the RBI and the valuation of shares must be done by a registered valuer.
- Time Zone and Communication Barriers: Coordinating with foreign shareholders can be challenging due to differences in time zones and communication barriers. Ensuring timely acceptance or renunciation of the offer and completing the necessary documentation can be a cumbersome process.
- Compliances with respect to Share Application Money: When a foreign shareholder processes a payment for a rights issue, the foreign bank is required to provide a six-pointer KYC to the domestic bank where the funds are to be remitted, which includes details such as the shareholder’s identity, source of funds, and purpose of the transaction. If the bank fails to supply this KYC documentation or does not specify the reason for the transfer (e.g., investment in equity), it can cause delays. Nonetheless, the Foreign Inward Remittance Certificate (FIRC), which provides both the date of processing and the date of credit, serves as sufficient proof that the payment was made before the closing date. This documentation helps protect against the lapse of the offer letter, ensuring compliance with the specified timeline.
- Compliance with Currency Exchange Rates: When a domestic company raises funds in INR but receives the transfer is in the currency of the foreign shareholder’s country, it is crucial to ensure that the share application money meets or exceeds the amount intended to be raised. For example, if the domestic company seeks to raise INR 2,00,00,000, which is equivalent to USD 230,000 at an exchange rate of INR 86.96 per USD on the offer’s opening date, and the exchange rate changes to INR 88 per USD by the processing date, the foreign shareholder must ensure that the transferred amount still corresponds to the required INR amount. Failure to match the required share application money could lead to complications. It is acceptable for the amount received to exceed the required sum, but it must not be less.
- Mismatch in Name of the Account Holder and Shareholder Name: One of the challenges encountered during a rights issue process is the mismatch between the name of the account holder and their registered name as a shareholder as reflected in the official records. Such mismatches can lead to delays in processing share application money and/or completion of the rights issue process, as banks/ the relevant authority may reject transactions or require additional verification to reconcile the records. To address this issue, the company must ensure that the names on all relevant documents, including the shareholder register and bank account details, are consistent and accurate. In cases where discrepancies exist, letters from the company and other supporting documents from shareholders may be necessary to validate their identity and ensure processing of funds within the stipulated timeframe.
During our experience with rights issues involving foreign shareholders, we have encountered several challenges that can potentially delay the process or result in non-compliance. For example, obtaining the KYC of the foreign shareholder, obtaining the necessary approvals can be time-consuming, particularly if the foreign shareholder’s country has stringent regulations regarding outbound investments. Additionally, there has to be some margin kept as the date of opening of the offer and the date of closing, there could be a fluctuation of the foreign exchange rate.
In conclusion, while the rights issue process under Section 62 of the Companies Act, 2013, is designed to be straightforward, the involvement of foreign shareholders introduces several complexities. By understanding the challenges and adopting best practices, companies can navigate the process effectively and ensure a successful rights issue.
Contributed by Nishant Kantawala.
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