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‘Preferential Allotment’

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

2 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

3 Different Types of Issues

4 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.

5 Preferential Allotment-Regulatory Framework
Listing Agreement SEBI (DIP) Guidelines, 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

6 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.

7 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.

8 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

9 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.

10 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)

11 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.

12 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

13 Preferential Allotment – DIP Guidelines
Situations where Preferential Issue can’t 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)

14 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. ( ) 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)

15 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. ( 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)

16 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.

17 Preferential Allotment – DIP Guidelines
Changes proposed by PMAC, SEBI (Dec’04) 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.

18 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.

19 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.

20 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)

21 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.

22 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.

23 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)

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

25 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]

26 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

27 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.

28 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

29 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 doesn’t fall into ‘public deposits’ category). Other Provisions as applicable to issue of debentures.

30 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 70:30, etc.

31 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.

32 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.

33 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.

34 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.

35 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 Auditor’s Certificate Disclosures in Balance Sheet / Directors’ Report

36 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 Committee’s Views, if any Appointment of Valuer, if required Allotment and Issue within time

37 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

38 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)]

39 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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