Companies Act Section 42

Companies Act Section 42: Issue of Shares on Private Placement Basis

1. Authorization for Private Placement

Section 42 of the Companies Act allows a company to issue securities through a process known as private placement, which refers to the sale of shares or other securities to a select group of investors rather than to the general public. 

This type of issuance is governed by specific rules and conditions outlined in the section, ensuring that the process remains controlled, transparent, and compliant with the law.

The company's Board of Directors must first authorize the private placement, ensuring that the offer is made in accordance with legal provisions and procedures.

2. Scope and Identification of Persons

Private placements are restricted to a select group of persons (known as "identified persons") chosen by the company’s Board of Directors. 

These identified persons represent individuals or entities to whom the offer will be extended.

Limitation on Number of Persons: 

The total number of identified persons eligible to participate in the private placement must not exceed fifty in a financial year, or a higher limit if prescribed by relevant authorities. 

This number excludes:

Qualified Institutional Buyers (QIBs): 

Institutions like banks, mutual funds, and insurance companies that qualify to invest in securities due to their financial expertise.

Employees: 

Those offered securities under an employee stock option plan, as specified in Section 62 of the Companies Act.

The restriction on the number of persons ensures that the offering remains a private placement and does not become a public offer, which would be subject to a different set of regulations under the Companies Act.

3. Private Placement Offer and Application Process

To initiate the private placement, the company must provide a private placement offer and an application form to the identified persons. 

The offer and application must be issued in a prescribed format and must contain specific details, including:

The names and addresses of the identified persons who are invited to participate.

The offer must be direct and specific, with no opportunity for the recipients to transfer or assign their right to accept the offer (i.e., no right of renunciation is granted).

This ensures that the offer is made exclusively to the identified persons and that they alone are entitled to apply for the securities being offered.

4. Explanation of Key Terms

The section provides clarification for terms related to private placement:

Private Placement: 

This refers to an offer or invitation to a select group of individuals or entities to subscribe to or purchase securities from a company, in a manner that complies with the conditions laid down in Section 42.

Qualified Institutional Buyer (QIB): 

These are institutional investors defined under the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009. 

QIBs are sophisticated investors with substantial financial resources and expertise, and they are permitted to participate in private placements without being counted toward the maximum limit of identified persons.

5. Public Offer Deemed if Non-Compliance

If a company, whether listed or unlisted, makes an offer to more persons than the maximum prescribed number or fails to comply with the requirements of Section 42, the offer will no longer be treated as a private placement. 

Instead, it will be regarded as a public offer and will be subject to the provisions of the Companies Act and the associated rules governing public offerings. 

This provision ensures that companies adhere to the private placement framework and do not improperly use the process to circumvent the stricter regulations of public offerings.

6. Application and Allotment Process

Individuals or entities identified for private placement must apply for the securities using the private placement offer and application form provided by the company. 

Payment for the subscription must be made using non-cash methods such as cheques, demand drafts, or through banking channels. 

The company is not allowed to access or use the funds raised through the private placement until the process of allotment is complete, and a return of allotment has been filed with the Registrar of Companies (RoC).

This measure ensures that funds are not prematurely utilized and that the regulatory process for recording the issuance of securities is strictly followed.

7. Timing and Repayment Obligations

The allotment of securities must take place within sixty days of receiving the application money from the identified persons. If the company fails to allot the securities within this period, it must refund the application money within fifteen days from the end of the sixty-day period.

Penalty for Late Refund: 

  If the company fails to return the funds within the specified time frame, it is required to pay an interest of 12% per annum on the amount from the sixtieth day until the refund is completed.

This provision safeguards the interests of investors by ensuring that their funds are either allocated to securities promptly or returned within a defined time period with appropriate compensation for any delay.

8. Restrictions on Advertising

To preserve the private nature of the offering, the company is explicitly prohibited from engaging in any form of public advertising or using media, marketing, or distribution channels to promote the private placement. 

The offer must remain targeted exclusively at the identified persons and should not be marketed to the general public.

This restriction ensures that private placements remain confined to a select group of investors and are not treated as public offerings, which would trigger additional regulatory requirements.

9. Return of Allotment

Once the private placement process is complete and the securities have been allotted, the company is required to file a return of allotment with the Registrar of Companies within fifteen days of the allotment. 

This return must include detailed information about the allottees, including:

The full names and addresses of each allottee.

The number of securities that have been allotted to each individual or entity.

This filing is critical for maintaining transparency and ensuring that the issuance of securities is properly recorded in compliance with legal and regulatory requirements.

10. Penalties for Non-Compliance

If the company fails to file the return of allotment within the prescribed fifteen-day period, it will be subject to a penalty of one thousand rupees per day for each day the default continues, with a maximum penalty of twenty-five lakh rupees.

In the event the company violates any other provisions of Section 42, including accepting money in violation of the private placement regulations, the company and its promoters and directors may face penalties of up to:

The total amount raised through the private placement, or

Two crore rupees, whichever is lower.

In addition to these penalties, the company must refund all monies received from the non-compliant offer, with interest if applicable, within thirty days of the penalty order.

11. Public Offer Deemed in Case of Non-Compliance

Finally, if the private placement fails to comply with the requirements laid out in Section 42 such as exceeding the maximum number of identified persons or not adhering to the prescribed process it will automatically be treated as a public offer. 

This means that all relevant provisions of the Companies Act and other applicable regulations governing public offers will come into effect, subjecting the company to more stringent rules.

This provision ensures that companies cannot abuse the private placement process to avoid the higher level of scrutiny and regulation associated with public offerings.