Mandatory Dematerialisation of Securities for Private Companies

Background:

Earlier, the provisions relating to dematerialization of securities were applicable to listed companies and unlisted public companies only. In October 2023, MCA amended the rules to expand this applicability to include several categories, such as foreign subsidiary companies, domestic subsidiary companies, Section 8 companies, domestic holding companies, and companies governed by any special Act. The mandatory dematerialization of securities of a private company is ensured by placing restrictions on both a private company and the holders of securities issued by the same.

Requirements:

• MCA has inserted a new Rule 9-B under the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 which mandates that all private companies shall issue securities exclusively in dematerialized form and facilitate dematerialization of all its securities within 18 months from the closure of financial year 2022-23 i.e., by September 30th, 2024.
• Additionally, all private companies falling under these rules and engaging in activities such as securities offers, buybacks, or the issuance of bonus shares or rights offers are obligated to ensure that the entire holdings for their promoters, directors, and key managerial personnel have been dematerialized before making such offers.
• Furthermore, holders of securities planning to transfer or subscribe to securities must
  o ensure that their securities are in dematerialized form before the transfer of such securities; and
  o subscribe to the securities issued by a private company, in dematerialized form only.

Non-Applicability:

The above requirements do not apply to:

• Government companies; and
• A private company which is a small company as per audited financial statements for the financial year 2022-23. (Note: In case a company ceases to be a small company after March 31st, 2023, the timeline of 18 months triggers from the close of the financial year in which it ceases to be a small company.
  Therefore, if a company ceases to be a small company at any time during F.Y. 24-25, the timeline of 18 months will trigger from March 31st, 2025 and therefore, shall be complied with by September 30th, 2026)

Consequences of non-compliance:

There is no specific penalty specified under Section 29 of the Act read with afore-mentioned rule 9B and
therefore, the general penalty as per Section 450 of the Act will apply. As per Section 450 of the Act, company and every officer of the company who is in default or such other person shall be liable to a penalty of Rs. 10,000 and in case of continuing contravention, with a further penalty of Rs. 1,000 for each day after the first during which the contravention continues, subject to a maximum of Rs. 2,00,000 in case of a company and Rs. 50,000 in case of an officer who is in default or any other person.

Dematerialization Process

The dematerialization process for securities in India involves several key steps within the framework of depositories and includes the following services:

• Depository Selection: Investors choose a depository to hold their securities in electronic form. In India, the two registered depositories are the National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL).
• Depository Participant (DP) Interaction: Investors cannot directly engage with depositories; instead, they must interact through a Depository Participant (DP). A DP acts as an intermediary between the investor and the depository, offering depository services. Various entities, such as public financial institutions, commercial banks, stockbrokers, clearing corporations/clearing houses, and NBFCs compliant with SEBI requirements, can register as DPs.
• Agreement Execution: To convert shares of a private limited company into demat form, both the
  company and its investors enter into an agreement with the depository participants.
• Electronic Holding: The depository holds the securities in electronic form on behalf of the investors. This eliminates the need for physical share certificates.
• Transaction Facilitation: DPs facilitate transactions on behalf of investors, allowing them to buy or sell
  securities in electronic form.
• Agreement with Investors: The company and its investors establish an agreement with the depository participants, outlining the terms and conditions for holding and transferring securities in demat form.
• Continuous Oversight: Regulatory bodies like the Securities and Exchange Board of India (SEBI) oversee the functioning of depositories and ensure compliance with regulations.

Whether the Company will be required to appoint a Registrar and Share Transfer Agent (‘RTA’)?

The role of RTA is to act as an intermediary between the issuer and the depository for facilitating dematerialization and corporate actions undertaken by the issuer thereafter. It verifies the request received for dematerialization from the depository participant and forwards it to the Company. However, it is not mandatory under the Act to appoint an RTA if the company has an in-house arrangement. Accordingly, where an RTA is not appointed, the Company will be required to perform the said activities to enable the dematerialization of securities held by the investors.

SW Point of View:

These amendments showcase the Ministry of Corporate Affairs’ commitment of transparency efficiency, accountibilty, and investor protection, enforcing strict timelines in the issuance and management of securities by private companies. Mandating dematerialization for private companies aligns with global trends, enhancing efficiency and minimizing risks associated with physical securities.

Sahil Goyal, Audit Associate, SW India