Under the Companies Act, 2013 (‘Act’), the rights issue is one of the methods to raise share capital by a company. It entitles existing shareholders to subscribe for additional shares in proportion to their current shareholding in the company.[1] The subscription price for these shares is determined by the board of directors of the company without any valuation report from a registered valuer. However, the price identified for the shares shall not be less than its face value and in the case of non-residents, it must not be priced lower than those offered to the resident shareholders, if any. Shareholders who choose not to participate in the rights issue may either renounce their entitlement to another shareholder or to a third party including a non-resident, or decline the opportunity by not subscribing to the rights issue offer. If it is declined, the board of directors has the power to dispose of the unsubscribed portion in a manner that is ‘not dis-advantageous’ to the shareholders and the company. In cases where the unsubscribed portion is renounced or disposed of in favour of a non-resident, the Foreign Exchange Management (Non-debt Instrument) Rules, 2019 (‘NDI Rules’), read with the Master Direction – Foreign Investment in India amended as of 20 January 2025[2] (‘FDI Master Direction’) shall apply. The FDI Master Direction has recently brought clarity on the disposal of shares by the company when it remains unsubscribed under the rights issue.[3]
In this article, we shall analyze the concept of renunciation and disposal of unsubscribed shares with a special focus on non-residents in the light of the recent amendment in the FDI Master Direction.
Renunciation of unsubscribed portion of shares
Renunciation in favour of Person resident outside India
Renunciation of shares refers to the process by which an existing shareholder assigns or transfers their subscription rights to an existing shareholder or a third party, enabling the assignee to subscribe to the shares. This right of renunciation is conferred upon shareholders under Section 62(1)(a)(ii) of the Act and under Rule 7A of the NDI Rules, in case of non-residents i.e., a person resident in India renouncing his right in favour of a non-resident. In the event where shares are allotted to the non-resident renouncee, the same shall be subject to the pricing guidelines under Rule 21 of the NDI Rules.
Vide the Foreign Exchange Management (Non debt Instruments) (Second Amendment) Rules, 2020[4] (‘Second Amendment 2020’), the aforementioned Rule 7A was added, which provided clarification that any issuance to a non-resident through renunciation can only be done on fair market value (FMV). Prior to this, renunciation to a non-resident was possible at face value. This amendment shifted the renunciation mechanism from free pricing to restrictive pricing.
Renunciation in favour of person resident in India
Now the issue is whether renunciation to a resident Indian by a non-resident is also subjected to the same restriction as applicable to a non-resident. In the absence of any specific statutory requirement to obtain valuation at the time of issuance of shares via renunciation by a person resident outside India to a resident, the same is possible to be issued at face value. This position is further confirmed by the Madras High Court in Vikramjit Singh Oberoi v. Registrar of Companies[5], wherein it held that the issuance of shares via renunciation including to a non-resident is deemed to be a part of the rights issue and not the public issue.
Disposal of unsubscribed portion of shares
Shareholders who choose not to subscribe to the rights issue may opt to forego their rights. In cases where shares remain unsubscribed either due to a formal rejection of the offer by notice to the company or failure to respond to the offer letter within the specified offer period by the offeree, the unsubscribed shares may be disposed of by the directors of the company in a manner that is ‘not dis-advantageous’ to the company or the respective shareholders.[6] In such a case, the board of directors of the company can offer and allot the unsubscribed portion to any existing shareholder or an identified third party willing to invest, or otherwise cancel the issue to the extent of unsubscribed shares.
Issuance of unsubscribed portion in favour of person resident in India
Now the question arises whether the procedure for the disposal of unsubscribed shares should continue to be treated as part of the rights issue under Section 62(1)(a) of the Act or be reclassified as ‘preferential allotment’ or ‘private placement’ under the Act. Unlike the case of renunciation, the law is not clearly worded regarding the procedural mechanism / treatment of the disposal of shares except for a caveat that such disposal must be ‘not dis-advantageous’ to the company and the shareholders.
‘Preferential Offer’ or preferential allotment of shares and other securities does not include a rights issue.[7] This clearly implies that the disposal of shares does not take the form of a preferential offer. Further, ‘Private Placement’ includes an offer or invitation to subscribe to the securities of a company at FMV. Disposal of shares to a third-party investor would involve an offer or invitation to subscribe to the unsubscribed portion of the shares, which may procedurally appear as part of a private placement. For instance, a rights issue where none of the shareholders subscribed and the entire issue was allotted to a third-party investor under the mechanism of rights issue may be seen as a disguised form of a private placement. This is a grey area that can be exploited to bypass the stricter compliance requirements of private placement under Section 42 of the Act.
That being said, on a closer look, we can see that the legislative ambit of Section 62(1)(a)(iii) of the Act is wider in the sense that upon the rights shares being left unsubscribed, it is the wisdom of the board of directors of the company to dispose of the shares in a ‘not dis-advantageous’ manner regardless of the mechanism being adopted for the allotment of such unsubscribed portion of shares. The term ‘not dis-advantageous’ is not specifically defined under the Act and is subjective in nature and depends on a case-to-case basis. The Hon’ble Supreme Court in the case of Needle Industries (India) Ltd v. Needle Industries Newey (India) Holding Ltd.[8] has discussed that in the event the further issue of shares is for the benefit of the company regardless of any incidental benefit being passed on to the directors of the company, there is no basis for the courts to interfere in such a transaction. Therefore, in the absence of a specific legislative intention, imposing compliance for private placement under Section 42 of the Act in cases of disposal of unsubscribed rights shares may be far-fetched and uncalled for and the board of directors in their wisdom can directly allot the shares to the identified person.
Disposal in favour of person resident outside India
While Rule 7A of NDI Rules specifically provides that in case of renunciation, inter-alia pricing guidelines shall apply, there was no such provision with respect to the disposal of an unsubscribed portion of the rights issue. Industry wide there was a mixed approach to this situation. On one hand, it was argued that since renunciation amounts to the issuance of shares to non-residents where pricing guidelines apply then basis the same logic, disposal of shares of the unsubscribed portion to non-residents must also be subjected to the same treatment. However, on the other hand, it was argued that since there is no specific wording under the NDI Rules in this regard, such a position may not be taken, and therefore issuance is possible on the face value of the shares.
To clarify this ambiguity, the Reserve Bank of India (RBI) on 20 January 2025 released an amendment to the FDI Master Direction where it clarified that ‘Indian company may issue equity instruments under Section 62(1)(a)(iii) of Companies Act, to a person resident outside India (other than an OCB). Such issue shall be subject to the adherence to entry routes, sectoral caps or investment limits, pricing guidelines and other attendant conditions as applicable for investment by a person resident outside India specified in the NDI Rules.’
This amendment puts the debate to rest and clarifies that the disposal of unsubscribed shares by the board of directors of the company to a non-resident third-party investor shall only be on an FMV where the valuation of equity instruments must be done as per any internationally accepted pricing methodology on an arm's length basis and be duly certified by a Chartered Accountant.
Closing thoughts
The concept of rights issue works on the principle of free pricing unless renounced or disposed of to a non-resident by the board of directors. In the case of non-residents, it is necessary to keep in mind the macroeconomic conditions and the non-residents should not acquire shares at a price not favourable to the shareholders and company i.e., acquisition on face value should not be done when the actual FMV is high. This would directly impact forex reserves if shares were issued at a face value when their actual FMV is higher. To curb this price arbitrage, the pricing guidelines were made applicable vide the Second Amendment 2020 in the case of renunciation and recently vide clarification in the FDI Master Direction in case of disposal of unsubscribed shares by the board of directors of the company. With regard to the disposal of shares to a resident, the process of complying with private placement may not be applicable however any regulatory clarification in this regard may as well put this debate to rest.
[The authors are Partner, Senior Associate and Company Secretary, respectively, in Corporate and M&A practice at Lakshmikumaran & Sridharan Attorneys, Hyderabad]
[1] Section 61(1)(a) of the Companies Act, 2013.
[2] https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200.
[3] Paragraph 6.12.3 of the Master Direction – Foreign Direct Investment.
[4] https://issuer.nsdl.com/docs/(Second%20Amendment)_NDI%20Rules_2020_dated_April_27_2020.pdf.
[5] [2020] 223 Comp Cas 199 (Mad).
[6] Section 61(1)(a)(iii) of the Companies Act, 2013.
[7] Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014.
[8] AIR 1981 SC 1298.
