[Author: Eshvar Girish, student of 4th year BBA LLB at Christ (Deemed to be University)]
Rights issue is the process of issuance of shares at a special price by the company to it’s existing shareholders which is directly proportionate to the holding of their old shares in order to raise additional capital. The objective of rights issue is to ensure equal distribution of shares as it is essential that the proportion of voting rights must be not affected by issuing of new or fresh shares by the company. Such additional capital raised can be used to pay off debts of the company or can be used for other purposes.
Pre-emptive rights are given to the existing shareholders of a company which is in proportion to the shares held by them to participate in the new offer of shares by the company. The Companies Act, 2013 has codified this right and issuing of such shares is called as 'rights issue'.[1] The Securities and Exchange Board of India under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 defines ‘rights issue’ as an issue of shares by a listed company to it’s existing shareholders as on the record date fixed for the said purpose.[2] However, it is pertinent to note that these regulations will be applicable only if the issue size of rights issue is Rs. 10 crores or above. In case of rights issue of size less than ten crore rupees, the issuer can prepare a letter of offer and file the same with the SEBI for information and dissemination of such information on SEBI’s website.
Rights issue is a convenient method for companies to raise capital as it is cost-efficient especially when alternative sources of debt turn out to be expensive. This method of raising capital is generally preferred as it does not require the need for shareholder approval, mandatory underwriting and submission of a prospectus. It can be beneficial for the existing shareholders as it prevents dilution of control and allows them to buy more shares of the company at a discounted price.[3]
Pre-emptive rights include within its ambit the right to renounce if it is not restricted by the Articles of Association.[4] If it is permitted by the articles, then the renunciation of issue of shares under rights issue can be made in a complete or partial manner in the favour of any person who is not required to be an existing shareholder of the Company. These rights entitlements can be exercised by the existing shareholders in the favour of persons who are not existing shareholders once the announcement of the rights issue is made and before such issue of shares is closed.
SEBI Discussion Paper
The SEBI floated a discussion paper on May 21, 2019,[5] which discusses the process of rights issue and suggests reforms. This paper showcases ‘price risk’ as a hindrance in the success of rights issue by the company. It can have a negative impact on the value of a company’s stock as the announcement of further issue of shares can send pessimistic vibes about the company’s performance to both existing shareholders and prospective shareholders. The perception of the investors can be also be influenced by certain elements such as objects of the issue and amount of discount offered to both existing shareholders and prospective shareholders which can consequently lead to a decrease in the stock price thereby taking a toll on the overall valuation of the company. This can be observed in the case of rights issue of Vodafone’s shares. When the announcement was made with an issue price of INR 12.5, the stock price of the company plummeted from INR 33 to INR 16 which was devastating to the company’s valuation. This happened mainly because of the severe competition which exists in the telecom industry and also because Vodafone was in debt for defaulting in the payment of spectrum obligations. Announcement of rights issue of shares by Vodafone indicated the need for additional capital, which in turn made the investors sceptical about the company’s performance.
The SEBI Discussion Paper suggested various reforms like the reduction of notice period for a record date, removal of the requirement of publication of newspaper advertisement and introduction of the electronic medium for fundraising and trading of rights to the rights issue process under Chapter 3 and Chapter 4 of the SEBI (ICDR) Regulations.
Streamlining of rights issue
The reforms suggested under the SEBI Discussion Paper have been adopted by the SEBI appropriately by amending the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”) and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) accordingly.[6] The amendments have been listed below :
The Right Entitlements which were earlier allotted in ‘Composite Allocation Form’ (CAF) which was in physical form has now been amended such that right entitlements need to be credited in the Demat account of the shareholder.[7] This makes the process time-efficient and more transparent in nature.
Before the amendment,[8] the approval of allotment of rights entitlement was done through the procedure of verification of physical form but now after the amendment, the allotment of specified securities is required to be made in dematerialized form.
The option of ASBA (Applications Supported by blocked amount) which was not available earlier to shareholders who had partially or fully renounced their right entitlements has now been amended such that the facility of ASBA is available to every shareholder.[9] This has fastened the completion of the post-issue process.
The publication of advertisement in newspapers has been amended such that it now needs to be done two days before issue opening instead of the earlier requirement of three days.[10]
The advance notice for the record date has been reduced to three days instead of the earlier requisite of seven days which does not include the record date and the date of intimation.[11]
Conclusion
The amendments have definitely simplified the rights issue process for Indian listed companies as it has reduced the overall time duration required for rights issue process which has been reduced from 55 days to 31 days. The trading and renunciation of right entitlements have always taken place in physical form which is why using Demat accounts for the same will facilitate the formation of an effective platform for electronic and exchange-driven trading of right entitlements. The reduction of manual or physical intervention in capital market transactions can prove to be an important development as physical applications are being extinguished and ASBA is being mandated for raising of additional capital.
[1] Section 62(1), Companies Act, 2013. [2] Regulation 2(zg) of SEBI(Issue of Capital and Disclosure Requirements), 2009. [3] Paul L. Davies and L.C.B. Gower, “Gower and Davies' Principles of Modern Company Law”, Sweet and Maxwell Ltd. (7th edn., 2003) at 635; Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad, (2005) 11 SCC 314. [4] Section 62(1)(a)(ii), Companies Act, 2013. [5] https://www.sebi.gov.in/reports/reports/may-2019/discussion-paper-on-review-of-rights-issue- process_43049.html [6] https://www.sebi.gov.in/legal/circulars/jan-2020/streamlining-the-process-of-rights-issue_45753.html [7] Insertion of Regulation 70(7) in ICDR Regulations. [8] Insertion of Regulation 77A in ICDR Regulations. [9] Regulation 76 of ICDR Regulations. [10] Regulation 84(1) of ICDR Regulations. [11] Regulation 42(2) of LODR Regulations.