Presentation on

‘Preferential Allotment’
(71st SMTP – September 16, 2006)

- By Mahavir Lunawat
 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
Different Types of Issues
 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.
Preferential Allotment-Regulatory Framework
• Listing Agreement
• SEBI (DIP) Guidelines, 2000 - 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
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.
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.
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
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.
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)
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.
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
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)

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. (13.1.2.3)
• 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)
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. (13.5.1.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)
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.
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.
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.
 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.
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)
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.
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.
 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)
 Preferential Allotment - Time Table
15 days
30 days

25 days

Despatch of Offer Acceptance In-principle Allotment

Individual Approval of Shares
Notices from Stock
Exchanges
Board
meeting

Relevant General Meeting Completion of

Date formalities
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]
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
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.
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
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.
 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.
 Preferential Allotment – Specific Cases
QIP
• 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.
 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.
 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.
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.
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
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
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
• 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)]
• 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]
 AND DON’T FORGET,
ALL THIS HAS TO BE DONE
BY US –
COMPANY SECRETARIES
 Thank You

Your Feedback is invited at

mahavir.lunawat@ril.com