Introduction

A company looking to raise funds (other than by way of borrowing) can do so by following the process prescribed under the Companies Act, 2013 (‘Act’) by way of either (i) preferential allotment; (ii) private placement; or (iii) rights issue. 

A rights issue involves offering shares by a company only to its existing equity shareholders on a proportionate basis.  A rights issue is generally a quicker and more convenient way for a company to raise funds because:

• Shareholder approval by means of a special resolution is not needed.

• Pricing of the securities does not need to be based on an appraisal by a registered valuer.

Legal Framework Governing Rights Issue

The Act outlines the process and conditions related to a rights issue.  According to the Act, when a company decides to increase its subscribed capital by issuing additional shares, these shares must be offered to the company’s existing equity shareholders in proportion to their current shareholding in the company’s paid-up capital, subject to the following conditions:

• Offer Notice – The company must issue a notice (referred to as the ‘Offer Notice’) detailing the number of shares being offered (‘Offered Shares’) and the time period within which the offer must be accepted.  This period should be no less than 15 days and no more than 30 days (‘Stipulated Timeframe’).  If the offer is not accepted within the Stipulated Timeframe, it is considered declined.

• Renunciation Right – The Offer Notice must include a right for the shareholder to renounce the Offered Shares, either in full or in part, to another person.  This right should be clearly stated in the Offer Notice, unless the company’s articles of association specify otherwise.

• Board of Directors’ (‘Board’) Authority – After the Stipulated Timeframe expires, or if the shareholder notifies the company of its intention to decline the offer, the Board has the authority to dispose-off any remaining shares that were part of the Offer Notice.  This should be done in a manner which is not disadvantageous to the company and its shareholders.

Extent of the Power of the Board of a Company as regards disposal of unsubscribed portion of a Rights Issue

An important question to consider is whether the Board has an unrestricted authority to dispose-off the unsubscribed portion of a rights issue, or whether there are any limitations on such powers of the Board.

Per Section 62(1)(c) of the Act, read with Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014, the term ‘Preferential Offer’ means an issue of shares or other securities, by a company to any select person or group of persons on a preferential basis and does not include shares or other securities offered through inter alia a rights issue.  Therefore, conditions regarding preferential allotment do not apply to a rights issue. 

Additionally, according to Section 42 of the Act, a ‘private placement’ refers to any offer or invitation to subscribe to or issue of securities to a specific group of people by a company (other than through a public offer) via a private placement offer-cum-application, provided it meets the conditions outlined in the Act.  It is important to note that while Section 42 of the Act excludes qualified institutional buyers and employees of the company receiving securities under an employee stock option plan, as per Section 62(1)(b) of the Act, there is no specific exclusion for a rights issue from being considered a part of a private placement, unlike a preferential allotment, which is explicitly excluded under the Act.

As a result, an important question that arises due to this gap in the law is whether it is appropriate to apply the private placement compliance requirements under Section 42 of the Act to the disposal of unsubscribed rights shares.  In this context, the Act does not offer any clear guidance to the Board regarding how to handle the disposal of unsubscribed rights shares, including any specific conditions or procedural steps.  The law remains silent on this matter and leaves the disposal entirely to the Board’s discretion, with the sole condition being that the disposal must not be ‘disadvantageous to the shareholders and the company.’

However, it is important to note that certain restrictions, in the form of conditions, are imposed by the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘NDI Rules’) and the recently updated Master Direction on Foreign Investment in India (amended on 20 January 2025) (‘MDFI’). According to Rule 7A of the NDI Rules, a non-resident who obtains a right from an Indian resident who has renounced that right (in case of a rights issue) is allowed to acquire equity instruments against the said rights, in accordance with the pricing guidelines set out in Rule 21 of the NDI Rules.  Additionally, under paragraph 6.12.3 of the MDFI, an Indian company may issue equity instruments under Section 62(1)(a)(iii) of the Act (which pertains to the disposal of unsubscribed rights shares by the Board) provided that the following conditions are met:

• the applicable entry routes;

• compliance with sectoral caps or investment limits;

• adherence to pricing guidelines; and

• other conditions related to investment by non-residents as specified in the NDI Rules.

While the NDI Rules and the MDFI provide the aforementioned conditions, it is key to note that these are only applicable when the recipient of the shares forming part of the rights issue, whether after renunciation of right by an existing equity shareholder of a company or by virtue of disposal of any unsubscribed portion of the shares forming part of a rights issue by the Board, is a non-resident.  Therefore, the law as it stands today, remains silent as regards the disposal of unsubscribed portion of a rights issue when the recipient of such shares is an Indian resident.

In the absence of any guidance provided by the law, a closer look may be had at leading judicial pronouncements particularly in the context of the extent of powers available with the Board as regards a rights issue.  In Gujarat High Court’s judgement in Re: Mafatlal Industries Ltd.[1], the court observed that “Shares, allotment of which has not been accepted by the existing shareholders and/or renounced, can be dealt with by the company in such manner as the board of directors thinks in the best interest of the company.”

Guidance may also be taken from Supreme Court judgments in the cases of Nanalal Zaver v. Bombay Life Assurance Company[2] (‘Nanalal Zaver Case’), Needle Industries (India) Ltd v. Needle Industries Newey (India) Holding Ltd[3] (‘Needle Industries Case’) and Tin Plate Dealers Association Pvt. Ltd. and Ors. v.Satish Chandra Sanwalka and Ors.[4] (‘Tin Plate Dealers Case’).

In the Nanalal Zaver Case, the Supreme Court observed that if the Board’s power to issue additional shares is used not for the company’s benefit but for personal gain of the directors, to the detriment of the company, the Court will intervene to prevent such actions.  However, if the directors issue shares for the benefit of the company, even if they have a secondary motive that does not harm the company or its shareholders, the Court will not interfere.

This principle was reaffirmed in the Needle Industries Case, where it was established that the key test is whether the share issuance primarily benefits the directors.  The Supreme Court noted that if shares are issued in the company’s best interests, any incidental benefit to the directors as shareholders does not invalidate the decision.  Furthermore, if a rights issue allows the directors to retain control over the company, this does not amount to an abuse of their fiduciary duty.  What is considered improper is the use of such powers for an unrelated purpose, such as preserving or acquiring control over the company’s operations.

Further, in the Tin Plate Dealers Case, the Supreme Court reiterated the principle laid down in the Needle Industries Case as regards the powers of the Board to issue fresh shares.  It was observed that the Board of the company has the authority to issue fresh shares as part of its broader powers under the Act and that this authority cannot be questioned by saying that the issuance of new shares is only for certain specific purposes.

Concluding Remarks

While the amendments made to the NDI Rules and the recent amendments made to the MDFI do provide some guidance as regards renunciation or disposal of unsubscribed shares by the Board in relation to a rights issue, certain ambiguity remains when it comes to renunciation or disposal of unsubscribed shares by the Board in relation to a rights issue for transfers to residents.  Until a regulatory clarification comes into effect in this regard, it is imperative that the Board acts with caution and transparency in its decision-making, thereby ensuring that its decisions align with the company’s and its shareholders’ best interests.

Written by Nidhi Arora (Partner) and Manan Kapoor (Senior Associate)

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[1] (1996) 87 CompCas 705 (Guj)

[2] AIR 1950 SC 172

[3] AIR 1981 SC 1298

[4] AIR 2016 SC 4705