On June 5, 2020, the Ministry of Corporate Affairs (“MCA”) amended the Companies (Share Capital and Debentures) Rules, 2014 (“SCD Rules”) and issued the Companies (Share Capital and Debentures) Amendment Rules, 2020 (“Revised SCD Rules”). This alert apprises you with the amendment pertaining to issue of Sweat Equity Shares (“Sweat Equity”).
Background: As per section 54 of the Companies Act, 2013 and Rule 8(1) of SCD Rules, Sweat Equity is one of the modes of incentivizing permanent employees (including directors) to accept stock and participate in the growth of the company. In order to issue Sweat Equity, companies are required to pass a special resolution in a general meeting. As per Rule 8(2) of SCD Rules, the explanatory statement annexed to the notice of the general meeting must include key details such as reasons for the issue; name and class of directors or employees to whom such equity shares are to be issued and their relationship with the promoter or/and key managerial personnel; principal terms and conditions; basis of valuation of share; any breach in ceiling of managerial remuneration due to this issue and the proposal to deal with such breach; and diluted earning per share pursuant to the issue.
Rule 8(4) of SCD Rules imposes certain restrictions. Companies cannot issue Sweat Equity for more than 15% of its existing paid-up equity share capital in a year or shares of issue value of INR 50 million, whichever is higher. Further, Sweat Equity cannot exceed 25% of the paid-up equity capital of the Company at any time. However, this requirement was liberalized in 2016 with the formal recognition of “start-ups”. On July 19, 2016, the MCA issued the Companies (Share Capital and Debentures) Third Amendment Rules, 2016 and allowed the Department for Industrial Policy and Promotion (“DIPP”) registered “start-ups” to issue Sweat Equity for up to 50% of its paid-up capital till 5 years from its date of incorporation.
Amendment: Through the Revised SCD Rules, MCA has amended second proviso to Rule 8(4) of SCD Rules and increased the 5 year period to 10 years. This means that now DIPP registered “start-ups” can issue Sweat Equity up to 50% of its paid-up capital till 10 years from the date of its incorporation.
As a background, the 5 and 10 year duration described above is linked to the definition of “start-ups”. On February 17, 2016, the DIPP allowed a company to be termed as a “start-up” only for 5 years from the date of its incorporation. On February 19, 2019, this definition was revised where the 5-year term was extended to 10 years. It appears that the revised SCD Rules have brought consistency vis-à-vis issuance of Sweat Equity.