Dematerialisation of Shares: A Mandatory Shift for Private Companies

The Ministry of Corporate Affairs (MCA) has introduced a significant regulatory change in corporate governance through the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023. This amendment mandates dematerialisation of shares for all private companies, except small and government companies, by introducing Rule 9B. This move aims to modernise and streamline securities management, reducing the risks associated with physical shareholding.

Understanding Dematerialisation

Dematerialisation is the process of converting physical share certificates into electronic form, stored in a demat account managed by a depository. In India, two primary depositories are registered with SEBI:

NSDL (National Securities Depository Ltd.)
CDSL (Central Depository Services (India) Ltd.)

Depository Participants (DPs), which are banks or brokers, facilitate the opening and maintenance of demat accounts for investors.

Key Provisions of MCA’s Rule 9B

Mandatory Dematerialisation for Private Companies

Prior to this amendment, private companies were not required to dematerialise their shares. Now, all private companies, except small and government companies, must:

Issue securities only in dematerialised form.
Facilitate the dematerialisation of all existing securities.

A small private company is defined as one with a paid-up capital of less than ₹4 crore and a turnover of less than ₹40 crore.

Compliance Timeline

Companies exceeding the "small company", the initial deadline for compliance, set for 30 September 2024, caused significant confusion and challenges for many companies. In response to these concerns, the MCA has recently amended the rules, extending the deadline to 30 June 2025.

Conditions for Share Transactions

Promoters, Directors & Key Managerial Personnel (KMPs) must dematerialise their shares before issuing new securities.
Share Transfers: Investors looking to transfer securities must dematerialise them before any transaction.
New Allotments: Any securities issued through private placements, rights issues, or bonus shares must be in dematerialised form.

Step-by-Step Guide for Compliance

Amendment of Articles of Association (AoA)
The company must update its AoA to allow shareholders to hold shares in dematerialised form.
Appointment of Registrar and Transfer Agent (RTA)
A SEBI-registered independent RTA must be appointed to act as an intermediary between the company and depositories.
Obtaining International Securities Identification Number (ISIN)
An ISIN is a unique identifier for each type of security issued by the company.
Opening a Demat Account
The company must open a demat account with a Depository Participant (DP).
Conversion of Physical Shares
Existing physical share certificates must be converted to electronic form via the DP.
Dematerialisation of Promoters' and Directors’ Shares
Promoters, directors, and KMPs must ensure their shares are dematerialised before issuing any new securities.
Regulatory Reporting (PAS-6)
Companies must submit half-yearly returns in Form PAS-6 to the MCA, reporting their dematerialisation status.

Key Considerations

Fees: Opening demat accounts involves costs (Approx 1 lakh rupee)
KYC and PAN: The company and shareholders must provide KYC documents and PAN for the dematerialisation process.
Share Transfer Restrictions: Companies should implement additional checks with depositories to ensure compliance with AoA restrictions.
Processing Delays: Given the large number of companies undergoing dematerialisation, delays may occur. It is advisable to initiate the process early.

Consequences of Non-Compliance

Companies failing to comply with Rule 9B may face penalties under Section 450 of the Companies Act:

Inability to Issue Securities: The company will be barred from issuing new securities, including bonus shares and buybacks.
Trading Restrictions: Shareholders with non-dematerialised holdings cannot sell or subscribe to new shares.
Monetary Penalties:
- Company: ₹10,000 fine plus ₹1,000 per day (maximum ₹2,00,000).
- Officers in Default: ₹10,000 fine plus ₹1,000 per day (maximum ₹50,000).

Conclusion

The mandatory dematerialisation of shares under Rule 9B is a pivotal step toward digitising private company securities in India. By eliminating physical certificates, companies can enhance security, transparency, and efficiency in share management. Given the approaching compliance deadline, companies should initiate the dematerialisation process promptly to avoid penalties and operational disruptions.

Quote of the day:

“Success is not final, failure is not fatal: It is the courage to continue that counts”

-Winston Churchill

Regards

CA Umang Jain

CA Hemant Bardia

+ 91 96323-32850

umang@caumang.com

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