Sweat Equity, Share Premium and the Ban on Shares at a Discount

"Whether for cash or otherwise" matters: a premium on shares issued for a consideration other than cash goes into the account too.

And the deeming is the whole point. By treating the account as paid-up share capital, the Act makes it reducible only by going through section 66, the capital reduction procedure, with the Tribunal and the creditors' objections. It cannot be distributed as dividend.

Section 52(2): the five permitted applications. Notwithstanding sub-section (1), the securities premium account may be applied by the company:

• (a) towards the issue of unissued shares to the members as fully paid bonus shares;
• (b) in writing off the preliminary expenses of the company;
• (c) in writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures;
• (d) in providing for the premium payable on the redemption of any redeemable preference shares or of any debentures; or
• (e) for the purchase of its own shares or other securities under section 68.

Learn these five. They are a closed list, and any other use is a reduction of capital requiring section 66.

Section 52(3): a narrower list for a prescribed class. Notwithstanding sub-sections (1) and (2), the account may be applied by such class of companies as may be prescribed, whose financial statements comply with the accounting standards prescribed under section 133, only:

• (a) in paying up unissued equity shares to be issued to members as fully paid bonus shares;
• (b) in writing off the expenses of, or the commission paid or discount allowed on, any issue of equity shares; or
• (c) for the purchase of its own shares or other securities under section 68.

Compare the two lists. For the prescribed class, writing off preliminary expenses and providing for the premium on redemption are not available, and the surviving items are confined to equity shares. So the prescribed class has three uses, not five.

The ban on shares at a discount: section 53

Section 53(1). Except as provided in section 54, a company shall not issue shares at a discount.

Section 53(2). Any share issued by a company at a discount shall be void.

Not voidable, not irregular: void. So the allottee acquires nothing.

Section 53(2A): the one statutory exception besides sweat equity. Notwithstanding sub-sections (1) and (2), a company may issue shares at a discount to its creditors when its debt is converted into shares in pursuance of any statutory resolution plan or debt restructuring scheme in accordance with any guidelines, directions or regulations specified by the Reserve Bank of India under the Reserve Bank of India Act 1934 or the Banking Regulation Act 1949.

This is the rescue exception. When a failing company's debt is converted into equity, insisting on face value would defeat the restructuring, because the shares are not worth face value.

Section 53(3): the penalty. Where a company fails to comply:

• the company and every officer in default shall be liable to a penalty which may extend to an amount equal to the amount raised through the issue of shares at a discount, or five lakh rupees, whichever is less; and
• the company shall also refund all monies received, with interest at twelve per cent per annum from the date of issue of the shares, to the persons to whom the shares were issued.

Note the second limb. Because the shares are void, the money must go back, and it goes back with interest.

Sweat equity shares: section 54

Section 54(1). Notwithstanding anything contained in section 53, a company may issue sweat equity shares of a class of shares already issued, if the following conditions are fulfilled:

• (a) the issue is authorised by a special resolution passed by the company;
• (b) the resolution specifies the number of shares, the current market price, consideration, if any, and the class or classes of directors or employees to whom the shares are to be issued;
• (d) where the equity shares are listed on a recognised stock exchange, the sweat equity shares are issued in accordance with SEBI's regulations, and if not so listed, in accordance with such rules as may be prescribed.

Clause (c) was omitted, which is why the surviving clauses run (a), (b), (d). It used to require a minimum period of one year since the company had commenced business, and its removal means a young company may now issue sweat equity.

Note "of a class of shares already issued": sweat equity cannot be used to create a new class.

Section 54(2): they are ordinary equity shares. The rights, limitations, restrictions and provisions applicable to equity shares shall be applicable to sweat equity shares, and the holders shall rank pari passu with other equity shareholders.

So sweat equity is not a lesser share. Once issued, it is equity, with the same votes and the same dividend rights.

What sweat equity is. Section 2(88) defines sweat equity shares as equity shares issued by a company to its directors or employees at a discount or for consideration other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called. That definition explains why section 54 opens "notwithstanding section 53": sweat equity is by definition capable of being issued at a discount.

A worked example

Ratnagiri Robotics Limited has equity shares of ten rupees each.

A premium issue. It issues ten lakh shares at twenty-five rupees. The face value is ten rupees, so the premium is fifteen rupees a share, one crore fifty lakh rupees in all. Under section 52(1) that whole sum goes into the securities premium account and is thereafter treated as paid-up share capital, so it can be reduced only under section 66.

Using it. The company may apply that account to issue fully paid bonus shares to members, to write off its preliminary expenses, to write off the commission on the share issue, to provide for the premium on redemption of its redeemable preference shares, or to buy back its own shares under section 68: the five uses in section 52(2). It may not pay a dividend out of it, and it may not use it for working capital.

If it falls in the prescribed class under section 52(3), only three of those uses remain, confined to equity shares, and writing off preliminary expenses and providing for redemption premium are not among them.

A discount issue. The company's shares are quoted at four rupees. It proposes to issue new shares at six rupees, below the ten rupee face value. That is an issue at a discount, prohibited by section 53(1), and any share so issued is void under section 53(2). The company and every officer in default face a penalty up to the amount raised or five lakh rupees, whichever is less, and the company must refund all monies with interest at twelve per cent per annum from the date of issue: section 53(3).

The one way it could be lawful. If the company's bank debt were being converted into shares under a statutory resolution plan or a debt restructuring scheme in accordance with Reserve Bank guidelines, section 53(2A) would permit the issue to the creditors at a discount.

Sweat equity. Its chief engineer has developed a control algorithm the company now owns. The company wishes to give her one lakh equity shares for it. Under section 54 it passes a special resolution specifying the number of shares, the current market price, the consideration and the class of employees. Being unlisted, it complies with the prescribed rules; had it been listed, with SEBI's regulations. The shares are of a class already issued. Once issued, by section 54(2) they carry the same rights as other equity shares and rank pari passu with them.

Why is that not caught by section 53? Because section 54(1) opens "notwithstanding anything contained in section 53", and sweat equity is by definition issued at a discount or for consideration other than cash.

Distinctions that carry marks

What this does NOT mean

It does not mean a company may never issue shares below face value. Sweat equity under section 54 and a debt conversion under section 53(2A) are lawful.

It does not mean the securities premium is profit. It is treated as paid-up share capital, so it cannot be distributed and can be reduced only under section 66.

It does not mean sweat equity shares are a separate class. Section 54(2) makes them subject to the same rights and restrictions as equity shares and ranks them pari passu.

It does not mean a share issued at a discount is merely voidable. Section 53(2) makes it void.

Quick revision

• 52(1): premium, whether for cash or otherwise, into the securities premium account, treated as paid-up share capital, so reducible only under section 66.
• 52(2), five uses: fully paid bonus shares; preliminary expenses; issue expenses, commission or discount on shares or debentures; premium on redemption of redeemable preference shares or debentures; buy-back under section 68.
• 52(3): for a prescribed class complying with section 133 standards, only three uses, and confined to equity shares.
• 53(1) and (2): no issue at a discount; any such share is void.
• 53(2A): exception for conversion of debt into shares under a statutory resolution plan or debt restructuring scheme under RBI guidelines.
• 53(3): penalty up to the amount raised or five lakh rupees, whichever is less, on the company and every officer in default, plus refund with interest at twelve per cent per annum from the date of issue.
• 54(1): sweat equity, notwithstanding section 53, of a class already issued, on special resolution specifying number, current market price, consideration and class of directors or employees; SEBI regulations if listed, prescribed rules if not. Clause (c) omitted.
• 54(2): same rights and restrictions as equity shares; pari passu.
• 2(88): sweat equity means equity shares issued to directors or employees at a discount or for consideration other than cash, for know-how, intellectual property rights or value additions.

Test yourself

1. What must a company do with a premium received on shares? Transfer a sum equal to the aggregate premium to a securities premium account, which is then treated as if it were the paid-up share capital of the company for the purposes of the provisions on reduction of capital: section 52(1).

2. Name the five purposes for which the securities premium account may be applied. Issuing unissued shares as fully paid bonus shares; writing off preliminary expenses; writing off the expenses of, or commission paid or discount allowed on, any issue of shares or debentures; providing for the premium payable on redemption of redeemable preference shares or debentures; and the purchase of its own shares or other securities under section 68: section 52(2).

3. What is the consequence of issuing a share at a discount? The share is void: section 53(2). The company and every officer in default are liable to a penalty up to the amount raised or five lakh rupees, whichever is less, and the company must refund all monies received with interest at twelve per cent per annum from the date of issue: section 53(3).

4. Are there any exceptions to the ban on shares at a discount? Two. Sweat equity shares under section 54, and an issue at a discount to creditors on conversion of debt into shares under a statutory resolution plan or debt restructuring scheme in accordance with Reserve Bank of India guidelines, directions or regulations: section 53(2A).

5. State the conditions for issuing sweat equity shares. The issue must be authorised by a special resolution; the resolution must specify the number of shares, the current market price, the consideration if any, and the class or classes of directors or employees; and, where the equity shares are listed, the issue must comply with SEBI's regulations, and where they are not listed, with the prescribed rules: section 54(1).

6. What rights do sweat equity shares carry? The same rights, limitations, restrictions and provisions as are applicable to equity shares, and their holders rank pari passu with other equity shareholders: section 54(2).