Photo: Reuters
Photo: Reuters

Dematerializing unlisted shares: How changes affect shareholders

An existing shareholder of an unlisted public company will have to get the securities dematerialized, failing which he will not be able to transfer such securities

Listed companies in India had moved from paper share certificates to the electronic-form, i.e. dematerialized shares way back in the year 1996. However, there was no such mandate in case of unlisted companies leading to instances of fraudulent share transfers and other disputes which resulted in unwanted litigation and hardship for the actual share-holders. To bring in further transparency, improve the know your customer (KYC) framework and overall investor protection, the Indian government has recently made it mandatory for all unlisted public companies to dematerialize their securities. It is pertinent to note that private companies are still exempt from getting their shares dematerialized.

This article focuses on the impact and way forward for the shareholders of Indian unlisted public companies in light of this recent development.

A public company means a company, other than a private company, formed under the Companies Act, 2013 by seven or more members.

A private company means a company, which by its articles restricts the right to transfer its shares, limits the number of its members to 200 and prohibits any invitation to the public to subscribe for any securities of the company.

Thus, if securities of a public company are not registered or listed on any recognized stock exchange, it is treated as an unlisted public company’

Dematerialization is the process by which one can get the physical share certificates converted into electronic balances. The process for dematerializing shares is broadly as under:

•An investor intending to dematerialize the securities needs to open an account with a depository participant. A depository participant works as an agent of a depository, an administrative body which holds the investor’s securities in an electronic format. An investor is required to place a request with the depository for this purpose through a registered Depository Participant. The National Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL) are the two depositories in India who have the mandate for providing these services.

• The investor has to deface and surrender the share certificates registered in its name to the depository participant.

• After intimating the depositories electronically, the depository participant sends the securities to the concerned issuer company.

• The depository in turn informs the issuer company electronically, using the depository system, about the request for dematerialization.

•If the issuer company finds the certificates in order, it registers the depository as the holder of the securities (with the investor as the beneficial owner) and communicates electronically to the depository regarding the confirmation of request.

•On receiving the confirmation, the depository credits the securities in the depository account of the Investor with the depository participant.

Issue of new shares: The regulations provide that any new issue of securities by an unlisted public company can only be in a dematerialized form. Before making any new offer for issue of securities, buy back of securities, issue of bonus shares or rights offer by an unlisted public company, the shares held by promoters, directors and key managerial personnel are required to be dematerialized.

Impact for existing shareholders: An existing shareholder of an unlisted public company will have to get the securities dematerialized, failing which he will not be able to transfer such securities.

Unlisted public company’s obligation: The unlisted public company shall facilitate dematerialization of its existing securities by making necessary application to a depository to secure the international security identification number (ISIN) for each type of security issued and shall inform all its existing security holders about such facility.

The above changes came into effect from 2 October and as such all unlisted public companies and investors who hold physical shares in such unlisted public companies are required to make the changes at the earliest.

Shareholders (including non-resident individual shareholders) of an unlisted public company, who intend to transfer the securities on or after 2 October would need to open an account with a depository participant and dematerialize such securities before transferring the same. Existing security holders who intend to further subscribe to the securities of the unlisted public company by way of private placement, bonus shares or a rights offer shall ensure that all their existing securities are dematerialized before such subscription.

Every unlisted public company needs to ensure that all its securities are dematerialized in accordance with the Depositories Act, 1996 prior to making any offer for issue of securities, for buy-back of securities, for issue of bonus shares and for rights issue.

Unlisted companies are expected to facilitate the dematerialization of their securities in coordination with depositories and share transfer agents. The unlisted public companies which have or will have dematerialized their securities shall ensure timely payment of fees and comply with the regulations, guidelines or circulars, if any issued by the regulators from time to time.

They shall obtain an audit report from a qualified chartered accountant or a practising company secretary in order to submit the same with Registrar of Companies on a half yearly basis reconciling the total issued capital, capital held by depositories in dematerialized form, and other details of changes in share capital.

In case of default in payment of applicable fees, unlisted public companies shall be restricted to offer any securities or buyback, or issue any bonus or right shares until the payment due to depository or to the registrar to an issue or the share transfer agent, etc are made.

Private companies are not mandatorily required to issue shares in dematerialized form. However, there is no bar, if the private companies provide this facility to its shareholders.

Holding securities in dematerialized form will help in removing instances of duplication, risk of loss of physical share certificates, improve corporate governance and bring in more transparency in the share ownership structure. Further, it should discourage benami (any transaction in which property is transferred to one person for consideration paid by another person) shareholding and other such practices.

No stamp duty is payable on transfer of shares held in dematerialized form which can save a significant amount for the shareholders. It will also result in a time and cost efficient process of transfer and pledge of securities. There is a nominal cost associated with maintaining an account with the depository participant, however, the long term benefits generally out-weigh the cost.

From a regulator’s perspective, it is easier to find an audit trail of the past transactions, hence easier to track the shareholders as well as the real beneficiaries of the shares.

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FAQs

1.What are the documents required to be submitted to open a demat account in India by non-resident Indians/foreign nationals?

The non-resident Indian/foreign national is required to submit copy of proof of identity, proof of address, PAN (Permanent Account Number) card and a declaration that the non-resident Indian/foreign national has complied with and will continue to comply with foreign exchange regulations to the depository participant. Passport, driving licence, utility bills, recent bank statement, copy of rent agreement/sale deed, etc are the documents that may be submitted to establish proof of identity and address. These documents should be apostilled/ notarized/counselarized in the country of their residence, as specified.

2.What is the recourse available to the shareholders in case of any grievances against the unlisted public company?

The shareholders can file their grievances before the Investor Education and Protection Fund Authority which has been established for the purpose of promotion of investors’ awareness and protection of their interests.

Prasenjit Sarkar and Ashish Sharma have contributed to this article.

Vikas Vasal is national leader tax–Grant Thornton India LLP.

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