Rights Issue of Shares to Person resident Outside India| FEMA Guidelines

Issuing securities to existing shareholders is one approach for a public corporation to raise more money. This is referred to as a “Rights Issue“. A public limited company may issue rights under Section 62(1) of the Companies Act. A rights issue is distinguished by the fact that it is limited to the company’s current shareholders. It could be a public firm that is listed or unlisted. If the Offer allows it, the shareholders can relinquish their rights in favor of other shareholders.

1. Why is the Rights Issue of Shares Mandatory?

• It is obligatory for every company registered under Companies Act, 2013 to follow the provisions of Companies Act, 2013 and any non-compliance may lead to penalties and punishments.
• Section 62 of Companies Act deals with “Further Issue of Share Capital”. As per Section 62(1) of Companies Act, 2013, whenever a company having a share capital proposes to increase its  subscribed capital by the issue of further shares then such company shall first offer such shares to:
  • To existing equity shareholders, i.e.,  persons who are holding equity shares on the date of offer;
  • To employees under a scheme of employees’ stock option, subject to special resolution passed by the company and other conditions.
  • To any persons, if it is authorised by a special resolution, either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer and subject to the compliance of other conditions.
• Therefore, right issue of shares is an obligation of the public company.

2. Right issue of shares to Non-Residents

• If shares of a company are held by a non-Resident then whether the company is required to make the right issue of shares to such non-resident shareholders as well? Since, Company law requires right issue of shares to existing shareholders, therefore, right issue is offered to all resident and non-resident shareholders.

• However, instructions for right issue of shares to Non-resident is provided Master Direction – Foreign Investment in India issued vide RBI/FED/2017-18/60 FED Master Direction No. 11/2017-18 dated 4th January, 2018 and Rule 7 of Foreign Exchange Management (Non-Debt Instrument) Rules, 2017. 
• Para 6.11 of Master Directions deals with “Acquisition through rights issue or bonus issue”.

• As per Para 6.11, A person residing outside of India who owns stock in an Indian firm may invest in capital instruments (other than share warrants) issued by the company as a rights or bonus issue subject to fulfillment following conditions: 

• The offer made by the Indian company is in compliance with the provisions of the Companies Act, 2013;
• Such issue will not result in a breach of the sectoral cap applicable to the company;
• The shareholding on which the rights issue or bonus issue is based must have been acquired and held in accordance with the provisions of FEMA regulations.
• The shares acquired through right issue will be subject to the same conditions and restrictions with respect to repatriability as applicable to the original holding against which rights issue has been made;
• The rights granted to persons living outside India by a listed Indian business shall be at a price established by the firm; 
• The rights issued to a person resident outside India by an unlisted Indian company shall not be at a price less than the price offered to persons resident in India.
• Such an investment made through a rights issue is subject to the terms and conditions in effect at the time of the issue.
• The consideration for acquisition of shares under right issue shall be made via banking channels or from funds kept in an NRE/FCNR(B) account maintained in compliance with the Foreign Exchange Management (Deposit) Regulations, 2016.
• If the original investment was made on non-repatriation basis*, the consideration for right issue of shares may also be paid by debit to the NRO account maintained in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016.

*Investment on a non-repatriation basis means an investment, the sale/ maturity proceeds of which are, net of taxes, not eligible to be repatriated out of India. 

• NOTE: 
  • If a person residing outside of India exercises a right that was issued while he or she was a resident of India, shares acquired as a result of the right issue must be held on a non-repatriation basis.
  • With effect from November 12, 2002, the Indian company could, on an application made to it, allot to existing shareholders who are persons resident outside India additional shares under rights issue over and above their rights entitlement subject to individual or sectoral caps, as the case may be.

3. What shall be the price of shares offered under Right Issue?

As discussed above, as per Para 6.11 of Master Direction – Foreign Investment in India issued vide RBI/FED/2017-18/60 FED Master Direction No. 11/2017-18 dated 4th January 2018, the companies are free to decide the price of right issue subject to following conditions:

• In case of unlisted Company, securities must be offered to non-residents at a price that is not less than the price offered to residents in a rights issue.
• In case of publicly traded enterprises, the price shall be decided by the company.

4. Rights Issue of shares to Non-Residents in case of renouncement

4.1 Renunciation of Rights

• According to the Companies Act of 2013, existing shareholders can accept, deny, or renounce their right to subscribe to a rights issue in favour of a third party if a rights offer is made. This renunciation can be made in the name of an Indian citizen or a foreigner.

• As per master directions, A person resident in India and a person resident outside India may renounce the shares offered to them through right issue. Renunciation can be done either in full or part thereof in favour of a person named by them.

4.2 Pricing guidelines when right issue is renunciated

• Investments in India through equity instruments by a person resident outside India is governed by Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”)

• Explanation to Rule 7 to NDI Rules and Rule 6.11.4 of Master Directions, any person resident outside India may acquire shares under right issue due to renunciation of rights. However,  Price for such right issue shall be determined as per above mentioned guidelines. Therefore, price shall be:

• In case of an unlisted Indian company, price of rights issue to persons residing outside India will not be less than the price offered to persons residing in India, and 
• In case of a listed company, the rights issue to persons residing outside India will be at a price determined by the company.

• Since, no restriction was provided for pricing therefore, non-resident shareholders were able to make major investments in India at a fraction of the fair market value.

• To curb this situation, an amendment was introduced in Rule 7 of NDI Rules vide notified the Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules, 2020 issued on 27th April, 2020. Amendment deleted explanation to Rule 7 of NDI Rules and inserted a new Rule 7A which states that:

‘a person resident outside India who has acquired a right from a person resident in India who has renounced it may acquire equity instruments (other than share warrants) against the said right as per pricing guidelines specified under Rule 21 of the NDI Rules’ (“Amendment”).

• According to Rule 21(2)(a)(ii) of the NDI Rules, when equity shares are issued by a company to a person resident outside India then price of such share shall not be less than:
  • In case of listed company, the price worked out in accordance with the Securities and Exchange Board of India guidelines or in case of a company going through a delisting process as per the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009;
  • In case of unlisted Indian company, the valuation of equity instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India or a practising Cost Accountant.

• While the Amendment has made a long-awaited modification to the price parameters in the case of residents renouncing a rights offer, it does not cover a situation in which an existing non-resident investor renounces a rights issue entitlement in favour of another non-resident investor. It is critical that these clarifications be provided in order to ensure that no equity instruments be purchased for less than their fair market value.

5. Reporting requirement for equity shares issued under Right Issue

• Reporting requirement in case of shares issued under Right Issue is given under Rule 4 of Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.
• Unless otherwise provided, all reporting with respect to issue of right shares shall be made through or by an Authorised Dealer Bank, as the case may be.
• As per Rule 4 of FEM (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, An Indian company issuing equity instruments to a person resident outside India and where such issue is reckoned as Foreign Direct Investment shall report such issue in Form FC-GPR.
• Form FC-GPR must be filed within 30 days from the date of issue of equity instruments.
• Issue of ‘participating interest / rights’ in oil fields shall be reported in Form FC-GPR.

6. Frequently asked Questions (FAQs)