Dematerialization Mandate - A WOS Perspective

In the dynamic realm of corporate governance, the dematerialization of securities has emerged as a transformative force, particularly impacting wholly owned subsidiaries (WOS) established as private companies under the provisions of the Companies Act, 2013 (CA 2013). This article delves into the intricacies of the dematerialization mandate issued by the Ministry of Corporate Affairs (MCA) through the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (Amended PAS Rules), outlined in a Notification dated October 27, 2023 (Notification). It examines the implications, challenges, and benefits specific to WOS operating under the new regulatory framework.

The Notification provides that all private companies (other than a small company) must issue the securities only in dematerialized form and facilitate the dematerialization of all its securities before the Due Date (defined below).

It is imperative to note that in terms of the Companies Act, 2013, the term ‘small company’ does not include a subsidiary company even if it satisfies the paid-up share capital and turnover threshold limits provided therein. Thus, all WOS are mandatorily required to ensure that they issue the securities only in dematerialized form and facilitate the dematerialization of all its securities before the Due Date.

Dematerialization, involving the conversion of physical share certificates into electronic form, fundamentally alters how securities are held and traded for WOS operating beneath a parent company. This process introduces additional layers of compliance within their complex regulatory environment.

Pros of Dematerialization Mandate for WOS:

Dematerialization, beyond being a regulatory obligation, presents tangible opportunities for WOS:

Efficiency and Cost Reduction: Streamlining shareholding processes reduces administrative overheads, leading to cost savings.

Enhanced Transparency: Electronic records foster trust among stakeholders by providing a transparent view of shareholding.

Improved Accessibility: Electronic securities facilitate faster and more convenient transactions, increasing liquidity for both the company and investors.

Reduced Risk of Physical Loss: Digital securities eliminate the risk of physical loss or damage, ensuring secure and easily retrievable records.

Cons of Dematerialization Mandate for WOS:

Despite substantial benefits, WOS may encounter challenges in the dematerialization process:

Initial Implementatin Costs: The transition to dematerialization may incur initial setup costs, including investments in technology, employee training, and system integration.

Educational Hurdles: Ensuring that all stakeholders, including shareholders and employees, are educated about the dematerialization process can be challenging.

Regulatory Compliance Burden: Keeping up with evolving regulatory requirements for dematerialization can be a burden for WOS, requiring ongoing efforts to stay compliant.

Limited Impact on Control Structure: While dematerialization can enhance efficiency, it may have limited impact on the overall control structure of WOS.

The dematerialization process for WOS necessitates meticulous coordination with regulatory bodies, depository participants, and internal stakeholders. Opening demat accounts by shareholders in India is a crucial milestone. The Notification introduces Rule 9B, outlining various compliances for WOS entities.

Compliances for WOS:

Mandatory Conversion: WOS must issue the securities only in dematerialized form and facilitate dematerialization of all its securities before the Due Date.

Due Date for Conversion: Compliance within 18 months of closure of the financial year ending on or after March 31, 2023 (Due Date). For instance, if the financial year of a WOS has closed on March 31, 2023, then it must facilitate the dematerialization of all its securities before September 30, 2024, and issue the securities in dematerialized form only on or after September 30, 2024. Whereas, if the financial year of a WOS has closed on June 30, 2023, then it must facilitate the dematerialization of all its securities before December 31, 2024, and issue the securities in dematerialized form only on or after December 31, 2024.

Dematerialization of Promoters/Directors/Key Personnel Holdings: Mandatory dematerialization of the entire holding of securities of the promoters, directors, key managerial personnel before making offers, buybacks, or issuing bonus or rights shares after the Due Date.

Depository and Registrar Compliance: Timely payment of fees, maintenance of security deposit, and compliance with depository and registrar requirements. If a WOS defaults in any of the specified compliances, it is prohibited from making offers of securities, conducting buybacks, or issuing bonus or rights shares until the outstanding payment to the depository, registrar to an issue, and share transfer agent has been rectified.

Compliance with Acts and Regulations: Adherence to SEBI or depository regulations regarding the dematerialization of securities for unlisted private companies is a must.

Filing of Form PAS 6: WOS must submit Form PAS 6 with the concerned Registrar of Companies within sixty days from the conclusion of each half-year. The form must be duly certified by either a practicing company secretary or a practicing-chartered accountant.

Discrepancies in Capital: The responsibility rests with the WOS to promptly notify the depository if any disparities are observed between its issued capital and the capital held in dematerialized form.

Transfer in Dematerialized Form: Security holders must dematerialize securities before transfer after the Due Date. This means that the security holders can continue to hold the securities acquired by them before the Due Date in physical form. However, if they wish to transfer the said securities after the Due Date, they will have to get the securities converted into dematerialized form.

Subscription in Dematerialized Form: New subscribers must ensure dematerialization before subscribing to WOS securities.

Implication for Foreign Shareholders: In light of the dematerialization mandate, foreign investors seeking to initiate new investments or transfer existing ones in a WOS after the Due Date must establish a demat account with Indian depositories. The process involves obtaining a Permanent Account Number (PAN) from Indian tax authorities, complying with the Know Your Customer (KYC) norms set by the depositories, and fulfilling additional requirements, including the payment of fees and apostillization/ consularization of the documents.

Filing of Complaint: Security holders can file grievances related to dematerialization with the Investor Education and Protection Fund Authority (IEPFA) for initiating necessary actions against involved entities.

Neither the Companies Act, 2013 nor the Amended PAS Rules specifies a particular penalty for a failure to comply with the provisions of the Amended PAS Rules. In such cases, the general penalty outlined in Section 450 of the Companies Act, 2013 becomes applicable. According to this Section, the company, every defaulting officer, or any other individual involved may be subject to a penalty of ten thousand rupees. For continuous contraventions, an additional penalty of one thousand rupees per day subsequent to the first day of non-compliance may be imposed. However, the cumulative penalty is capped at two lakh rupees for a company and fifty thousand rupees for an officer or any other individual in default.

The dematerialization mandate is not merely a regulatory requirement but a catalyst for positive change in the WOS landscape. Navigating the process strategically, embracing technology, and prioritizing effective communication allows WOS to harness the full potential of dematerialization. This sets the stage for a future marked by efficiency, transparency, and adaptability in the corporate governance of WOS.

About the author: Gunjan Gupta is an Associate Partner at Singhania & Partners.