Mandatory Dematerialisation Of Securities By Private Companies – Shareholders

The time for dematerialisation of physical securities by every
private company, which is not a small company¹, is fast
approaching. The Ministry of Corporate Affairs (“MCA”) on
October 27, 2023, notified Companies (Prospectus and Allotment of
Securities) Second Amendment Rules, 2023 (“Prospectus
Amendment Rules”) vide notification no. G.S.R. 802(E). The
Prospectus Amendment Rules encompass two key changes: (i)
surrendering of share warrants issued by public companies prior to
the commencement of the Companies Act, 2013 and get the shares in
dematerialized mode; and (ii) private companies, other than small
companies, to mandatorily issue the securities only in
dematerialized form and facilitate the dematerialization of all its
existing securities.

In view of the foregoing, every private company (other than a
small company), should, within 18 (eighteen) months from March 31,
2023 i.e., prior to September 30, 2024, comply with the aforesaid
conditions of the Prospectus Amendment Rules by undertaking the
following steps:

a. amendment of articles of association (“AoA”) of the
company by passing a special resolution to authorise shareholders
to hold securities in dematerialised form;

b. appointment of a Securities and Exchange Board of India
(“SEBI”) registered Registrar and Transfer Agent
(“RTA”) which inter alia includes executing a tripartite
agreement between the company, RTA and depository i.e., either
National Securities Depository Limited or Central Depository
Services Limited. However, the same is not mandatory if the company
has an inhouse arrangement;

c. facilitation of dematerialisation of all its existing
securities by making an application to a depository and obtaining
an International Securities Identification Number
(“ISIN”) for each type of security and thereafter inform
all its existing security holders about such facility;

d. ensure timely payment of fees (admission as well as annual)
to the depository and registrar to an issue and RTA in accordance
with the agreement executed between the parties.

e. Maintain a security deposit of not less than 2 (two) years
fees with the depository and RTA at all times and comply with the
regulations or directions or guidelines or circulars, if any,
issued by SEBI or depository from time to time with respect to
dematerialisation of shares and matters incidental or related
thereto such as applicable provisions of Depositories Act, 1996,
SEBI (Depositories and Participants) Regulations, 2018 and SEBI
(Registrars to an Issue and share Transfer Agents) Regulations,
1993; and

f. Filing e-Form PAS-6 (half yearly return for reporting of
shares held in demat form) with the Registrar of Companies within a
period of 60 (sixty) days from the conclusion of each half year
duly certified by a company secretary in practice or chartered
accountant in practice.

While dematerialization of securities is being mandated under
the Prospectus Amendment Rules, it does not bar the security holder
to continue to hold his existing securities in a physical form.
However, after September 30, 2024, when the security holder decides
to transfer these securities, dematerialization would be mandatory
prior to initiating the transaction. Further, the shareholder will
be able to subscribe to any further issue only after
dematerialising the securities.

Dematerialisation Process

Securities can be credited to depositories either for
dematerialisation of physical securities or on fresh issue of
securities in dematerialised form. The process of dematerialization
requires² investors to open demat accounts with
Depository Participants (“DP”) who act as intermediaries
between them and the depository. A request for conversion of
securities held in physical form may be done by filing an
application in Dematerialisation Request Form (“DRF”) to
the DP, along with the certificates of securities to be
dematerialised (if the securities are required to be converted from
physical to demat form). Before submission, the investor is
required to deface the certificates by writing “Surrendered
for Dematerialisation”.

Pursuant to confirming the accuracy of details submitted in DRF,
the DP will provide the investor with an acknowledgement slip that
has been properly signed and stamped. The DP after electronically
registering such a request with the depository will then forward
the DRF so received, together with the security certificates, to
the company or its RTA.

Following the verification, the company or its RTA will notify
the depository to approve an electronic credit for that security in
the investor’s name (the investor will be the beneficial
owner). Upon receiving this notification, the Depository will
initiate the necessary credit entries into the investor’s
account.

Conclusion

From a legal standpoint, introduction of Prospectus Amendment
Rules is an attempt towards mitigating disputes and risks
associated with securities issued or held in physical form. The
process of dematerializing shares by private companies offers a
multitude of benefits, including enhanced efficiency, transparency,
and security in the trading of securities and increasing
accountability of private companies to identify the true owners of
the securities. By transitioning from physical certificates to
electronic form, companies stand to streamline their operations,
reduce costs, and align with evolving market standards. Embracing
dematerialization not only meets regulatory requirements but also
positions companies to thrive in an increasingly digitized
financial landscape, fostering investor confidence and facilitating
smoother transactions in the securities market.

Indeed, the process of dematerializing shares for private
companies entails certain operational and compliance costs, which
extend to both the companies themselves and their shareholders.
These expenses include payments for admission and annual fees to
various entities such as the depository, RTA, and DP, among others.
While these costs may initially seem burdensome, it’s essential
to consider the long-term benefits and efficiencies that
dematerialization brings.

Footnotes

1 Small companies is defined under Section 2 (85) of
the Companies Act, 2013 read with Rule 2(1)(t) of the Companies
(Specification of Definitions Details) Rules, 2014 to mean a
company, other than a public company, having paid up share capital
not exceeding Rs. 4 crores and turnover not exceeding Rs. 40
crores. However, a holding company or a subsidiary company, a
company registered under section 8, a company or body corporate
governed by any special Act will not be considered as a small
company.

2 https://nsdl.co.in/services/demat.php