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The sweat over equity

The unusual April heat is definitely being felt by the players on the cricket ground. But surprisingly, there are some who are sweating it even in the airconditioned box stands. The recent debate relating to the issuance of ‘sweat equity’ has drawn attention to the legislation regulating such issuance and the procedure that needs to be followed.

The Companies Act, (the ‘Act’) provides that equity shares can be issued only to employees or directors of a company, at a discounted rate, or for consideration other than cash, in recognition of their contribution for providing know-how or intellectual property or for value additions for the benefit of the company.

Such contributions may be in any form, which increases the value of the company in economic terms and is attributable to the efforts of the concerned employee or director. The equity shares so issued are termed as ‘sweat equity’ shares.

Further, the Act stipulates that sweat equity shares must be of the same class of equity shares as are already issued by the company and all the limitations, restrictions, and provisions relating to equity shares are also applicable to sweat equity shares.

The issuance of sweat equity is required to be authorised by a special resolution passed by the company in the general meeting. The special resolution must inter-alia specify the number of shares, current market price, and the class or classes of directors or employees to whom such equity shares are being issued.

The Act also states that, as on the date of the issuance of the sweat equity shares, one year should have elapsed since the company was entitled to commence its business.

Where sweat equity is issued by a company whose equity shares are not listed on any recognised stock exchange, the sweat equity shares are required to be issued in accordance with prescribed guidelines.

In 2003, the Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003 (‘MCA rules’) were issued by the ministry of corporate affairs.

Under the MCA rules a company cannot issue sweat equity shares in a year for more than 15% of the total paid up equity share capital of the company or shares in excess of the value of Rs 5 crore, whichever is higher.

In the event the number of shares exceeds the foregoing cap, prior approval from the central government has to be obtained.

Further, in the case of a non-cash consideration for issuing sweat equity, the consideration needs to be valued by a valuer who is expected to submit a valuation report giving justification for the valuation.

It should be noted that such valuation report is also required to be sent to the shareholders with the notice of the general meeting and the company has to give justification for the issue of sweat equity shares, which has to form part of the notice sent for the general meeting.

It may also be relevant to note that where sweat equity is issued for non-cash consideration, then, if it takes the form of a depreciable or amortisable asset, it has to be carried to the balance sheet of the company in accordance with the relevant accounting standards.

Of equal relevance is the fact that any sweat equity issued is subject to a mandatory three year lock-in from the date of its allotment.

Additionally, under rules issued by the Institute of Companies Secretaries of India the issuance of sweat equity must be permitted by the articles of association of the company and stipulates that the company must make the requisite filings with the registrar of companies within 30 days from the date of the special resolution permitting such issuance of sweat equity, together with a copy of the resolution.

Whether or not the procedures, detailed above, were followed by the company which recently won the franchise for a cricket league is a matter that can only be determined after a detailed review. But what this controversy once again brings to the fore is the need for better enforceability and policing of the laws.

Presumably, there are numerous other private companies that issue sweat equity without following the above procedures. Not all of these make it to the front page for their breach. And it may be impractical to expect the government to monitor all of these diligently.

Thus, and as a matter of public policy, what is perhaps required is that the consequences for breach of any law must visit the delinquent with an iron hand. Punishments need to be stringent, which they currently are not, so as to be a deterrent. Of equal importance to enforceability is the concept of retribution.

While the question about what restraints on actions of other people should exist has been the subject of a long standing legal, moral and political debate, the real issue is how the restraints are enforced.

In the final analysis, enforceability is not only a matter of command-andcontrol. Some amount of self-regulation is also required on the part of the seven lakh plus registered private companies to demonstrate their acceptance of the rule of law.

First Published in the Economic Times on April 20, 2010

 

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