Introduction

Through its recent decision the Ministry of Corporate Affairs (MCA) reached a breakthrough by requiring private limited companies to participate in the dematerialization process. The management team seeks to prevent fraudulent practices while implementing better governance standards through digital initiatives that match national digitalization goals.

Only listed companies and certain public limited companies had previously needed to hold their securities through dematerialized form. The MCA requires private companies including a few exemptions to convert their physical shareholding into electronic form through Demat.

Regulatory Background

• The rule comes from a modification to the Companies (Prospectus and Allotment of Securities) Rules, 2014 in its Rule 9A section.

• Unlisted public companies along with private companies can issue securities through dematerialized form based on rule 9A of the Companies (Prospectus and Allotment of Securities) Rules due to the October 27th 2023 notification (G.S.R. 802(E)) that increased accessibility to private companies.

Key Notification

• MCA Notification Date: 27th October 2023

• Applicable Rule: Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023

• New Insertion: Rule 9B – Dematerialization of securities by private companies

Applicability: Who Needs to Comply?

Under Rule 9B, all private companies (excluding small companies and certain government companies) are required to facilitate dematerialization of shares.

• Applicable Companies:

1. According to Section 2(85) of the Companies Act 2013 the definition of a Small Company exists.
2. Government Companies

• Important Timelines:

1. The rule is effective from 27th October 2023.

2. Private companies must ensure dematerialization before making any new issuance or transfer of shares.

3. Existing physical shares must be converted to Demat within the prescribed timeline.

Key Provisions Under Rule 9B

• Fresh Issuance of Securities : No private company (to which Rule 9B applies) shall make any offer of securities or buyback or issue bonus shares unless the entire holding of its existing securities is in Demat form.
• Transfer of Shares : Transfer of shares by shareholders of such companies is permitted only in dematerialized form.
• Maintenance of Records : The company must ensure that the Register of Members, Return of Allotment, and other related records are maintained in electronic format.

Steps for Private Companies to Comply with Demat Mandate

Here is a step-by-step guide for private companies to comply with MCA’s Demat requirement:

Step 1: Appoint a Registrar and Transfer Agent (RTA)

1. Engage with a SEBI-registered RTA to handle the dematerialization process and interface with depositories (NSDL or CDSL).

Step 2: Enter into Tripartite Agreement

Sign a Tripartite Agreement between:

1. The Company
2. The Depository (NSDL or CDSL)
3. The RTA

Step 3: Obtain ISIN for Securities

1. Apply for an ISIN (International Securities Identification Number), which uniquely identifies each type of security issued by the company.

Step 4: Facilitate Shareholder Demat

1. Inform all shareholders about the need to open Demat accounts.

2. Shareholders must:

• Any person who wants a Demat account needs to start the process with a Depository Participant (DP).
• The delivery of Demat Request Forms (DRF) together with physical share certificates must be sent to your Depository Participant
• The shares become electronic when the verification process completes and get added to their accounts

Step 5: File with ROC

1. File all necessary forms and returns such as:

• PAS-3 (Return of Allotment)
• MGT-7A or MGT-7
• Maintain MGT-1 electronically

Responsibilities of Private Companies

When operating under Rule 9B private firms need to:

• Ensure all securities are dematerialized before any new allotment or transfer

• Not process any transfer in physical form

• Update their Articles of Association (AOA), if necessary, to reflect provisions for Demat

• Ensure timely communication and assistance to shareholders in completing their dematerialization

Consequences of Non-Compliance

Failure to comply with the provisions under Rule 9B can attract penalties under the Companies Act, 2013, including:

• Rejection of filings like PAS-3

• Invalidation of share transfers

• Penalties against the company and officers for non-compliance

Benefits of Dematerialization for Private Companies

• The system enables improved visibility into who holds ownership stakes in the company through its power to track shareholding and ownership details.

• Reduced Risk of forgery, duplication, or loss of physical certificates

• The system simplifies capitalization table administration for young businesses along with expanding entities.

• Fundraising Norms compliance requires VCs/PEs to process shares in Demat form as several entities enforce this requirement now.

• Better Corporate Governance

Conclusion

A fully digital corporate environment becomes more attainable through the MCA's requirement for Demat share registration by private organizations. The initial expenses involved in implementing both companies and shareholder obligations under this mandate will be eclipsed by future efficiencies together with regulatory improvements and transparency benefits.

Every base constituent company except those that are small and government-based entities needs to establish demat architecture alongside RTA coordination tasks and shareholder facilitation for their shift to dematerialization.

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