Conversion of loans in company without authorisation legally

 ⚖️𝐂𝐚𝐧 𝐚 𝐂𝐨𝐦𝐩𝐚𝐧𝐲 𝐂𝐨𝐧𝐯𝐞𝐫𝐭 𝐚 𝐃𝐢𝐫𝐞𝐜𝐭𝐨𝐫’𝐬 𝐋𝐨𝐚𝐧 𝐢𝐧𝐭𝐨 𝐄𝐪𝐮𝐢𝐭𝐲—𝐖𝐢𝐭𝐡𝐨𝐮𝐭 𝐏𝐫𝐢𝐨𝐫 𝐂𝐨𝐧𝐯𝐞𝐫𝐬𝐢𝐨𝐧 𝐓𝐞𝐫𝐦𝐬?


Recently, I dealt with an interesting compliance scenario commonly faced by startups and unlisted companies.


𝐂𝐚𝐬𝐞:


A company took an unsecured loan from its directors for 5 years. When the repayment date arrived, the company hit a liquidity crunch. They wanted to settle the debt by issuing equity, but there was a catch: No conversion terms were agreed upon at the time the loan was raised.


Does this lack of "prior agreement" block the conversion? Let’s break down the legal mechanics.


🔍 𝐓𝐡𝐞 𝐒𝐞𝐜𝐭𝐢𝐨𝐧 𝟔𝟐(𝟑) 𝐁𝐚𝐫𝐫𝐢𝐞𝐫


Our first instinct is often to look at Section 62(3) of the Companies Act, 2013. This section allows for the increase of subscribed capital via the exercise of an option attached to a loan.


However, there is a strict proviso which states as follows:


The terms of the loan containing such an option must be approved by a Special Resolution before the loan is raised.


Since in our case no such terms were ever approved or documented at the start, Section 62(3) was off the table.


💡 𝐓𝐡𝐞 𝐒𝐞𝐜𝐭𝐢𝐨𝐧 𝟔𝟐(𝟏)(𝐜) 𝐒𝐨𝐥𝐮𝐭𝐢𝐨𝐧


Does this mean the company is stuck? Not necessarily. We looked toward Section 62(1)(c), which allows for the issuance of shares to any person for consideration other than cash.


By treating the outstanding loan as "consideration other than cash," the company can technically settle the debt by issuing shares, provided they comply with:


👉 Section 62(1)(c): Preferential Allotment

👉 Section 42: Private Placement

👉 Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014.


 ⚖️ 𝐑𝐎𝐂 𝐈𝐧𝐬𝐢𝐠𝐡𝐭


The importance of choosing the correct route was highlighted in the ROC Karnataka Order dated 08.09.2023 in the matter of Dhiomics Analytics Solutions Private Limited.


In this case, the company issued shares in lieu of a loan but mistakenly treated it as a Rights Issue under Section 62(1)(a) instead of Preferential Allotment under Section 62(1)(c) read with Section 42 of the Companies Act, 2013.


⚠️ Result: ROC imposed penalty for wrong section and non-compliance.


Compliance isn't just about what you do, but how you route it.


#CorporateLaw #CompaniesAct2013 #CS #LegalInsights #Compliance #ROC #StartupLaw #Section62 #PrivatePlacement #CorporateCompliance

This blog is authored by Company Secretary Ronak Gupta. He is author of many blogs and runs many websites and youtube channels. His work is dedicated to corporate laws, legal, secretarial, professional services and also in strategy formulations for corporates. Mail him at: csronakgupta23@gmail.com or call at :9910226715

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