SRM Energy Limited vs sebi appeal no 34 of 2011 sat order dated 6 june 2011

                                                  Appeal No. 34 of 2011

Date of Decision: 6.6.2011
SRM Energy Limited
601, Pressman House,
70A, Nehru Road, C.T.S. No.76 & 87,
Vile Parle (East), Mumbai.

              …… Appellant

Versus

Securities and Exchange Board of India
SEBI Bhavan, Plot No. C-4A, G Block,
Bandra Kurla Complex, Bandra (East),
Mumbai.
Arihant Capital Markets Limited
3rd Floor, Krishna Bhavan,
67, Nehru Road, Vile Parle(East),
Mumbai. …… Respondents Mr. Pesi Modi, Advocate with Mr. Anant Updhayay, Advocate for the Appellant.
Mr. Shiraz Rustomjee, Advocate with Mr. Ajay Khaire, Advocate for
Respondent No.1.
None for Respondent no.2.
CORAM : Justice N. K. Sodhi, Presiding Officer
P. K. Malhotra, Member
S. S. N. Moorthy, Member
Per : Justice N. K. Sodhi, Presiding Officer

Whether the unsecured loans advanced by the promoter group could be
adjusted against allotment of shares to them in the rights issue is the solitary question
that arises in this appeal. The brief facts of the case are as under:-

The appellant was incorporated as a public limited company in the year 1985
under the name and style of Hitkari Fibers Limited. Its shares are listed on the
Bombay Stock Exchange. Spice Energy Pvt. Ltd (for short SEPL) is another company
incorporated under the Companies Act, 1956 and promoted by the Rastogi family of
Delhi which owns more than 80 per cent shares in this company. Some time around
December, 2007, SEPL received a ‘Letter of Facilitation’ from the Government of
Tamil Nadu for setting up a coastal imported coal based Thermal Power Plant in 2
Cuddalore for 1000 MW capacity which was subsequently enhanced to 2000 MW in
December, 2008. SEPL then received all the regulatory clearances for the power
project. The Spice Energy Group which had promoted SEPL formed another private
limited company under the name and style of SRM Energy Pvt. Ltd. as a special
purpose vehicle for implementing the aforesai d power project. The total cost of the
project was 9,438 crores. Looking at the size of the investment required to implement the project and based on the interest evinced by certain strategic investors at that time, the Spice Energy group decided to implement the power project through a listed entity so as to provide the strategic investors with an exit option. The group also decided to channelize the investment th rough a Global Depository Receipt issue. SEPL then took over Hitkari Fibers Ltd. in March, 2008 by acquiring 71.19 per cent of its shares and the remaini ng 28.81 per cent shareholding is widely held by around 5,400 public shareholders. SEPL took over the management and control of the appellant which was then known as Hitkari Fibers Ltd. This was done after complying with the provisions of the Securities a nd Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regula tions 1997. At the time of the takeover, Hitkari Fibres Ltd. was incurring losses and its net worth had also been completely eroded. As against the paid up capital of 3.06 crores, its accumulated losses were
` 6.47 crores as on March 31, 2008. The shar es of Hitkari Fibres Ltd. were not
getting traded on the stock exchange fo r a long time and it had never declared
dividend. SEPL after taking over the company decided to discontinue with its then
existing business and focused only on the proposed power plant. After the takeover of
Hitkari Fibres Ltd. by SEPL, the special purpose vehicle formed for the purpose of
implementing the power project viz., SRM Ener gy Pvt. Ltd. was merged with Hitkari
Fibers Ltd. This was done in pursuance of a scheme of amalgamation framed under
sections 391 and 394 of the Companies Act. In terms of the scheme of amalgamation,
the name of the company was also changed from Hitkari Fibers Ltd. to its present
name i.e. SRM Energy Ltd which is now the appellant before us. As already observed
above, the funds for the proposed power pr oject had been planned through a Global
Depository Receipt issue which did not come through for reasons with which we are 3
not concerned. Due to the failure of th e Global Depository Receipt issue and the
negative net worth of the appellant compa ny, it was facing difficulty in arranging the
funds for the project. It was in these circumstances that SEPL, the promoter of the
appellant stepped in with it s funds in the interest of the appellant company and its
shareholders and kept lending its own funds from time to time as and when required
by the appellant for implementing the power project. As on August 12, 2010, SEPL
had lent to the appellant a sum of 4052.05 lacs which was standing in its books of account. We have on record a certificate from the statutory auditors of the appellant company showing that a sum of 4052.05 lacs was due to SEPL as unsecured loans
and this fact is not in dispute. It is also on record that as on December 31, 2010, a sum
of ` 4160.89 lacs was the amount of unsecured loans standing in the books of the
appellant company which amount had been advanced by SEPL.
With a view to mobilize further funds for the power proj ect, the appellant
company came out with a rights issue and decided to issue shares on rights basis to its
shareholders. On July 8, 2010 the board of directors of the appellant passed a
resolution deciding to issue shares on rights basis and sought the approval of the
shareholders by a resolution through postal ball ot. It was, inter alia, stated in the
notice that the rights issue was for funding th e implementation of the power project.
On August 13, 2010 the shareholders of the appellant passed a unanimous resolution
through postal ballot approving th e rights issue. Since SEPL, the promoter of the
appellant, was holding 71.19 per cent shares on the date of the rights issue, its
entitlement in that issue worked out to 4,19,25,000 shares amounting to 4192.50 lacs. As already noticed above, SEPL had already br ought in funds to the extent of 4052.05 lacs till August 12, 2010 which were shown as unsecured loans in the books
of the appellant. According to the appellant, there was an oral understanding between
it and the promoter (SEPL) at the time of providing funds from time to time that if and
when the appellant came out with a right s issue, the unsecured loans would be
adjusted against the share price. SEPL by its letter of August 13, 2010 authorised the
appellant company to adjust the unsecured loans hitherto provided to the appellant
towards its entitlement in the proposed right s issue making it clear that if there was 4
any short fall, the same would be subscrib ed by the promoter (SEPL). On August 17,
2010, the appellant company through its merchant banker filed with the Securities and
Exchange Board of India (hereinafter called the Board) a draft letter of offer for the
rights issue which was to be sent to the shareholders. The appellant company had
decided to issue rights shares in the ratio of 65 equity shares for every 10 fully paid up
equity shares held by an existing equity shareholder on the record date. It was
specifically mentioned in the draft letter of offer that the unsecured loans lying in the
books of the company and due to SEPL sha ll be adjusted towards the price of the
shares as per the entitlement of the latter. The draft letter of offer was sent to the
Board in terms of Regulation 6 of the Secu rities and Exchange Board of India (Issue
of Capital and Disclosure Requirements) Regulations 2009 (for short the Regulations).
On receipt of the letter of offer, the same was examined by the Board and the Assistant
General Manager, Corporation Finance Depa rtment, Division of Issues and Listing
acting on behalf of the Board informed the merchant banker that “You are advised to
ensure that unsecured loans of promoter and promoter group are not adjusted
against allotment of shares against thei r right entitlements and also against
shares to be allotted to them as a result of renunciation or unsubscribed portion”.
Feeling aggrieved by this direction, the appellant has come up in appeal.
We have heard the learned counsel for the parties who have taken us through
the record. The primary argument of Shri P.N. Modi learned counsel for the appellant
is that there is no provision in any law nor in the Regulations which prohibits the
adjustment of unsecured loans against the pric e to be paid for the shares allotted in
rights issue. He pointed out that SEPL which is the promoter of the appellant
company had been advancing loans from time to time which are shown in the books of
account of the appellant as unsecured loans wh ich could be adjusted against the price
to be paid by the promoter for the shares allotted in the rights issue. The argument is
that the unsecured loans due to the promoter could be treated as share application
money and the Board was not justified in dire cting the appellant not to make such an
adjustment. Learned counsel referred to cl ause (5)(VII)(G)(2) of part E of Schedule
VIII to the Regulations and contended that the same permits adjustment of money 5
brought in advance by the promoters which is deployed in the project towards their
entitlement in the rights i ssue. It was strenuously argue d by the learned counsel for
the appellant that the shares proposed to be allotted in accordance with the provisions
of section 81(1) of the Companies Act and that all the necessary disclosures having
been made, the impugned direction given by the Board was not called for. Mr. Shiraz
Rustomjee learned counsel for the Board, on the other hand, contended that the
unsecured loans advanced by the promoter ha d a condition attached thereto that they
could be converted into equity as and when the appellant came out with a rights issue
and since these loans do not comply with the stringent conditions prescribed by the
proviso to section 81(3) of the Companies Act, the loans of the promoter could not be
converted and the Board was right in gi ving such a direc tion in the impugned
communication. The argument is that only such loans can be c onverted into equity
which satisfy all the conditions of section 81(3) of the Companies Act including those
in the proviso thereto and the loans which do not satisfy all these conditions are not
convertible at all. Sin ce the answer to the rival contentions depends on the
interpretation of section 81 of the Companies Act, the relevant part thereof is
reproduced hereunder for ease of reference:-
“Further issue of capital
(1) Where at any time af ter the expiry of two years from the formation of a
company or at any time after the expiry of one year from the allotment of
shares in that company made for the first time after its formation, whichever is
earlier, it is proposed to increase the subscribed capital of the company by
allotment of further shares, then,-
(a) such further shares shall be offered to the persons who, at the date of the
offer, are holders of the equity sh ares of the compa ny, in proportion, as
nearly as circumstances admit, to the capital paid-up on those shares at that
date;
(b) the offer aforesaid shall be made by notice specifying the number of shares
offered and limiting a time not being less than fifteen days from the date of
the offer within which the offer, if not accepted, will be deemed to have
been declined;
(c) unless the articles of the company ot herwise provide, the offer aforesaid
shall be deemed to include a right ex ercisable by the person concerned to
renounce the shares offered to him or any of them in favour of any other
person; and the notice referred to in cl ause (b) shall contain a statement of
this right;
(d) after the expiry of the time specified in the notice aforesaid, or on receipt of
earlier intimation from the person to whom such notice is given that he
declines to accept the shares offered, the Board of directors may dispose of
them in such manner as they think most beneficial to the company. 6
Explanation : In this sub-section, “e quity share capital” and “equity shares”
have the same meaning as in section 85.

(1A) Notwithstanding anything contained in sub-section (1), the further shares
aforesaid may be offered to any persons whether or not those persons include
the persons referred to in clause (a) of sub-section (1 ) in any manner
what-soever –
(a) if a special resolution to that effect is passed by the company in general
meeting, or
(b) where no such special resolution is passed, if the votes cast (whether on a
show of hands, or on a poll, as the ca se may be) in favour of the proposal
contained in the resolution moved in that general meeting (including the
casting vote, if any, of the chairman ) by members who, being entitled so
to do, vote in person, or where proxies are allowed, by proxy, exceed the
votes, if any, cast against the proposal by members so entitled and voting
and the Central Government is satis fied, on an application made by the
Board of directors in this behalf, that the proposal is most beneficial to the
company.
(2) ……………………………….

(3) Nothing in this section shall apply –
(a) to a private company; or
(b) to the increase of the subscribed capital of a public company caused
by the exercise of an option attached to debentures issued or loans
raised by the company –
(i) to convert such debentures or loans into shares in the company, or
(ii) to subscribe for shares in the company :

Provided that the terms of issue of such debentures or the terms of such
loans include a term providing for such option and such term –

(a) either has been approved by the Cent ral Government before the issue
of debentures or the raising of the lo ans, or is in conformity with the
rules, if any, made by that Government in this behalf; and
(b) in the case of debentures or loans ot her than debentures issued to, or
loans obtained from, the Government or any institution specified by
the Central Government in this be half, has also been approved by a
special resolution passed by the company in general meeting before
the issue of the debentures or the raising of the loans.

(4) to (7) …………………………………………..……………………….”
A bare reading of section 81(1) makes it clea r that when it is proposed to increase the
subscribed capital of a company by allotm ent of further shares, the normal rule
referred to therein needs to be followed. Th is normal rule is that further shares must
be offered to the existing body of shareholders of the company in the same proportion
in which they already hold shares of th e company. The underlying object of this
normal rule is to maintain the balance of voting rights and control in the company. It
is for this reason that section 81(1) ma ndatorily requires that further shares shall be
offered to the existing shareholders in th e same proportion to the capital paid up on
those shares on the date of offer. Section 81(1A), however, carves out an exception to

7
the aforesaid normal rule and enables the comp any to offer further shares to a chosen
few who may or may not be its shareholders. When offer is made to this select group
of persons, the section requi res, as a condition precedent, that the general body of
shareholders must pass a special resolu tion in a general mee ting authorizing and
permitting the said allotment. A special resolution is one which is passed by a
majority of three fourth shareholders. Th e underlying object of this requirement is
that the shareholders who are going to waive their right and entitlement to such further
shares must agree to do so and if three fourth of them agree, that decision would bind
the entire body of shareholders. It is pertinent to note that when the normal rule as
aforesaid is resorted to, there is no requ irement for the shareholders to pass any
resolution, special or otherwise, because none of them is going to be deprived of the
further allotment. It is only when the comp any decides to deprive them of the further
allotment that a resolution from them is required.

The opening words of section 81(3) ma ke it clear that cases which fall under
this provision shall not be governed by section 81(1) and section 81(1A). A reading of
this provision makes it clear that it car ves out yet another cat egory/exception for a
preferential allotment to which section 81( 1) and section 81(1A) shall not apply.
Section 81(3) would apply where a company has raised loans or issued debentures and
those loans/debentures have a stipulation attached theret o that the lender will be
entitled to exercise an opti on to convert those loans/de bentures into shares or
subscribe to the shares of the company. Th e proviso then imposes further restrictions
requiring the terms of the loan to be approved by the Cent ral Government before the
raising of the loan or such terms have to be in conformity with the rules made by the
Central Government in that behalf and if the loan has been obtained from a person
other than the government or a specified in stitution a special resolution approving the
same has to be passed by the company in a ge neral meeting before the loan is raised.
Now coming to the case in hand, it is common ground between the parties that
the unsecured loans of SEPL, the promoter of the appellant do not meet the
requirements of section 81(3) of the Companies Act. This being so, the said provision
is not applicable. It is also not the case of either party that a preferential allotment of 8
shares has been made to a select group of persons under section 81(1A). It is the case
of the appellant and we agree with Mr. Modi that the present case falls squarely under
section 81(1) of the Companies Act. Shares have been offered by the appellant to all
the existing shareholders in the same proportion in which they held shares on the date
of the offer. In other words, the normal rule referred to above has been followed
which will not result in changing the bala nce of voting rights and control in the
company. It is not in dispute that SEPL held 71.19 per cent shares of the appellant on
the date of the offer and its entitlement under the rights issue works out to 4,19,25,000
shares for which it had to make the payment. It is also common case of the parties that
unsecured loans to the tune of ` 4160.89 lacs advanced by SEPL were lying in the
books of account of the appellant as on the date of offer. The unsecured loans were
payable on demand and SEPL could have demanded from the appellant the immediate
return of those loans and then paid the money back to it towards the price of the shares
allotted to SEPL in the right s issue. It did not go through this ritual and instead,
requested the appellant to adjust the amount of unsecured loans to wards the price of
the shares allotted to it. In other word s, SEPL requested and made payment to the
appellant by adjustment in the books of account. Payment by adjustment in the books
of account is a well recognized mode by a ll accounting standards and we find no fault
with this mode being adopted. All that SEPL has done is that it received shares in the
rights issue and made payment by adjust ment of the unsecured loans which were
payable on demand. In the strict sense of the term, it is not a conversion of a loan into
equity. The learned counsel for the Board pointed out that by making payment in this
manner, the promoter has converted its loans into equity which is not permissible and
that the debt equity ratio of the company has undergone a change. So what if the debt
equity ratio has altered. This is precisely what the appellant wanted. The debt equity
ratio has improved and this may enable it to get further loans from financial
institutions but this does not mean that th e promoter loses its right to make payment
for the shares by way of adjustment of its unsecured loans. The methodology adopted
was only a mode of payment for the shares received in the rights issue and since all the
necessary disclosures have been made by th e appellant in the offer document(s), we 9
are satisfied that in the circumstances of this case section 81(1) of the Companies Act
alone is applicable. In this view of th e matter we cannot uphold the direction issued
by the Board requiring the appellant not to adjust the unsecured loans advanced by the
promoter towards the price of the shares allotted in the rights issue.
For the view that we have taken, it is not necessary, in the circumstances of
this case, to decide the other issues raised by the learned counsel for the parties.
In the result, the appe al is allowed and the im pugned communication dated
February 8, 2011 in so far as it directs the appellant not to adjust the unsecured loans
of the promoters against allotment of shares in the rights issue set aside. There is no
order as to costs. Sd/- Justice N.K.Sodhi
Presiding Officer
Sd/-
P.K. Malhotra
Member

Sd/-
S.S.N. Moorthy
Member
6.6.2011
Prepared & Compared By: RHN

After we pronounced the order in the C ourt today, the learned counsel for the
respondent prays that we should stay the operation of our order for a period of 6 weeks
to enable the respondent Board to file an Appeal to the Supreme Court. No irreparable
loss is likely to be caused to the Board even if our order is reversed in Appeal. The
prayer is untenable and, therefore, declined.
Prayer for stay declined.
Sd/-
Justice N.K.Sodhi
Presiding Officer

                                     Sd/-    
S.S.N. Moorthy

6.6.2011 Member
Prepared & Compared By: Pmb

BEFORE THE SECURITIES APPELLATE TRIBUNAL
MUMBAI

                                                  Appeal No. 34 of 2011

Date of Decision: 6.6.2011
SRM Energy Limited
601, Pressman House,
70A, Nehru Road, C.T.S. No.76 & 87,
Vile Parle (East), Mumbai.

              …… Appellant

Versus

Securities and Exchange Board of India
SEBI Bhavan, Plot No. C-4A, G Block,
Bandra Kurla Complex, Bandra (East),
Mumbai.
Arihant Capital Markets Limited
3rd Floor, Krishna Bhavan,
67, Nehru Road, Vile Parle(East),
Mumbai. …… Respondents Mr. Pesi Modi, Advocate with Mr. Anant Updhayay, Advocate for the Appellant.
Mr. Shiraz Rustomjee, Advocate with Mr. Ajay Khaire, Advocate for
Respondent No.1.
None for Respondent no.2.
CORAM : Justice N. K. Sodhi, Presiding Officer
P. K. Malhotra, Member
S. S. N. Moorthy, Member
Per : Justice N. K. Sodhi, Presiding Officer

The appellant was incorporated as a public limited company in the year 1985
under the name and style of Hitkari Fibers Limited. Its shares are listed on the
Bombay Stock Exchange. Spice Energy Pvt. Ltd (for short SEPL) is another company
incorporated under the Companies Act, 1956 and promoted by the Rastogi family of
Delhi which owns more than 80 per cent shares in this company. Some time around
December, 2007, SEPL received a ‘Letter of Facilitation’ from the Government of
Tamil Nadu for setting up a coastal imported coal based Thermal Power Plant in 2
Cuddalore for 1000 MW capacity which was subsequently enhanced to 2000 MW in
December, 2008. SEPL then received all the regulatory clearances for the power
project. The Spice Energy Group which had promoted SEPL formed another private
limited company under the name and style of SRM Energy Pvt. Ltd. as a special
purpose vehicle for implementing the aforesai d power project. The total cost of the
project was 9,438 crores. Looking at the size of the investment required to implement the project and based on the interest evinced by certain strategic investors at that time, the Spice Energy group decided to implement the power project through a listed entity so as to provide the strategic investors with an exit option. The group also decided to channelize the investment th rough a Global Depository Receipt issue. SEPL then took over Hitkari Fibers Ltd. in March, 2008 by acquiring 71.19 per cent of its shares and the remaini ng 28.81 per cent shareholding is widely held by around 5,400 public shareholders. SEPL took over the management and control of the appellant which was then known as Hitkari Fibers Ltd. This was done after complying with the provisions of the Securities a nd Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regula tions 1997. At the time of the takeover, Hitkari Fibres Ltd. was incurring losses and its net worth had also been completely eroded. As against the paid up capital of 3.06 crores, its accumulated losses were
` 6.47 crores as on March 31, 2008. The shar es of Hitkari Fibres Ltd. were not
getting traded on the stock exchange fo r a long time and it had never declared
dividend. SEPL after taking over the company decided to discontinue with its then
existing business and focused only on the proposed power plant. After the takeover of
Hitkari Fibres Ltd. by SEPL, the special purpose vehicle formed for the purpose of
implementing the power project viz., SRM Ener gy Pvt. Ltd. was merged with Hitkari
Fibers Ltd. This was done in pursuance of a scheme of amalgamation framed under
sections 391 and 394 of the Companies Act. In terms of the scheme of amalgamation,
the name of the company was also changed from Hitkari Fibers Ltd. to its present
name i.e. SRM Energy Ltd which is now the appellant before us. As already observed
above, the funds for the proposed power pr oject had been planned through a Global
Depository Receipt issue which did not come through for reasons with which we are 3
not concerned. Due to the failure of th e Global Depository Receipt issue and the
negative net worth of the appellant compa ny, it was facing difficulty in arranging the
funds for the project. It was in these circumstances that SEPL, the promoter of the
appellant stepped in with it s funds in the interest of the appellant company and its
shareholders and kept lending its own funds from time to time as and when required
by the appellant for implementing the power project. As on August 12, 2010, SEPL
had lent to the appellant a sum of 4052.05 lacs which was standing in its books of account. We have on record a certificate from the statutory auditors of the appellant company showing that a sum of 4052.05 lacs was due to SEPL as unsecured loans
and this fact is not in dispute. It is also on record that as on December 31, 2010, a sum
of ` 4160.89 lacs was the amount of unsecured loans standing in the books of the
appellant company which amount had been advanced by SEPL.
With a view to mobilize further funds for the power proj ect, the appellant
company came out with a rights issue and decided to issue shares on rights basis to its
shareholders. On July 8, 2010 the board of directors of the appellant passed a
resolution deciding to issue shares on rights basis and sought the approval of the
shareholders by a resolution through postal ball ot. It was, inter alia, stated in the
notice that the rights issue was for funding th e implementation of the power project.
On August 13, 2010 the shareholders of the appellant passed a unanimous resolution
through postal ballot approving th e rights issue. Since SEPL, the promoter of the
appellant, was holding 71.19 per cent shares on the date of the rights issue, its
entitlement in that issue worked out to 4,19,25,000 shares amounting to 4192.50 lacs. As already noticed above, SEPL had already br ought in funds to the extent of 4052.05 lacs till August 12, 2010 which were shown as unsecured loans in the books
of the appellant. According to the appellant, there was an oral understanding between
it and the promoter (SEPL) at the time of providing funds from time to time that if and
when the appellant came out with a right s issue, the unsecured loans would be
adjusted against the share price. SEPL by its letter of August 13, 2010 authorised the
appellant company to adjust the unsecured loans hitherto provided to the appellant
towards its entitlement in the proposed right s issue making it clear that if there was 4
any short fall, the same would be subscrib ed by the promoter (SEPL). On August 17,
2010, the appellant company through its merchant banker filed with the Securities and
Exchange Board of India (hereinafter called the Board) a draft letter of offer for the
rights issue which was to be sent to the shareholders. The appellant company had
decided to issue rights shares in the ratio of 65 equity shares for every 10 fully paid up
equity shares held by an existing equity shareholder on the record date. It was
specifically mentioned in the draft letter of offer that the unsecured loans lying in the
books of the company and due to SEPL sha ll be adjusted towards the price of the
shares as per the entitlement of the latter. The draft letter of offer was sent to the
Board in terms of Regulation 6 of the Secu rities and Exchange Board of India (Issue
of Capital and Disclosure Requirements) Regulations 2009 (for short the Regulations).
On receipt of the letter of offer, the same was examined by the Board and the Assistant
General Manager, Corporation Finance Depa rtment, Division of Issues and Listing
acting on behalf of the Board informed the merchant banker that “You are advised to
ensure that unsecured loans of promoter and promoter group are not adjusted
against allotment of shares against thei r right entitlements and also against
shares to be allotted to them as a result of renunciation or unsubscribed portion”.
Feeling aggrieved by this direction, the appellant has come up in appeal.
We have heard the learned counsel for the parties who have taken us through
the record. The primary argument of Shri P.N. Modi learned counsel for the appellant
is that there is no provision in any law nor in the Regulations which prohibits the
adjustment of unsecured loans against the pric e to be paid for the shares allotted in
rights issue. He pointed out that SEPL which is the promoter of the appellant
company had been advancing loans from time to time which are shown in the books of
account of the appellant as unsecured loans wh ich could be adjusted against the price
to be paid by the promoter for the shares allotted in the rights issue. The argument is
that the unsecured loans due to the promoter could be treated as share application
money and the Board was not justified in dire cting the appellant not to make such an
adjustment. Learned counsel referred to cl ause (5)(VII)(G)(2) of part E of Schedule
VIII to the Regulations and contended that the same permits adjustment of money 5
brought in advance by the promoters which is deployed in the project towards their
entitlement in the rights i ssue. It was strenuously argue d by the learned counsel for
the appellant that the shares proposed to be allotted in accordance with the provisions
of section 81(1) of the Companies Act and that all the necessary disclosures having
been made, the impugned direction given by the Board was not called for. Mr. Shiraz
Rustomjee learned counsel for the Board, on the other hand, contended that the
unsecured loans advanced by the promoter ha d a condition attached thereto that they
could be converted into equity as and when the appellant came out with a rights issue
and since these loans do not comply with the stringent conditions prescribed by the
proviso to section 81(3) of the Companies Act, the loans of the promoter could not be
converted and the Board was right in gi ving such a direc tion in the impugned
communication. The argument is that only such loans can be c onverted into equity
which satisfy all the conditions of section 81(3) of the Companies Act including those
in the proviso thereto and the loans which do not satisfy all these conditions are not
convertible at all. Sin ce the answer to the rival contentions depends on the
interpretation of section 81 of the Companies Act, the relevant part thereof is
reproduced hereunder for ease of reference:-
“Further issue of capital
(1) Where at any time af ter the expiry of two years from the formation of a
company or at any time after the expiry of one year from the allotment of
shares in that company made for the first time after its formation, whichever is
earlier, it is proposed to increase the subscribed capital of the company by
allotment of further shares, then,-
(a) such further shares shall be offered to the persons who, at the date of the
offer, are holders of the equity sh ares of the compa ny, in proportion, as
nearly as circumstances admit, to the capital paid-up on those shares at that
date;
(b) the offer aforesaid shall be made by notice specifying the number of shares
offered and limiting a time not being less than fifteen days from the date of
the offer within which the offer, if not accepted, will be deemed to have
been declined;
(c) unless the articles of the company ot herwise provide, the offer aforesaid
shall be deemed to include a right ex ercisable by the person concerned to
renounce the shares offered to him or any of them in favour of any other
person; and the notice referred to in cl ause (b) shall contain a statement of
this right;
(d) after the expiry of the time specified in the notice aforesaid, or on receipt of
earlier intimation from the person to whom such notice is given that he
declines to accept the shares offered, the Board of directors may dispose of
them in such manner as they think most beneficial to the company. 6
Explanation : In this sub-section, “e quity share capital” and “equity shares”
have the same meaning as in section 85.

Provided that the terms of issue of such debentures or the terms of such
loans include a term providing for such option and such term –

The opening words of section 81(3) ma ke it clear that cases which fall under
this provision shall not be governed by section 81(1) and section 81(1A). A reading of
this provision makes it clear that it car ves out yet another cat egory/exception for a
preferential allotment to which section 81( 1) and section 81(1A) shall not apply.
Section 81(3) would apply where a company has raised loans or issued debentures and
those loans/debentures have a stipulation attached theret o that the lender will be
entitled to exercise an opti on to convert those loans/de bentures into shares or
subscribe to the shares of the company. Th e proviso then imposes further restrictions
requiring the terms of the loan to be approved by the Cent ral Government before the
raising of the loan or such terms have to be in conformity with the rules made by the
Central Government in that behalf and if the loan has been obtained from a person
other than the government or a specified in stitution a special resolution approving the
same has to be passed by the company in a ge neral meeting before the loan is raised.
Now coming to the case in hand, it is common ground between the parties that
the unsecured loans of SEPL, the promoter of the appellant do not meet the
requirements of section 81(3) of the Companies Act. This being so, the said provision
is not applicable. It is also not the case of either party that a preferential allotment of 8
shares has been made to a select group of persons under section 81(1A). It is the case
of the appellant and we agree with Mr. Modi that the present case falls squarely under
section 81(1) of the Companies Act. Shares have been offered by the appellant to all
the existing shareholders in the same proportion in which they held shares on the date
of the offer. In other words, the normal rule referred to above has been followed
which will not result in changing the bala nce of voting rights and control in the
company. It is not in dispute that SEPL held 71.19 per cent shares of the appellant on
the date of the offer and its entitlement under the rights issue works out to 4,19,25,000
shares for which it had to make the payment. It is also common case of the parties that
unsecured loans to the tune of ` 4160.89 lacs advanced by SEPL were lying in the
books of account of the appellant as on the date of offer. The unsecured loans were
payable on demand and SEPL could have demanded from the appellant the immediate
return of those loans and then paid the money back to it towards the price of the shares
allotted to SEPL in the right s issue. It did not go through this ritual and instead,
requested the appellant to adjust the amount of unsecured loans to wards the price of
the shares allotted to it. In other word s, SEPL requested and made payment to the
appellant by adjustment in the books of account. Payment by adjustment in the books
of account is a well recognized mode by a ll accounting standards and we find no fault
with this mode being adopted. All that SEPL has done is that it received shares in the
rights issue and made payment by adjust ment of the unsecured loans which were
payable on demand. In the strict sense of the term, it is not a conversion of a loan into
equity. The learned counsel for the Board pointed out that by making payment in this
manner, the promoter has converted its loans into equity which is not permissible and
that the debt equity ratio of the company has undergone a change. So what if the debt
equity ratio has altered. This is precisely what the appellant wanted. The debt equity
ratio has improved and this may enable it to get further loans from financial
institutions but this does not mean that th e promoter loses its right to make payment
for the shares by way of adjustment of its unsecured loans. The methodology adopted
was only a mode of payment for the shares received in the rights issue and since all the
necessary disclosures have been made by th e appellant in the offer document(s), we 9
are satisfied that in the circumstances of this case section 81(1) of the Companies Act
alone is applicable. In this view of th e matter we cannot uphold the direction issued
by the Board requiring the appellant not to adjust the unsecured loans advanced by the
promoter towards the price of the shares allotted in the rights issue.
For the view that we have taken, it is not necessary, in the circumstances of
this case, to decide the other issues raised by the learned counsel for the parties.
In the result, the appe al is allowed and the im pugned communication dated
February 8, 2011 in so far as it directs the appellant not to adjust the unsecured loans
of the promoters against allotment of shares in the rights issue set aside. There is no
order as to costs. Sd/- Justice N.K.Sodhi
Presiding Officer
Sd/-
P.K. Malhotra
Member

Sd/-
S.S.N. Moorthy
Member
6.6.2011
Prepared & Compared By: RHN

                                     Sd/-    
S.S.N. Moorthy

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SRM Energy Limited vs sebi appeal no 34 of 2011 sat order dated 6 june 2011

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