Private Equity funds, domestic and multi-national, have become major players in the Indian real estate market, investing tens of thousands of crores. While Blackstone and Brookfield have hitherto been largest foreign investors in Indian real estate, a gamut of Japanese Private Equity giants are also making waves. Heavyweight Japanese Corporations such as Mitsui Fudson, Mitsubishi Corporation, Sumitomo Corporation and Genkai Capital too have made big-ticket investments in Indian metro cities.
Sumitomo’s purchase of 3 acres in Mumbai’s tony BKC business district for INR 2238 crore. Even Softbank, much ridiculed for the failed WeWork IPO, has adopted a tier-2 city investment strategy, beginning with Punjab.
Applicability of Section 42 of Companies Act, 2013 – Invitations to subscribe to a maximum of fifty persons
When a private equity major chooses to invest in an Indian real estate project, a gamut of statutes, rules and regulations apply, beginning with the Companies Act of 2013. Section 42 of the Companies Act permits a company to make private placement of shares through issuance of a ‘private placement offer letter’. It provides that the invitation to subscribe to securities (shares/debentures etc.) can be made to a maximum of fifty persons. This limit of fifty would exclude Qualified Institutional Buyers and company employees.
Therefore, if a developer company seeks to raise capital from a private equity fund, he can issue an invitation for subscription to shares under Section 42 of the Companies Act, 2013. Once he issues this invitation, it will be treated as a public offer under the law and provisions of the SEBI Act, 1992 and the Securities Contracts (Regulation) Act, 1956 will also require to be complied with.
Cash payment prohibited
Once the invitation has been issued and interested parties apply for allotment of shares, they can make payment of application money either through cheque, demand draft or official banking channels. Cash payment is prohibited.
Once applications are received from the invited parties along with the monies, the developer company will have to allot the shares or securities within sixty days of receipt of the same. If it fails to do so, then the entire monies received will have to be refunded by the developer company along with interest at the rate of twelve per cent per annum, applicable from the expiry of the sixty-day period.
Offer for private placement to be communicated only to specific intended recipients and no one else – No offers or subscriptions to be considered from third parties
Section 42(7) of the Companies Act states that any offer inviting bids or subscriptions by way of private placement can be made only to those persons whose names have been listed beforehand. This means that the Company must prepare the list of investment funds, sovereign wealth funds and business houses to whom it intends to circulate the offer. Each offer for private placement should be addressed personally to each recipient. It cannot be generally worded or addressed to the public at large.
Once the offer for private placement has been communicated, the Company has maintained a complete record of all recipients of such communication. This record must be filed with the Registrar of Companies through the MCA21 e-filing system. The e-filing must be effected within thirty days of communication of the offer for private placement to the intended beneficiaries.
Prohibition of public advertisements
Under Section 42(8) of the Companies Act, no company, including real estate developers, shall publish any public advertisements inviting applications for shares subscription from the public. The offer for private placement can be communicated to a select group of investors, such as sovereign wealth funds, venture capital firms etc. Under no circumstances should any invitation be extended to members of the public to solicit investments from them.
Filing of return of allotment
Once a developer company allots shares in a project through private placement, it must file a return of allotment with the Registrar of Companies. Such return of allotment would contain a list of security holders along with their names, address and number of shares allotted to each. All filings under the Act are online in nature via the MCA21 website.
Stiff penalties for violation
Any developer company that accepts private equity investment in violation of Section 42 can be punished with a monetary penalty of up to two crore rupees. In addition, all monies or investments raised will have to be refunded within thirty days.
Legal disputes involving real estate private equity funds – Case studies
The most prominent case pertaining to illegal raising deposits from the public is that of Sahara Real Estate Corporation. This case unearthed the massive lacunae in the erstwhile Companies Act of 1956, which enabled Sahara India to raise over INR 19,400/- crore from members of the public. The company effectively bypassed the old law and exploited every possible loophole contained therein. The ensuing legal battle, which reached its crescendo in the Supreme Court, precipitated the long-sought amendments in the Companies Act, 2013.
In this case, Sahara India Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment Corporation Limited (SHICL) issued unsecured optionally fully convertible debentures (OFCDs) amounting to INR 17,400/- crore. This amount was raised from over 2 crore public investors. When SEBI received information of these activities, it issued Show Cause Notices (SCN) to SIRECL and SHICL under Section 73 of the erstwhile Companies Act, 1956. In these notices SEBI alleged that both companies were effectively conducting a public issue in an illegal manner, making them liable for prosecution.
In their defence, the two Sahara companies contended that they were unlisted companies and outside the jurisdiction of SEBI. Further the funds were raised by private placement of Optionally Fully Convertible Debentures (OFCDs), which were outside the definition of “securities” under SEBI regulations.
The Supreme Court of India in its judgment passed scathing remarks against Sahara. It held that the companies indulged in a pre-planned attempt to bypass the regulatory and administrative authority of SEBI. It directed both Sahara Companies to refund the entire monies collected from investors by depositing the same with SEBI. Interest would also be applicable at 15 per cent on the same.
The Companies Act of 2013 has indeed streamlined and regulated the process of private placement of shares by companies. While developers are at liberty to raise monies from private equity funds, Section 42 safeguards public interest by ensuring no unsolicited offers are made to them. Further the emergence of Real Estate Investment Trusts (REITs) now offers the public a vehicle to invest directly in select real estate projects coming within their ambit.
The Sahara India case is a dark reminder of the financial crisis that results in the absence of regulatory oversight. While the Companies Act of 2013 may not be a final fix, it is indeed a step forward in regulating a sector that has hitherto been perceived as the ‘wild west’ of the Indian economy.
By Aditya Pratap,
Advocate, Bombay High Court
About the Author
Aditya Pratap is a practising lawyer in the Bombay High Court, specialising in real estate and finance litigation. Questions may be addressed to him at aditya@adityapratap.com. For further information one may visit his website at adityapratap.in or his YouTube Channel.
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