The Companies Act, 2013 first time came up with the new provision of converting the loan into equity pursuant to Section 62 (3) of the Companies Act, 2013.
This section provides an option to Companies to convert their loan into equity subject to the mandatory condition that such loan is attached with an option to convert it to equity at some future period of time and such option has been approved by shareholders through a special resolution.
Thus only such loan can be converted which has an option to convert into equity and special resolution has been passed in that respect.
If a company has taken any unsecured loan from its directors and wants to convert such unsecured loan into equity at some future period of time, then it has to ensure to enter into debt conversion agreement with such directors at the time of accepting such loan and also to pass a special resolution.
Further, the Company shall get any declaration from such director/relative of a director pursuant to Rule 2(c) (viii) of the Companies (Acceptance of Deposits) Rules, 2014 stating that such amount is not being given out of borrowed funds and the same is disclosed in the board report.
The procedure for conversion of unsecured loan into equity:
A. Compliance at the time of taking a loan
1. Hold a Board Meeting for :
- For accepting a loan with an option to convert it to equity in future.
- To fix time, date and place of Extra Ordinary General Meeting.
- To approve the draft notice along with Explanatory Statement of Extra Ordinary General Meeting.
2. Hold Extra Ordinary General Meeting and pass a special resolution for accepting the loan with an option to convert it to equity in future and giving authority to enter into loan conversion agreement.
3. Execute a loan conversion agreement between the company and lenders.
4. File form MGT-14 within 30 days of passing the special resolution.
B. Compliance at the time of converting the loan to equity
- Hold a Board Meeting and pass a resolution for allotment of shares by converting the loan to equity.
- Finalize list of allottees to whom the allotment is to be made pursuant to such conversion.
- File Form MGT-14 for filing board resolution.
- File Return of Allotment in Form PAS-3 within 30 days of passing board resolution.
Advantages of converting a loan to equity
- No cash exchange: Conversion eliminates the need for immediate cash outflow, as no cash is exchanged in the debt-to-equity swap.
- Increased cash flow: Converting debt to equity reduces liabilities, freeing up cash flow for other purposes.
- Avoids financial resource scarcity: The conversion helps the company avoid a shortage of financial resources by addressing debt obligations without requiring immediate cash payment.
The author can also be reached at csneharedekar@gmail.com
Disclaimer: Please note that the above article is based on the interpretation of related laws, which may differ from person to person and is not legal advice.
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