Conversion of Loan into Equity:

Under the Companies Act, 2013

Picture this: a company, in its quest for financial sustenance, may find
solace in loans from its director, their kin, or even other corporate entities.
These funds serve myriad purposes, from greasing the wheels of
day-to-day operations to amplifying existing infrastructures. Now, here's
the kicker: while obligated to settle its debts within agreed-upon terms,
this company has a sneaky little ace up its sleeve. Instead of the mundane
ritual of repayment, it can charm its lenders by offering to morph those
loans into shares – a sort of financial shape-shifting, if you will. And guess
what?

It's all legit, courtesy of Section 62(3) of the Companies Act of 2013.

Talk about turning debt into dividends, right?

(Section 73(2) of the Companies Act, 2013 read with

Companies (Acceptance of Deposits) Rules, 2014) “Loan
Can the director
received from the Directors of the Company shall be
or their relative
considered as Exempted Deposit.”
give a loan to the
company?
Loan accepted by a private limited company from its
directors or their relatives is allowed (out of own fund)
and is considered as an exempt category deposit.
Can the Rule 3 of Companies (Acceptance of Deposits) Rules,
Shareholders 2014 , restricts company from accepting or renewing
give loans to a deposit from its members if the amount of such deposits
Company? together with the amount of other deposits outstanding
as on the date of acceptance or renewal of such deposits
exceeds 35% [thirty-five per cent] of the aggregate of the
Paid-up share capital, free reserves and securities
premium account of the company.

Notification issued by MCA dated June 13, 2017 exempts

 Private Limited Companies from the restriction of
accepting deposit only up to 35% from its members and
they can accept it beyond 35% but subject to the
following conditions:
i. The amount of deposit should not exceed 100% of
the aggregate of the paid up share capital, free
reserves and securities premium account; or
ii. It is a start-up, for five years from the date of its
incorporation; or
iii. which fulfills all of the following conditions, namely:
-
(a) Which is not an associate or a subsidiary
company of any other company;
(b) The borrowings of such a company from banks
or financial institutions or any Body corporate
is less than twice of its paid-up share capital or
fifty crore rupees, whichever is less; and
(c) such a company has not defaulted in the
repayment of such borrowings subsisting at
the time of accepting deposits under section
73

Provided also that all the companies accepting deposits

shall file the details of monies so accepted to the Registrar
in Form DPT-3.
Limits of Borrowings & Approvals required, if any

Pursuant to MCA Notification dated June 05, 2015, the provisions of

Section 180 of the Companies Act, 2013 is not applicable to the private
limited Companies.

Sections Requirements

This section states that The Board of Directors of a

company shall exercise the Borrowing powers only with the
Section 180 consent of the company by a special resolution where the
(1) (c) of the money to be borrowed, together with the money already
Act, 2013 borrowed by the company will exceed aggregate of its
paid-up share capital, free reserves and securities
premium, apart from temporary loans obtained from the
company’s bankers in the ordinary course of business.

Every special resolution passed by the company in general

meeting in relation to the exercise of the powers referred
Section
to in clause (c) of sub-section (1) shall specify the total
180(2)
amount up to which monies may be borrowed by the Board
of Directors.

No debt incurred by the company in excess of the limit

imposed by clause (c) of sub-section (1) shall be valid or
Section 180
effectual, unless the lender proves that he advanced the
(5)
loan in good faith and without knowledge that the limit
imposed by that clause had been exceeded
Section 62(3) under the Companies Act of 2013
Groundbreaking shift in the financial landscape.

The introduction of Section 62(3) under the Companies Act of 2013

marked a groundbreaking shift in the financial landscape. This provision
allows companies to metamorphose loans into equity, but with a quirky
catch. Only loans that come with an in-built option for future equity
conversion, approved by shareholders through a special resolution, can
take this magical transformational journey.

Now, let's delve into the spellbinding process of converting these loans.
Suppose a company has borrowed an unsecured loan from its directors
and dreams of turning it into equity down the line. To make this
enchantment happen, it must first forge a debt conversion agreement with
said directors, sealing the pact. Then, through the mystical power of a
special resolution, the company can set the wheels in motion for the
conversion.

But wait, there's more! Before the magic unfolds, the company must seek a
declaration from the director or their kin, as per Rule 2(c)(viii) of the
Companies (Acceptance of Deposits) Rules, 2014. This declaration is like a
potion, ensuring that the borrowed sum isn't conjured from thin air but has
a tangible source i.e. such amount is not being given out of borrowed
funds and the same is disclosed in the board report.

And thus, through this bewitching procedure, loans are transmuted into
equity, weaving a tale of financial alchemy that dances between the realms
of loans and shares.
Compliances to be undertaken at the time
of taking loans
Compliances to be undertaken at the time of
Converting loans to Equity
Benefits and Drawbacks:

Transforming loans into shares presents a tantalizing array of benefits for

both companies and lenders alike. For companies, this maneuver provides a
convenient escape from the burdens of debt repayments, potentially
bolstering their financial metrics in the process. Meanwhile, lenders stand to
gain a foothold in the company's ownership structure, forging a symbiotic
relationship wherein their fortunes are intricately tied to the company's
prosperity.

Yet, amid the allure of these advantages, it is crucial to cast a discerning eye
on the potential pitfalls lurking in the shadows. The conversion process may
cast a spell of dilution upon existing shareholders, diminishing their
ownership stakes and potentially stirring unrest within the company's ranks.
Additionally, the mercurial nature of equity ownership introduces an element
of unpredictability for lenders, as they navigate the turbulent waters of
market fluctuations and volatility.

Thus, while the alchemy of converting loans into shares may promise riches,
it is prudent for both companies and lenders to tread carefully, weighing the
glittering rewards against the shadows of potential risks. After all, in the
realm of finance, every enchantment carries its own set of enchantments
and perils.
Conclusion

Converting loans into shares stands as a strategic financial maneuver, but it

demands meticulous scrutiny and compliance with legal and regulatory
frameworks. To embark on this journey successfully, one must grasp the
benefits and drawbacks, meticulously weigh practicalities, and seek expert
guidance.

Through such diligent navigation of complexities, companies and lenders

can unlock the unique advantages inherent in loan-to-share conversions
while effectively managing associated risks. In essence, it's a delicate dance
where careful steps pave the way to financial opportunity and compliance.
Get in touch with us

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