The Indian Premier League (“IPL”) has been mired in controversies over the award of the Kochi franchise. The Rendezvous Consortium won the Kochi IPL franchise for $ 333 million last month. The IPL chairman and commissioner Lalit Modi revealed the shareholder ownership of the Kochi franchisee last week. Mr. Modi claimed that Rendezvous Sports World Pvt. Ltd., a member of the consortium, had received 25% free equity, of which Ms. Sunanda Pushkar reportedly received 18%, valued at nearly Rs 70 crore. This became a political issue for Member of Parliament Shashi Tharoor due to his relationship with Ms. Pushkar and Mr. Tharoor subsequently resigned as a cabinet minister.
A critical question became Ms. Pushkar’s sweat equity. Mr. Tharoor stated that Rendezvous had issued sweat equity to its associates, ie. Ms. Pushkar in lieu of a salary as this is “common practice across the world for start up ventures”.
What are sweat equity shares and how are they valued and issued?
Sweat Equity Shares mean equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing know how or making available rights in the nature of intellectual property rights or value additions, or by whatever name called.
Although Mr. Tharoor is correct that sweat equity shares are often used in start up ventures, under Indian law there are specific regulations governing the issuance of sweat equity shares.
Section 79A(c) of the Companies Act, 1956 (1 of 1956) (the “Companies Act”), states that a company may issue sweat equity shares only after completing a year since its incorporation. According to press reports, Rendezvous Sports was incorporated only in August 2009 and therefore a year has not elapsed. The logic behind the one year requirement presumably is that a person must have worked in a company for at least a year before being given any sweat equity.
In addition, the Ministry of Company Affairs has notified the Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003 (the “Sweat Equity Rules”) the provisions of which must be complied with by an Unlisted Company proposing to issue sweat equity shares.
Pursuant to the Sweat Equity Rules, the total sweat equity shares issued during a year should not exceed 15% of the total paid-up equity share capital in a year or shares of the value of Rs.5 crores, whichever is higher. However, if the ceiling is to be exceeded, prior approval of the Government of India (“GoI”) must be obtained. The price of sweat equity shares shall be at a fair price calculated by an independent valuer and the shares shall be locked in for a period of 3 years from the date of allotment. Further, the issue of sweat equity shares should be approved by members by means of a special resolution and a separate resolution should be passed if the shares to be issued (during any one year, to identified employees and promotes) is equal to or exceeds 1% of the issued capital (excluding outstanding warrants and conversion) as stood on the day of grant of sweat equity shares.
It is also to be noted that, if shares are to be issued for consideration other than cash, the valuation of intellectual property or know-how shall be carried out by a valuer. Such valuer shall consult experts considering the nature of industry and the nature of property or value addition. The valuer shall submit a valuation report giving justification and a copy of the valuation report should also be sent to shareholders along with the notice of the general meeting. The notice of the general meeting should also give justification for issue of shares for consideration other than cash. The amount of shares shall be treated as part of the managerial remuneration if they are issued to any director or manager and they are issued for non-cash consideration which does not take the form of asset which can be carried forward in the balance sheet.
Current Debate/Multiple Discrepancies:
It is unclear from the press reports whether any of the above regulations regarding the issuance of sweat equity shares to Ms. Pushkar have been complied with and therefore the shares may have been incorrectly allotted to Ms. Pushkar.
There appear to be multiple discrepancies:
1. Sweat equity shares can only be issued a year after a company has been incorporated; it has not been a year since Rendezvous has been incorporated.
2. Sweat equity shares may not exceed 15% of the share capital and may not exceed Rs. 5 crores in value; Ms. Pushkar appears to have received 18% equity at a valuation of Rs. 70 crore
In order to go above the shareholding percentage and valuation ceilings, prior government approval must be obtained; there appears to be no prior government approval.
3. Issue of sweat equity needs to be passed by a special resolution; no confirmation that such a resolution was passed.
4. In addition, pursuant to section 77A of the Companies Act, there are specific regulations regarding the buyback of shares including where the company must get the resources for the buy back and objectives, conditions and procedures for the buy back of shares. All of these provisions must be complied with in order for the company to buy back Ms. Pushkar’s shares.
As mentioned above, there seem to multiple discrepancies with the issuance of sweat equity in this case. The time periods do not have appeared to be complied with and no government permissions or valuation reports seem to have been obtained. All of this seems to add to the murkiness of the situation. The sweat equity shares may just be the tip of the iceberg with respect to the IPL as matters continue to unfold.
Sweat equity shares are typically used to encourage entrepreneurs to form start-up ventures. However, there are specific regulations in India which must be followed regarding the issuance of sweat equity shares. It is part of a wider discussion as to whether the regulations are too onerous for start-up companies but in this case it seems that there are some valid reasons for checks and balances in the system.
(Shantanu Surpure was assisted by Nisha Mallik and Varun Shah, Associates, Sand Hill Counsel).