In an important ruling, the Securities and Exchange Board of India has said shares issued upon conversion of loan into equity shall not attract the provisions of Sebi norms on preferential allotment.

Sebi today ruled that, "If the shares are issued in compliance with Section 81(3) of Companies Act, 1956, pursuant to conversion of loans as per loan agreement signed before or after August 4, 1994, they do not come under the purview of Chapter XIII of the SEBI (Disclosure and Investor Protection) Guidelines, 2000."

The Sebi ruling came in response to a reference made by Essar Steel relating to the corporate debt restructuring (CDR) that has been recently approved by banks and financial institutions.

Essar sought a ruling on whether conversion of loan into equity would require compliance with the guidelines for preferential allotments.

This query was raised by the company "considering that the conversion of loan into equity shares is being proposed pursuant to the recently approved CDR package and not pursuant to the event of default called upon by the lenders under the loan agreement."

The company also enquired if the conversion of loans represented by loan agreements after August 4, 1994, into equity will also be covered by the guidelines.

The company, in its letter to the securities watchdog, said: "The Sebi guidelines for preferential allotment covers only the allotment made under section 81 (1A) of the Companies Act, 1956.

"It does not specifically cover the allotment made under Section 81(3) of the Companies Act. This means that the allotment under section 81(3) can be made without complying with the requirement of Sebi guidelines.

"However, such allotments should also fall under purview of the Sebi guidelines for preferential issues as the non applicability would adversely affect the interest of the existing shareholders of the company and it is also against the letter and spirit of the Sebi guidelines, which are specifically made for protecting the interest of shareholders at large."

The company requested Sebi to clarify specifically whether allotment under Section 81(3) will require the compliance of the Sebi guidelines for preferential allotment.

With respect to the compliance with Section 81(3) of Companies Act, Sebi clarified that "where the original loan agreement was approved by the central government under section 81(3) - any modification pursuant to the CDR package would not be deemed to be in conformity with section 81(3), unless fresh approval of the central government is taken under that section subsequent to the modification."

"Where the original loan agreement was in conformity with the public companies Rules, 1977 any modification pursuant to the CDR package would be deemed to be in compliance with section 81(3), if the agreement continues to be in compliance with the said rules after the modification."

Sebi's clarification has also said that if the proposed conversion does not comply with section 81(3) of Companies Act, a resolution would have to be passed under section 81(1A) and Sebi's DIP guidelines would also have to be complied with.