Dematerialisation of Shares of Unlisted Companies

Dematerialisation of shares refers to the process of converting physical share certificates into electronic form. This transformation replaces paper-based ownership with digital records maintained in a demat account. Over time, dematerialisation has become a central feature of India’s securities market, ensuring greater transparency, efficiency and security.

While dematerialisation was initially associated with listed companies and stock market transactions, the regulatory framework has extended its scope to unlisted companies as well. The introduction of the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 marked a significant shift by making dematerialisation mandatory for unlisted public companies.

This article explains the concept, legal framework, procedure, rules and implications of dematerialisation of shares in unlisted companies in a structured and detailed manner.

Concept of Dematerialisation of Shares of Unlisted Companies

Dematerialisation involves converting physical share certificates into electronic records. Traditionally, shareholders received paper certificates as proof of ownership. These certificates were prone to risks such as loss, theft, damage or forgery.

Under the dematerialised system, ownership of shares is recorded electronically in a demat account maintained with a depository. In India, depositories such as National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) perform this function.

The shift from physical to electronic form has simplified the process of holding, transferring and managing securities. It aligns the securities market with modern digital practices and reduces operational inefficiencies.

Legal Framework Governing Dematerialisation of Unlisted Companies

The dematerialisation of shares of unlisted companies is primarily governed by the Companies Act, 2013 and the Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018. These rules came into force on 2 October 2018.

The Government of India introduced these provisions to ensure that all securities issued by unlisted public companies are held in dematerialised form. The requirement applies not only to equity shares but also to other securities such as debentures.

Additionally, the dematerialisation process must comply with the provisions of the Depositories Act, which governs the functioning of depositories and related intermediaries.

Mandatory Nature of Dematerialisation

Dematerialisation is mandatory for unlisted public companies in certain contexts. Shareholders holding physical shares are required to convert them into electronic form before undertaking specific transactions.

The regulatory framework mandates that:

• All new securities must be issued only in dematerialised form. This ensures that no further physical certificates are introduced into the system.
• Existing physical securities must be converted into electronic form to enable smooth corporate actions and compliance.
• Shareholders must hold securities in demat form for transfer or subscription of additional shares.

This requirement ensures uniformity in record-keeping and enhances transparency in ownership structures.

Applicability to Different Types of Securities

The obligation to dematerialise is not limited to equity shares. It extends to all forms of securities issued by unlisted companies, including:

• Equity share capital
• Preference shares
• Debentures and other debt instruments

This broad applicability ensures that all forms of ownership and financial instruments are integrated into the electronic system.

Rules Relating to Share Capital

The regulatory framework imposes specific obligations on unlisted companies in relation to their share capital.

Issue of Securities in Dematerialised Form

Unlisted companies are required to issue shares, debentures and other securities only in dematerialised form. This eliminates the possibility of future physical certificates being issued.

Conversion of Existing Securities

Where securities were previously issued in physical form, companies must facilitate their conversion into electronic form. This requires coordination with depositories and adherence to prescribed procedures.

Compliance with Depositories Act

The dematerialisation process must comply with the Depositories Act. This ensures that all transactions are carried out through recognised depositories and authorised intermediaries.

Restrictions on Corporate Actions

Unlisted companies are restricted from undertaking certain corporate actions unless all securities are fully dematerialised. These include:

• Initial Public Offer (IPO)
• Issue of bonus shares
• Buyback of shares or debentures
• Preferential allotment to promoters or directors

These restrictions ensure that corporate actions are carried out in a transparent and standardised electronic environment.

Payment of Fees

Before undertaking such transactions, companies must pay the required fees to the depository and the share transfer agent. Only after fulfilling these obligations can the transactions proceed.

Rules Relating to Transfer of Shareholding

The transfer of shares in unlisted companies is closely regulated under the dematerialisation framework.

Mandatory Dematerialisation Before Transfer

Where a shareholder holds shares in physical form and intends to transfer them, the shares must first be dematerialised. This ensures that all transfers occur in electronic form, reducing delays and disputes.

Allotment of Shares

Before allotting new shares to an applicant, the company must verify whether the applicant already holds shares in physical form. If so, the company must inform the applicant to convert those shares into electronic form before allotment.

Communication with Shareholders

Companies are required to inform shareholders and debenture-holders about the dematerialisation of securities. The communication must include the International Securities Identification Number (ISIN), which uniquely identifies the securities.

The ISIN plays an important role in ensuring that securities can be easily tracked and recognised in the electronic system.

Procedure for Dematerialisation of Shares 

The process of dematerialisation follows a structured mechanism involving multiple intermediaries.

Opening a Demat Account

The shareholder must first open a demat account with a Depository Participant (DP), such as a bank or broker. This account serves as the repository for electronic securities.

Submission of Dematerialisation Request

The shareholder submits a Dematerialisation Request Form (DRF) along with physical share certificates to the DP. The form contains details of the securities and ownership.

Verification Process

The DP forwards the request to the Registrar and Transfer Agent (RTA). The RTA verifies the details of the certificates with the company’s records to ensure authenticity.

Cancellation of Physical Certificates

Upon successful verification, the physical certificates are cancelled. This step prevents duplication or misuse of certificates.

Credit of Electronic Shares

The depository credits the corresponding number of shares to the shareholder’s demat account. The shareholder can then access and manage the shares electronically.

Role of Depositories and Intermediaries

Dematerialisation involves several intermediaries who play distinct roles.

Depositories

Depositories such as NSDL and CDSL act as central record-keeping institutions. They maintain electronic records of ownership and facilitate transfers.

Depository Participants

Depository Participants serve as intermediaries between investors and depositories. They handle account opening, submission of requests and communication.

Registrar and Transfer Agent

The RTA verifies the authenticity of certificates and ensures that the conversion process is accurate and compliant.

The coordinated functioning of these entities ensures the efficiency and reliability of the dematerialisation process.

Rules Relating to Depositories

Unlisted companies must comply with certain requirements when dealing with depositories.

Payment of Fees

Companies must pay prescribed fees to the depository and share transfer agent at the time of applying for dematerialisation. The fees are calculated in accordance with the Depositories Act.

Security Deposit

Companies are required to create a security deposit equal to twice the fees paid. This deposit is maintained for a specified duration as agreed with the depository.

Grievance Redressal

Shareholders may face issues relating to dematerialisation or transactions. Such grievances can be addressed through the Investor Education and Protection Fund Authority, which provides a mechanism for resolution.

Dematerialisation in Private Companies

Dematerialisation is not mandatory for private companies. However, private companies may opt for dematerialisation to improve efficiency and transparency.

For adopting dematerialisation, private companies must amend their Articles of Association. The process is governed by the Companies Act, 2013.

Although optional, many private companies prefer dematerialisation due to its operational advantages and ease of managing shareholding.

Advantages of Dematerialisation

Dematerialisation offers several benefits for companies and shareholders.

• Improved Safety: Electronic records eliminate risks associated with physical certificates such as loss, theft, damage and forgery. This enhances the overall security of ownership.
• Ease of Management: Shares held in demat form can be managed easily through online systems. Record-keeping becomes simpler and more organised.
• Faster Transactions: Transfer and settlement of shares are completed quickly in electronic mode. This reduces delays that were common in physical transfers.
• Cost Efficiency: Dematerialisation reduces costs associated with stamp duty, printing and handling of physical certificates. Over time, it results in financial savings.
• Transparency: Electronic records provide clarity in ownership and reduce the chances of disputes. This contributes to better corporate governance.
• Facilitation of Listing: Dematerialisation enables companies to list their shares on stock exchanges. Listing enhances the credit-worthiness of the company and allows easier access to capital.

Disadvantages and Challenges

Despite its benefits, dematerialisation also involves certain challenges.

• Dependence on Technology: The system relies heavily on technology. Technical failures, system crashes or cyber threats may disrupt operations.
• Maintenance Costs: Shareholders are required to pay account maintenance charges. These costs may be significant for small investors.
• Accessibility Issues: Individuals in areas with limited internet access or low technological awareness may face difficulties in managing demat accounts.
• Dependence on Intermediaries: The process involves multiple intermediaries such as DPs and depositories. Errors or inefficiencies on their part may cause inconvenience.

Conclusion

Dematerialisation of shares represents a fundamental shift from paper-based ownership to electronic systems. For unlisted companies, the regulatory framework has made this transition essential for ensuring transparency, efficiency and compliance.

The Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018 have played a crucial role in extending the benefits of dematerialisation to unlisted public companies. By mandating electronic holding of securities, the framework reduces risks, simplifies processes and enhances the credibility of companies.