By Neha Sinha & Radhika Malpani

November 30, 2021

The Securities and Exchange Board of India (SEBI)constituted an Expert Group in October 2020 to revisit and recommend policy changes to the existing frameworkfor share-based employee benefits and sweat equity shares under the SEBI (Share Based Employee Benefits) Regulations, 2014 (the ‘SBEB Regulations’) and the SEBI (Issue of Sweat Equity) Regulations, 2002 (the ‘SE Regulations’) (collectively, the ‘Erstwhile Regulations’). Based on the recommendations received, SEBI issued the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (the ‘New Regulations’), which came into force with effect from 13 August 2021. 

The changes introduced by the New Regulations are primarily aimed at making the framework more employee-friendly, while allowing listed companies the flexibility to design share-based employee benefit (‘SBEB’) plans that are best suited to their specific needs. The key changes introduced by the New Regulations are discussed below.

Changes impacting the employees and grantees:

The New Regulations seek to establish a framework that will allow a larger number of employees to participate in a company’s growth story and for a longer period of time. A multi-pronged approach, as detailed below, has been used to achieve this goal.

  • Eligibility criteria:The requirements for participation in SBEB plans and issue of sweat equity shares have been relaxed under the New Regulations. SEBI has removed the requirement that only permanent employees are eligible to participate in employee benefit plans or be issued sweat equity shares.

In the case of SBEB plans, any employee designated by the company and working exclusively for the company is eligible to participate in its SBEB plan. Additionally, it has been specified that a non-executive director, who is not a promoter or part of the promoter group is eligible to participate in SBEB plans.

Furthermore, under the SBEB Regulations only employees of subsidiaries and holding companywere eligible to participate in an SBEB plan of a listed company (a ‘Granting Company’). Under the New Regulations, employees of associate companies are also eligible to participate in a Granting Company’s SBEB plan.

Unlike under the previous regime, listed companies can now establish common employee benefit plans for employees across all its group companies, as opposed to only its holding company and subsidiaries.

  • Suspension of minimum vesting and lock-in period:In June 2020, SEBI suspended the minimum vesting period (under stock option schemes and stock appreciation rights (‘SARs’)schemes) in case of death of an employee (for any reason) and mandated vesting of all options, SARs, and other benefits granted till such date in the legal heir or nominee of such employee with effect from the date of death of such employee. This relaxation was granted retroactively with effect from 01 April 2020.

These relaxations have been codified in the New Regulations. Furthermore, the New Regulations provide for suspension of the minimum lock-in period mandated for employee stock purchase plans in the event of an employee’s death or permanent incapacitation.

  • Vesting upon retirement/ superannuation:The New Regulations provide that all benefits granted to an employee shall continue to vest under their respective vesting schedules even after retirement/superannuation, subject to the company’s policies and applicable laws, in order to allow employees to continue to benefit from their contributions to the company’s growth even after their retirement/superannuation.
  • Cashless exercise: The term ‘cashless exercise’ was used in the SBEB Regulations, but there was little clarity on how the funds received from cashless exercise should be utilised.

SEBI issued an informal guidance to Way to Wealth Brokers Pvt. Ltd. in July 2020, observing that a company may allow its empaneled stockbrokers to fund the payment of exercise price, to be adjusted against the sale proceeds of the shares. However, there was ambiguity regarding the application of funds for the payment of tax payable upon exercise of options and other related expenses.

The New Regulations have paved the way to enable ‘an employee to fund the payment of the exercise price, the tax obligations arising from such exercise and other related expenses’, by replacing the term ‘cashless exercise’ with suchdetailed explanation.

Furthermore, the New Regulations permit the implementingtrustee, in addition to the Granting Company and empaneled stockbrokers, to fund such exercise.

Changes relating to the implementation of schemes:

The New Regulations also include a number of provisionsthat allow for operational flexibility in implementation of SBEB plans while balancing the interests of the shareholders and grantees.

  • Administration of a plan:Unlike the SBEB Regulations, the New Regulations allow a Granting Company to switch the administration of a plan from direct to trust route and vice-versa, after obtaining shareholders’ approval by way of a special resolution. Such flexibility was not available under the SBEB Regulations.
  • Appointment as trustee:The eligibility criteria for appointment as a trustee has been further tightened under the New Regulations. It is specified in the New Regulations that any person who is a director, key managerial person, or promoter of a ‘group company’, as defined, is not permitted to be appointed as a trustee of the implementing trust. Furthermore, any person who beneficially owns 10% or more of the voting rights in the Granting Company has also been included in the negative list for appointment as a trustee of the implementing trust.
  • Higher threshold for shareholders’ approval:The New Regulations require the shareholders to approve the key terms of an SBEB plan, by way of a special resolution, before such plan is offered to the employees, similar to the requirement under the SBEB Regulations.

However, unlike the SBEB Regulations, the New Regulations require that any significant changes to the terms of an SBEB plan, as listed below, be approved by a special resolution rather than ordinary resolution of the shareholders:(i) changes to the terms of an SBEB plan offered to employees that has not yet been exercised; (ii) repricing of options, SARs, or shares that have not yet been exercised, whether vested or not, in the event that the scheme has become unattractive due to a devaluation of the shares; and (iii) changes in price, vesting period, or maturity in terms of a pre-IPO scheme.

  • Appropriation of shares:Under the New Regulations, a Granting Company has been granted an additional year for appropriation of shares that are not backed by grants, subject to consent of the compensation committee. This change should allow Granting Companies to acquire shares at favorable prices while still having enough time to allocate such shares to grantees.
  • Stock exchange approval:The New Regulations require that in case of fresh issue of shares under an SBEB plan, such sharesmust be listedon all recognized stock exchanges where the existing shares of the Granting Company are listed. Furthermore, a Granting Company must obtain an in-principle approval from all stock exchanges where it proposes to list the shares issued pursuant to an employee stock option scheme, or employee share purchase plan, or SAR scheme, prior to the grant of such options or SARs.  
  • Variation of an SBEB plan:It is expressly stated in the New Regulations that any variation in the terms of an SBEB plan due to regulatory requirements does not require shareholders’ approval. This change should put an end to the confusion that existed under the SBEB Regulations regarding the requirement for shareholders’ consent in case changes were necessitated by a regulatory requirement.
  • Equity-settled SARs:SEBI has previously received several requests for informal guidance on the application of SBEB Regulations to phantom stock plans. In this regard, the New Regulations state that for the purpose of these regulations, SARs only refer to equity-settled SARs, and any scheme that does not, directly or indirectly, involve dealing in or subscribing to or purchasing securities of the Granting Company are not governed by the New Regulations.
  • Use of surplus funds upon winding-up: The New Regulations permit the trustee of the implementingtrust to transfer excess monies and shares held in the trust at the time of winding-up of a scheme, to another share-based employee scheme of the company with the approval of the shareholders. It appears that the rationale for such a change is that the trust’s assets are acquired and earmarked for the benefit of the employees and thus, if any surplus remains at the time of winding-up of the scheme, such amounts could effectively be used in other employee benefit scheme rather than being distributed to employees. This additional route may be a more convenient way for Granting Companies to use such surplus funds.
  • Compliance certificate:According to the New Regulations, a Granting Company or a company that has issued sweat equity shares must place a compliance certificate from the company’s secretarial auditor, rather than the statutory auditor, at its annual general meeting. The rationale being that a secretarial auditor is more familiar with relevant laws and thus better positioned to certify compliance.
  • Sweat Equity Shares:The New Regulations attempt to bring a parity between the rules applicable to sweat equity shares issued by listed and unlisted companies in the following manner:
  1. The New Regulations specify that sweat equity shares can be issued to employees (not just permanent employees) and directors of the listed company for providing know-how or making available rights in the nature of intellectual property rights or value additions. There was no such express stipulation under the SE Regulations (or should it be called as the Erstwhile Regulations?).
  2. The New Regulations state that in any financial year, a listed company shall not issue sweat equity shares in excess of 15% of its existing paid-up capital, and the overall cap for the issue of sweat equity shares shall be 25% of the paid-up share capital at any time. However, in the case of companies listed on the Innovators Growth Platform, the overall cap is 50% of the paid-up share capital, for a period of ten years from incorporation or registration.

Conclusion

Share-based incentive plans and sweat equity shares are excellent ways to integrate employees into the growth story of a company. As more and more new-age companies are getting listed on Indian stock exchanges, it was incumbenton SEBI to revisit the rules governing share-based incentives for employees.

While the New Regulations have not significantly altered the regulatory landscape for employee benefit schemes and sweat equity shares, they have brought a lot of clarity to various aspects of such share based incentives. The New Regulations are better suited to the needs of modern businesses and their employees.

In light of operational flexibility introduced under the New Regulations,new rules relating to vesting and exercise of options, revised criteria for appointment of trustees, as well as changes to compliance requirements, it is important for listed companies to examine their share based employee plans and sweat equity share plans to bring them in line with the New Regulations.

Neha Sinha is Partner, L&L Partners

Radhika Malpani is Associate, L&L Partners

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