Public Issue, Private Placement (Sections 23, 42) →

When a company needs money, the Companies Act, 2013 does not leave it free to solicit capital however it pleases. Section 23 sets out the permitted routes — a public offer through a prospectus, a private placement, a rights issue or a bonus issue — and Section 42 supplies the detailed code for the most heavily abused of these, the private placement. The two provisions together police the boundary between a controlled offer to a handful of identified investors and an open solicitation of the public, a boundary that the Sahara saga showed could conceal a ₹24,000-crore fraud. This chapter sets out the scheme of Section 23, the 200-person cap and procedural machinery of Section 42, the deeming of a non-compliant issue into a public offer, and the leading authorities that map the line.

For the judiciary and CLAT-PG aspirant, the topic sits at the intersection of company law and securities regulation. It rewards a candidate who can state the modes under Section 23 cleanly, recite the conditions of Section 42 in order, and explain why an offer to two hundred and one persons is no longer a private placement at all. The discussion below builds on the introduction to the Companies Act and the foundational vocabulary in our chapter on the definitions of company, director and member.

Statutory anchor and scheme

Chapter III of the Companies Act, 2013 — titled "Prospectus and Allotment of Securities" — opens with Section 23 and is divided into two parts. Part I deals with the public offer and the prospectus regime; Part II deals with private placement and contains the single, dense Section 42. Section 23 is the gateway: it enumerates exhaustively the ways in which a company may issue securities, and it routes each mode into the appropriate part of the chapter. A company that strays outside these routes does not merely commit an irregularity — it issues securities without authority of law, with consequences that can reach into the penal provisions of the SEBI Act, 1992 and the Securities Contracts (Regulation) Act, 1956.

The architecture reflects a deliberate policy. The 1956 Act regulated public issues tightly but left private placement loosely defined, anchored only in the fifty-person line of the first proviso to Section 67(3). The 2013 Act, drafted in the long shadow of the Sahara litigation, codified private placement into a self-contained section with numerical caps, mandatory disclosures, a dedicated bank account, and a return-of-allotment filing. Section 42 was then comprehensively substituted by the Companies (Amendment) Act, 2017, with effect from 7 August 2018, to tighten the regime further and to replace the earlier fine-and-imprisonment penalty with a civil, adjudicated penalty. The structure is a direct response to the chronic problem the older law could not police — the dressing-up of a public solicitation as a private one.

Section 23 — the routes to raise capital

Section 23(1) provides that a public company may issue securities in three ways. First, to the public through a prospectus — referred to in the section itself as a "public offer" — by complying with the provisions of Part I of Chapter III. Second, through a private placement, by complying with the provisions of Part II of the chapter, that is, Section 42. Third, through a rights issue or a bonus issue in accordance with the provisions of the Act and, in the case of a listed company or a company that intends to get its securities listed, also with the provisions of the SEBI Act and its regulations.

Section 23(2) confines a private company to a narrower menu. A private company may issue securities only by way of a rights issue or a bonus issue, or through a private placement under Section 42. It cannot make a public offer at all. This is not an arbitrary restriction; it follows directly from the defining feature of a private company under Section 2(68) — the prohibition, in its articles, on any invitation to the public to subscribe for its securities. A private company that wished to access the public would first have to convert into a public company, a topic taken up alongside the procedure for incorporation of a company.

Sub-sections (3) and (4) of Section 23, inserted by the Companies (Amendment) Act, 2020 and brought into force on 30 October 2023, carve out a further avenue: such class of public companies as may be prescribed may issue a prescribed class of securities for the purposes of listing on permitted stock exchanges in permissible foreign jurisdictions. This is the statutory hook for the direct overseas listing of Indian companies. It does not disturb the basic tripartite scheme; it merely adds a controlled, notified exception for cross-border capital-raising.

Public company versus private company

The whole of Section 23 turns on the distinction between a public and a private company, defined respectively in Sections 2(71) and 2(68). A private company is one which, by its articles, restricts the right to transfer its shares, limits its members to two hundred (excluding present and former employee-members), and — critically for this chapter — prohibits any invitation to the public to subscribe for any securities of the company. A public company is simply a company that is not a private company, with a minimum number of seven members under Section 3(1)(a). The proviso to Section 2(71) deems a subsidiary of a public company to be a public company even if its own articles say otherwise.

The practical upshot is that the menu of capital-raising options a company enjoys is determined the moment its constitution is settled. A company that wants to keep the public out must accept that it can never make a public offer; a company that wants to tap the public must accept the full prospectus, listing and disclosure burden of Part I. The constitutional documents that fix this character — the memorandum of association and the articles of association — are therefore the first place a lawyer looks before advising on any fundraising.

What counts as a public offer

The Explanation to Section 23 supplies the meaning of a public offer: it includes an initial public offer or a further public offer of securities to the public by a company, or an offer for sale of securities to the public by an existing shareholder, through the issue of a prospectus. The reference back to the prospectus is significant — a public offer is defined by the medium through which it is made. A document inviting the public to subscribe for or purchase securities is a prospectus within Section 2(70), and the moment such a document is issued to the public, the public-offer regime is engaged.

The leading authority on what it means to issue a prospectus "to the public" is the House of Lords decision in Nash v. Lynde, [1929] AC 158. The managing director of a company circulated a document marked "strictly private and confidential" among a small group of directors and their friends. The House of Lords held that this was not a prospectus issued to the public — a private communication between business associates does not amount to an offer to the public. Viscount Sumner's formulation endures: the test is whether the offer is such as to be open to anyone who brings his money and applies in due form. The case marks the conceptual frontier that Section 42 later codified in numerical terms.

The point matters because the consequences of issuing a prospectus are severe. A misstatement attracts civil liability under Section 35 and criminal liability under Section 34, and a fraudulent misstatement is punishable under Section 447. These liabilities, and the defences available to a director who withdrew consent or had no knowledge of the issue, are examined in the companion chapter on prospectus liability. A private placement is the route by which a company avoids all of this — provided it stays within the four corners of Section 42.

Private placement — the concept

Section 42(3) defines a private placement as any offer or invitation to subscribe, or an issue of securities, to a select group of persons by a company, other than by way of public offer, through the issue of a private placement offer-cum-application letter, and which satisfies the conditions specified in the section. The defining features are two: the offer is made to identified persons, and it is not made to the public at large. The offer letter must be addressed specifically to the recipient and serially numbered, and the company must maintain a complete record of the persons to whom the offer is made.

This is a fundamentally different exercise from a public offer. There is no prospectus, no listing requirement, and no general solicitation. The company knows in advance who its investors will be; it records their names and addresses; and it makes a targeted offer to them and them alone. The quid pro quo for escaping the prospectus regime is strict compliance with the conditions of Section 42 — the numerical cap, the special resolution, the dedicated bank account, the time-bound allotment, and the return of allotment. Fail any of these, and the placement risks being recharacterised as a public offer.

Section 42 — the 200-person cap

The numerical heart of Section 42 is its second proviso to sub-section (2). A private placement may be made only to a select group of persons whose number does not exceed two hundred in the aggregate in a financial year, for each kind of security. Two categories are excluded from the count: qualified institutional buyers, as defined in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, and employees who are offered securities under a scheme of employees' stock option in terms of Section 62(1)(b). The cap is reckoned separately for each kind of security and afresh for each financial year.

The third proviso supplies the consequence of breaching the cap. If a company, listed or unlisted, makes an offer to allot or invites subscription, or allots, or enters into an agreement to allot, securities to more than the prescribed number of persons, whether the payment is received in advance or not, and whether the company intends to list its securities or not, the offer or allotment shall be deemed to be a public offer. All the provisions of the Companies Act, the Securities Contracts (Regulation) Act, 1956, and the SEBI Act, 1992 are then attracted. This is the codified descendant of the fifty-person line that the Supreme Court applied in Sahara.

The cap is also a per-offer discipline, not merely an annual ceiling. Section 42(2) requires that the offer be made to persons whose names and addresses are recorded by the company prior to the invitation, and that the offer be made by serially numbered offer-cum-application letter in the prescribed Form PAS-4. The persons to whom the offer is made must be identified before the offer goes out — a company cannot make an open offer and then count heads afterwards.

The procedural machinery of Section 42

A valid private placement runs through a fixed sequence. First, the offer must be authorised by a special resolution of the members — Section 42(2) requires that the company pass a special resolution before making the offer or invitation, the explanatory statement of which discloses the basis or justification for the price at which the offer is made. In the case of an offer of non-convertible debentures within the limits of Section 180(1)(c), a single special resolution passed once a year for all offers during that year suffices.

Second, the offer can be made only to persons whose names and addresses are recorded in advance, through the Form PAS-4 offer-cum-application letter, sent to them in writing or in electronic mode within thirty days of recording their names. Third, Section 42(7) prohibits any public advertisement or use of any media, marketing or distribution channels to inform the public at large about the offer. The placement must remain genuinely private throughout. Fourth, Section 42(5) bars a fresh offer or invitation under the section unless the allotments under a previous offer have been completed, or that earlier offer has been withdrawn or abandoned by the company. The object of these conditions, read together, is to prevent the placement from becoming a rolling solicitation that is public in substance.

Allotment, refund and the separate account

Section 42(6) governs the money and the clock. The application money received under a private placement must be kept in a separate bank account in a scheduled bank, and may be utilised only for two purposes — adjustment against the allotment of securities, or repayment of the monies where the company is unable to allot. It cannot be used for any other purpose in the interim. This is a structural safeguard against the diversion of subscription money before allotment.

The same sub-section fixes the timeline. The company must allot the securities within sixty days from the date of receipt of the application money. If it fails to allot within those sixty days, it must repay the application money to the subscribers within fifteen days from the expiry of the sixty-day period. And if the company defaults even on this repayment, it becomes liable to repay the money with interest at the rate of twelve per cent per annum from the expiry of the sixtieth day. The graded structure — allot within sixty, refund within the next fifteen, and pay interest if you breach even that — is a recurring pattern in the Act's investor-protection provisions.

Section 42(4) reinforces the point that subscription money under a private placement must move through the banking system. Payment is to be made from the bank account of the person subscribing to the securities, and the company must keep a record of the bank account from which the payment was received. Monies payable on subscription cannot be received in cash. The paper trail is deliberate: it allows the regulator to trace who actually subscribed, defeating the use of fictitious or benami names to stay under the 200-person cap.

Return of allotment and utilisation

Section 42(8) requires the company to file a return of allotment with the Registrar in the prescribed Form PAS-3 within fifteen days of allotment, including a complete list of all allottees with their full names, addresses, and the number of securities allotted to each. The return is the regulator's window into the placement — it discloses who actually received securities and confirms compliance with the cap. Crucially, a company is not permitted to utilise the monies raised through the private placement until the return of allotment in Form PAS-3 has been filed with the Registrar. The filing is thus both a disclosure obligation and a precondition to the deployment of the capital raised.

The interlock between the separate account, the allotment timeline, and the return of allotment forms a closed loop. Money comes in to a ring-fenced account; it is allotted within sixty days or refunded; the allotment is reported in PAS-3 within fifteen days; and only on that filing can the company touch the money. A company that wishes to abuse the private placement route has, at every step, a procedural tripwire to cross — which is precisely the design.

The deeming of a public offer

The most consequential feature of Section 42 is its deeming provision. The moment a private placement breaches the 200-person cap, the offer ceases in law to be a private placement and is deemed to be a public offer. The company is then treated as having made a public issue without a prospectus, without listing, and without SEBI clearance — a serious set of contraventions. The deeming does not depend on the company's intention; the third proviso to Section 42(2) makes clear that it operates whether or not the company intended to list its securities and whether or not payment was received in advance.

This deeming converts a company-law irregularity into a securities-law violation, and it is here that the heaviest consequences lie. Under the SEBI Act and the SCRA, an unauthorised public issue can attract orders for refund with interest, disgorgement, debarment from the securities market, and prosecution. The civil penalty under Section 42(10), discussed below, is in many cases the least of the company's worries once the issue is recharacterised as a public offer. The lesson for the practitioner is that the cap is not a soft target to be managed — crossing it changes the regulatory universe the company inhabits.

The Sahara line

The doctrinal foundation of the modern deeming provision is the Supreme Court's decision in Sahara India Real Estate Corporation Ltd v. Securities and Exchange Board of India, (2012) 10 SCC 603, decided on 31 August 2012. Two unlisted public companies in the Sahara group — Sahara India Real Estate Corporation Ltd and Sahara Housing Investment Corporation Ltd — issued optionally fully convertible debentures and raised over ₹24,000 crore from roughly three crore investors. The companies contended that the issue was a private placement to "friends, associates, workers and other individuals associated with the group," and therefore outside SEBI's jurisdiction.

The Supreme Court rejected the contention. It held that under the first proviso to Section 67(3) of the Companies Act, 1956, an offer or invitation to subscribe for shares or debentures made to fifty persons or more is to be treated as an offer to the public, regardless of the company's characterisation of it. Once the offer crossed the fifty-person threshold, it was a public issue, attracting the compulsory listing requirement under Section 73(1) and the prospectus regime under Section 60B of the 1956 Act, and falling squarely within SEBI's regulatory jurisdiction over public issues of securities. The Court directed the Sahara companies to refund the monies collected, with interest, to the investors, under SEBI's supervision.

The significance of Sahara for the present chapter is structural. The fifty-person line of the 1956 Act became the two-hundred-person cap of Section 42, and the judicially-evolved principle that an offer to that many persons is a public issue was codified into the deeming proviso. A student who understands Sahara understands why Section 42 is drafted as it is — every numerical condition and every deeming clause is a legislative answer to the loophole the Sahara companies tried to exploit. The case is the bridge between the older prospectus-centred regime and the modern, numerically-policed private-placement code.

Penalty under Section 42(10)

Section 42(10), as substituted by the 2017 Amendment, supplies the penalty. If a company makes an offer or accepts monies in contravention of the section, the company, its promoters and its directors are liable to a penalty which may extend to the amount raised through the private placement or two crore rupees, whichever is lower. In addition, the company must refund all monies received from the subscribers, with interest as specified in sub-section (6), within thirty days of the order imposing the penalty. The earlier version of the provision had prescribed a fine extending to the amount involved or two crore rupees, but the 2017 substitution recast it as a civil, adjudicated penalty with the "whichever is lower" cap.

Two points repay attention. First, the penalty is capped at the lower of the amount raised or two crore rupees — a frequent examination trap, because the intuitive reading is "whichever is higher." It is not; the cap is deliberately the lower figure, the heavier deterrent being the deeming of the issue into a public offer. Second, the penalty attaches not only to the company but to its promoters and directors personally, reinforcing the personal accountability that runs through the duties-of-directors regime. The refund obligation, with interest, ensures that subscribers are made whole regardless of the penalty imposed.

Private placement versus public issue

The two routes can be set side by side. A public issue is made to the public at large through a prospectus, requires listing on a recognised stock exchange under Section 40, and is governed by the full disclosure and SEBI-regulation apparatus of Part I. A private placement is made to a select, pre-identified group not exceeding two hundred persons, requires no prospectus and no listing, and is governed by the self-contained conditions of Section 42.

The line between the two is not merely descriptive; it is jurisdictional. Stay within Section 42 and the company is governed by company law alone. Cross the cap and the issue is deemed public, dragging in the SCRA and the SEBI Act. The whole drafting strategy of Chapter III is to make that line bright, numerical, and difficult to blur — the antithesis of the vague "friends and associates" defence that failed in Sahara.

MCQ angle — the recurring distinctions

Several propositions recur in objective papers with high frequency. First, the three modes for a public company under Section 23(1) — public offer through prospectus, private placement, and rights or bonus issue — versus the two modes for a private company under Section 23(2), which exclude the public offer. Second, the 200-person cap under Section 42, reckoned per financial year and per kind of security, excluding qualified institutional buyers and ESOP employees. Examiners frequently test the exclusions and the "per kind of security" qualifier.

Third, the timeline: allotment within sixty days, refund within fifteen days thereafter, and interest at twelve per cent per annum on default. Fourth, the return of allotment in Form PAS-3 within fifteen days of allotment, and the offer letter in Form PAS-4. Fifth, the penalty under Section 42(10) — the amount raised or two crore rupees, whichever is lower — where the trap is the "lower," not "higher." Sixth, the Sahara proposition that an offer to fifty or more persons under the 1956 Act was a deemed public issue, the historical antecedent of the present cap. Carrying these six points precisely is usually enough to clear the topic in prelims.

Practical takeaways

Three points for the practitioner and the examinee. First, always begin by classifying the company — public or private under Sections 2(71) and 2(68) — because that classification fixes the menu of routes available under Section 23. A private company that purports to make a public offer has done something the Act simply does not permit. Second, treat the conditions of Section 42 as cumulative and non-negotiable: special resolution, pre-recorded offerees, Form PAS-4 letter, separate bank account, allotment within sixty days, no public advertisement, no overlapping offers, and the PAS-3 return within fifteen days. The failure of any one of them exposes the company to penalty and, more dangerously, to the deeming of a public offer.

Third, internalise the Sahara logic. The numerical cap exists because a vague, intention-based test of "private" was too easily gamed. The deeming provision is intention-independent by design — it bites whether or not the company meant to make a public issue. The safest counsel to a company raising capital privately is therefore to stay comfortably within the cap and to document every step, rather than to argue, after the event, that the offer was "really" private. For the wider statutory context in which these provisions sit, return to the Companies Act hub, which threads this chapter into the law of share capital, prospectus liability, and allotment.