Highlights of New SEBI ESOP Regulations, 2021

Shreya Patel

07 Jul, 2023

Introduction

The Securities and Exchange Board of India (SEBI) released a new set of regulations governing the share-based benefits and sweat equity. These regulations are SEBI (Share Based Employee Benefits and Sweat Equity) Regulations 2021 (hereafter ‘SEBI ESOP regulations’). These SEBI ESOP regulations are a successor to other regulations such as SEBI (Share Based Employee Benefits) Regulations, 2014 and SEBI (Issue of Sweat Equity) Regulations, 2002 (collectively referred to as ‘erstwhile regulations’). The SEBI ESOP regulations have been brought to address some of the issues and shortcomings in the previous regime. 

Highlights of SEBI ESOP Regulations 

• The scope of Eligible Employees broadened

The erstwhile regulations allowed share based benefits in the form of ESOPs, Stock Appreciation Rights (SARs), and sweat equity shares to the eligible employees of the company. These regulations permitted benefits of these schemes to the permanent employees of the company only and deprived the non-permanent employees of the company. The new SEBI ESOP regulations offer greater flexibility to the listed companies and allow them to incentivize non-permanent employees who were previously ineligible for such benefits.

Further, the fact that the new SEBI ESOP regulations have used the terminology of ‘employees’ instead of ‘exclusive employees’; therefore, in the absence of any clarification from SEBI’s end, the benefits have been extended to the employees of the listed companies or their group companies on a non-exclusive basis.

• Flexibility in the implementation of the scheme

The erstwhile regulations too allowed the implementation of the share-based benefits scheme either directly or through an irrevocable trust. The new SEBI ESOP regulations have gone a step further, allowing the listed companies to change the mode of implementation of the scheme if the circumstances warrant such a change. The circumstances warrant that: 

1. The company needs to obtain prior approval of the shareholders through a special resolution; and 
2. The proposed change should not be prejudicial to the interests of the employees.

• Limit set on the issue of sweat equity shares.

The new SEBI ESOP regulations have set a limit on the amount of sweat equity shares a company can issue, which was not present in the erstwhile sweat equity regulations. Following are the limits that have been set under the new SEBI ESOP regulations:

Listed companies have been permitted to issue sweat equity shares not more than 15 percent of the company’s existing paid-up equity capital in a year;

The aggregate sweat shares issued by a listed company which is not listed on the Innovators Growth Platform (IGP) shall not exceed 25 percent of its existing paid-up equity share capital at any time;

In case a company is listed on the IGP, then such a company has not been allowed to issue more than 50 percent of the aggregate sweat equity share of its existing paid-up equity share capital at any time.

This provision of limiting the issue of sweat equity share capital of a listed company has been taken to protect the interests of the public shareholders from being diluted significantly and from experiencing substantial price fluctuations in the price of the listed company’s shares. An even more significant cap has been put in place for technology start-ups, who often tend to offer sweat equity shares in place of monetary salary in order to retain the best talents.

• No vesting period in case of dead employees or on permanent incapacity of the employee

The new SEBI ESOP regulations provide that no vesting period or lock-in period shall be applicable in case of the death of an employee of a company or on permanent incapacity of an employee. In such cases, the benefits accruing to the employee shall be transferred to the legal heirs or nominees of the employee on the date of death or permanent incapacity of that employee. Therefore, it is suggested that the companies and start-ups and companies start framing their ESOP policies and SAR¹ schemes which are in consonance with the applicable laws and these new SEBI ESOP regulations. The erstwhile regulations were silent on this issue.

• Vesting benefits to an employee transferred because of a Merger

In the case of employees who have been vested with the options and shares and such employees are transferred pursuant to an amalgamation or merger before the completion of their vesting period. The new SEBI ESOP regulations mandate that the scheme of amalgamation has to specify how the unvested and unexercised options will be treated such that the interests of the employees are not prejudiced in any manner. Such kind of protection was not available to the employees in the erstwhile regulations.

• Secondary sale allowed to make payment of exercise price of ESOPs

In cases where a share benefit transfer scheme is entrusted by a trust, in such cases, the trust has been permitted to enter into secondary market sales to allow an employee to make payment for the exercise price of ESOPs and related taxes and expenses.

• Use of excess money and shares after winding up of schemes

According to new regulations, when a scheme is wound up, subject to the approval of shareholders, the excess money or shares with the trust is transferred to another scheme as recommended by the compensation committee.

Conclusion 

The new SEBI ESOP regulations provide much needed clarification regarding granting of share-based employee benefits by listed companies. This will better enable listed companies to comply with the SEBI framework in a better manner, especially related to the benefits to be given to non-exclusive employees. To date, grant and issuance of ESOPs are governed by Companies (Share Capital and Debentures) Rules, 2014, which state contrary to what the new SEBI ESOP regulations provide such as: (i) ESOPs and sweat equity must be issued to permanent employees only; (ii) do not state how the secondary sale of shares will be made in a cashless exercise of options by the employees; and (iii) do not provide a course of action as to how the excess monies and shares will be utilized after ESOP scheme is wound up. With the new SEBI ESOP regulations and the clarifications and liberalizations offered by them, the start-ups have got a shot in the arm for whom granting of ESOPs is relatively common.

FAQ

Read Our Article: Employee Stock Options under FEMA Compliance

1. https://en.wikipedia.org/wiki/Stock_appreciation_right