Companies Act 2013, SEBI,

Employee Stock Option Plans (ESOPs) are an effective tool to align employee interests with long-term shareholder value. Under the Trust Route, the company establishes a trust to acquire shares—either from the secondary market or through fresh issue—and subsequently transfers them to employees upon exercise of vested options.

This article explains the step-by-step procedure followed by A Limited, an Indian listed entity, to implement an ESOP Scheme through the Trust Route using secondary acquisition, with approval obtained via postal ballot.

Legal Provisions

  • Section 62(1)(b) of the Companies Act, 2013 read with Rule 16 of the Companies (Share Capital and Debentures) Rules, 2014

  • SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (“SBEB & SE Regulations”)

  • SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”)

Role of the Nomination and Remuneration Committee (NRC)

In compliance with Regulation 5 of the SBEB & SE Regulations, the NRC, acting as the Compensation Committee:

  • Drafts and formulates the ESOP Scheme and related policies,

  • Defines eligibility criteria, vesting conditions, and exercise terms, and

  • Recommends the scheme to the Board of Directors for approval and subsequent shareholder consent.

Convening the Board Meeting

Prior Intimation

As per Regulation 29 of the LODR Regulations, prior intimation of the Board Meeting must be given to the Stock Exchange(s) at least two working days in advance (excluding the date of intimation and the meeting).

Agenda Items

Typical agenda items include:

  • Approval of the draft ESOP Scheme;

  • Approval of the draft Postal Ballot Notice and Explanatory Statement as per Rule 16 of the Companies (Share Capital and Debentures) Rules, 2014;

  • Proposal for establishing an Employee Welfare Trust under the Indian Trusts Act, 1882;

  • Approval of the loan amount or financial assistance to be provided to the Trust for secondary acquisition; and

  • Delegation of powers to the NRC to grant and administer ESOPs.

Outcome of the Board Meeting

In accordance with Regulation 30 of the LODR Regulations, the outcome of the Board Meeting must be disclosed to the Stock Exchange(s) within 30 minutes of the conclusion of the meeting.

Shareholders’ Approval via Postal Ballot

Under Section 62(1)(b) of the Companies Act, 2013 read with the relevant Rules and Regulation 6 of the SBEB & SE Regulations, shareholder approval by way of special resolution is mandatory for implementing an ESOP Scheme.

Process and Timelines

  • Dispatch of Postal Ballot Notice: The notice, along with the explanatory statement, is dispatched to shareholders and simultaneously intimated to the Stock Exchange(s).

  • Newspaper Advertisement: Published within 48 hours of dispatch as required under Regulation 47 of the LODR Regulations.

  • Voting Period: The postal ballot remains open for a minimum of 30 days.

  • Scrutinizer’s Report: Submitted within 48 hours from the closure of voting. Results are disclosed to the Stock Exchange(s) and uploaded on the company’s website.

Establishment of the ESOP Trust

Following shareholder approval, A Limited establishes an Employee Welfare Trust under the Indian Trusts Act, 1882.
A Trust Deed is executed defining the objectives, powers, and responsibilities of the Trust.

  • If an individual or One Person Company acts as trustee — minimum two trustees are required.

  • If an institutional trustee or body corporate is appointed — one trustee suffices.
    The Trust acts in a fiduciary capacity solely for the benefit of employees.

Funding and Secondary Acquisition

The company provides loan or financial assistance to the Trust in compliance with Regulation 3 of the SBEB & SE Regulations.
The Trust utilizes this amount to purchase shares from the secondary market through a registered stockbroker. These shares are held in trust until they are transferred to eligible employees upon exercise.

Limits on Secondary Acquisition (Regulation 3(12)):

  • Not more than 2% of the paid-up equity capital in any financial year; and

  • Not more than 5% of the paid-up equity capital overall under all share-based benefit schemes combined.

Grant of Options

The Board of Directors delegates the power to grant options to the NRC, which:

  • Identifies eligible employees based on performance, role, and tenure;

  • Determines the number of options to be granted; and

  • Approves the grant list accordingly.

Vesting and Exercise

  • Minimum Vesting Period: One year from the date of grant.

  • Employees may exercise vested options within the defined exercise period by paying the exercise price as per the scheme.

Transfer of Shares by the Trust

Upon valid exercise and completion of the vesting period:

  • The Trust transfers equivalent shares to the respective employees.

  • The committee authorized by the Board oversees and approves each transfer.

  • The consideration received from employees is used by the Trust to repay the loan provided for secondary acquisition.

Stock Exchange Compliances

Throughout the implementation process, A Limited ensures continuous compliance with:

  • Regulation 30: Disclosure of events such as scheme approval, grant, vesting, and exercise.

  • Regulation 44: Disclosure of voting results of the postal ballot.

  • Regulation 47: Publication of statutory newspaper advertisements.

Important Points to Note

  1. Threshold Limit:
    As per Regulation 3(12) of the SBEB & SE Regulations, the ESOP Trust may undertake secondary acquisition up to 2% of paid-up equity capital per financial year and 5% overall under all share-based schemes.

  2. Secondary Acquisition Only Through Trust:
    Secondary acquisition can be carried out only through an ESOP Trust; direct purchase by the company is not permitted.

  3. Constitution of Compensation Committee (NRC):
    Every listed company must constitute a Compensation Committee, which, for listed entities, functions as the Nomination and Remuneration Committee.

  4. Exercise Price:
    The exercise price or its determination formula is at the company’s discretion, provided it is clearly defined in the scheme and approved by shareholders.

  5. Forfeiture on Non-Exercise:
    If an employee fails to exercise options within the exercise period, any amount paid (e.g., at grant or exercise) may be forfeited as per the scheme.

  6. Lock-in Period:
    Companies may, at their discretion, impose a lock-in period on shares allotted post-exercise.

  7. Trustee’s Voting Rights:
    Trustees cannot exercise voting rights on shares held by the ESOP Trust. All shares are held purely in a fiduciary capacity.

  8. Eligibility of Trustees:
    Any person can be appointed as a trustee except where such person—
    (i) is a Director, KMP, or Promoter of the company or its group company (including holding, subsidiary, or associate) or their relative; or
    (ii) beneficially holds 10% or more of the paid-up capital or voting rights of the company.

  9. Minimum Holding Period:
    Shares acquired through secondary acquisition must be held for a minimum of six months before being transferred to employees.

  10. Prohibition on Derivatives:
    The ESOP Trust is prohibited from dealing in derivatives of the company’s shares.

  11. Exclusion of Promoters and Independent Directors:
    Promoters and Independent Directors are not eligible to participate in ESOP Schemes.

  12. Secretarial Audit Certification:
    The Board must place before shareholders, at each Annual General Meeting, a certificate from the Secretarial Auditor confirming that the ESOP Scheme has been implemented in accordance with applicable regulations and resolutions.

  13. Disclosure Requirements:
    In addition to disclosures under the Companies Act, 2013, the Board must disclose details of the ESOP Scheme(s) in the Director’s Report and in compliance with Accounting Standards and the Guidance Note on Accounting for Employee Share-based Payments.

Conclusion

Employee Stock Option Plans (ESOPs) are a strategic and transparent mechanism to align employee interests with those of shareholders while fostering long-term value creation.

For listed entities like A Limited, ESOPs not only serve as an effective retention and motivation tool but also reinforce corporate governance and compliance discipline.

When implemented in accordance with the Companies Act, 2013, SEBI (LODR) Regulations, 2015, and SEBI (SBEB & SE) Regulations, 2021, ESOPs become a powerful bridge between individual performance and corporate success.


Disclaimer:
This article is limited in scope and may omit certain procedural nuances, interpretations, or exceptional cases that can vary depending on company-specific circumstances, regulatory updates, or stock exchange clarifications. Readers are advised to refer to the original provisions, circulars, and professional guidance before applying this in practice.

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