Section 62(1)(b), Rule 12, and MCA V3 compliance explained simply.
Applicable Law: Indian Companies Act, 2013 | Jurisdiction: India | Updated for MCA V3 Portal, 2026
Introduction
Employee Stock Option Plans (ESOPs) are not just incentive tools — they are a regulatory exercise governed by detailed company law provisions in India. While startups use ESOPs to retain and reward talent, few founders or HR heads fully grasp the legal foundation behind them. In 2026, with the MCA V3 portal now mandatory for all share capital filings, compliance has become more structured — and mistakes, more visible. This article simplifies the legal backbone of ESOPs for Indian private companies under Section 62(1)(b) of the Companies Act, 2013, and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
What is the legal basis for ESOPs in India?
The legal foundation of ESOPs in India comes from Section 62(1)(b) of the Companies Act, 2013, which allows companies to issue shares to employees under an approved ESOP scheme, and Rule 12 of the Share Capital Rules, which governs conditions, approvals, and disclosures.
1. Section 62(1)(b) — The Core Provision
Section 62(1)(b) empowers a company to issue shares to its employees under a scheme of employee stock options, approved by a special resolution in a general meeting. This provision acts as the statutory authority for granting stock options, ensuring that employee ownership is not a casual managerial decision but a shareholder-approved initiative.
In practice, private companies must:
- Pass a special resolution under Section 62(1)(b).
- Prepare an ESOP Scheme document (detailing eligibility, vesting, pricing, and exercise terms).
- File Form MGT-14 with the MCA for the special resolution.
Once approved, the scheme forms part of the company’s share capital structure and must be administered in line with Rule 12.
2. Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014
Rule 12 operationalises Section 62(1)(b). It prescribes who can receive ESOPs, what disclosures are required, and how approvals must be taken.
Key compliance aspects include:
- Eligible Employees: Only permanent employees, directors, or employees of holding/subsidiary companies (excluding promoters and those holding >10% shares).
- Special Resolution: A must before granting any options.
- Disclosure: Details of the ESOP scheme, including total options, vesting period, exercise price, etc., must be annexed to the notice of the general meeting.
- Register Maintenance: Form SH-6 must be maintained, recording option grants, vesting, and exercise.
- Exercise Pricing: The company’s board determines the price, allowing flexibility for startups.
This rule ensures that ESOPs are transparent and fair — both to employees and existing shareholders.
3. MCA V3 Compliance — Filing under the New Portal (2026 Update)
The transition to MCA V3 has streamlined ESOP-related filings but also increased compliance scrutiny. Every step now leaves a digital footprint.
Key forms under MCA V3 for ESOP-related actions:
- MGT-14 – Filing of special resolution for ESOP approval.
- PAS-3 – Return of allotment when options are exercised and shares issued.
- SH-6 – Internal register of ESOP grants and exercises (not filed but must be maintained).
Each form now requires e-verification through the company’s Business User account, and supporting documents (board resolutions, scheme copies, etc.) must be attached digitally.
For companies raising rounds, MCA filings are now a key part of due diligence — non-filing or mismatched data in PAS-3 or SH-6 can raise red flags with investors or auditors.
4. Private vs. Public Companies: Key Distinctions
Private companies enjoy greater flexibility, as SEBI (Share Based Employee Benefits) Regulations apply only to listed companies. However, compliance under Rule 12 is non-negotiable even for private entities.
| Aspect | Private Companies | Listed Companies |
| Applicable Law | Companies Act, 2013 + Rule 12 | SEBI (SBEB & Sweat Equity) Regulations, 2021 |
| Pricing Flexibility | Yes | SEBI pricing formula |
| Disclosure | In notice + Board’s report | In Board + SEBI filings |
| Valuation | Fair value by merchant banker or CA | Mandatory independent valuation |
Thus, while private companies have room for structuring, documentation, valuation, and timing remain legally sensitive.
5. Practical Steps to Ensure ESOP Legal Compliance
For private limited companies, ESOP compliance involves both board-level and shareholder-level approvals, followed by statutory filings.
Typical sequence:
- Draft ESOP policy and scheme rules.
- Obtain Board approval for the draft.
- Call and pass a special resolution under Section 62(1)(b).
- File Form MGT-14 on MCA V3.
- Maintain Form SH-6 Register.
- On exercise, issue shares and file Form PAS-3.
- Reflect details in annual return and Board’s report.
In our previous post on ESOP structuring for Indian startups, we discussed how ESOPs can be aligned with funding and retention strategy — this legal framework provides the compliance backbone for that structure.
Why Does ESOP Legal Compliance Matter?
ESOP compliance in India ensures that stock options granted to employees are legally valid and enforceable. It safeguards the company from penalties, builds investor confidence during funding rounds, and guarantees employees’ ownership rights — preventing future disputes, audit issues, and capital-raising delays.
The Real Value of Compliance
Legal compliance is not a bureaucratic checkbox — it’s the foundation that makes your ESOP legally real. For the company, it ensures that employee stock options are recognized under law, and not just internal promises. For employees, it secures their right to future ownership, preventing any ambiguity when they exercise options or during an exit event.
Consider this: a Bengaluru-based SaaS startup discovered during its Series A due diligence that it had issued ESOPs informally without a proper shareholder resolution or MCA filings. The investors’ counsel flagged it as a “non-compliant capital issuance”, forcing the company to re-approve and re-file the entire ESOP scheme retroactively — delaying closure by almost three months. The founders had to incur legal fees, penalties, and revaluation costs that could have been avoided through timely compliance.
For investors, ESOP compliance is an indicator of corporate hygiene. A company with clean ESOP records and MCA filings inspires greater trust because it signals sound governance and reduced legal risk — both essential for valuations and exits.
Common Pitfalls Companies Should Avoid
Issuing ESOPs without a Special Resolution
This is one of the most frequent errors among early-stage startups. Founders often approve ESOPs through a simple board meeting, not realizing that Section 62(1)(b) mandates a special resolution of shareholders. For example, a Delhi-based fintech startup had to retrospectively regularize its ESOP scheme when its investor’s auditor noticed there was no MGT-14 filing. The oversight not only caused delays but also raised red flags in their due diligence report.
Granting ESOPs to Promoters or Major Shareholders
Rule 12(1) expressly prohibits granting stock options to promoters or shareholders holding more than 10% equity. Yet, many early-stage founders assume they can allocate ESOPs to themselves for “motivation”. Unless registered as a DPIIT-recognised startup (within 10 years of incorporation), such grants are invalid. This mistake can later create confusion in the company’s cap table or during investor negotiations.
Not Maintaining Form SH-6 (ESOP Register)
Form SH-6 is an internal register that records every ESOP grant, vesting, and exercise. It is not filed on MCA but must be available for inspection during audits or diligence. In one case, a mid-size tech company lost employee trust when discrepancies in vested options were found — simply because SH-6 was not updated after each grant. Maintaining it is simple, but neglecting it creates avoidable legal and reputational risks.
Filing Delays under MCA V3
The MCA V3 portal has made compliance digital but also unforgiving. Each filing — whether MGT-14 (for resolutions) or PAS-3 (for allotments) — now requires e-verification and attaches timestamps. Delays automatically appear in the company’s public records. Imagine an investor opening your MCA master data and seeing outdated PAS-3 filings — it instantly creates doubts about your governance practices.
Ignoring ESOP Valuation and Tax Implications
Many companies issue options without proper valuation under Rule 11UA of the Income Tax Rules. When employees later exercise options, tax disputes arise over the fair market value. Engaging a registered valuer early ensures transparency and saves employees from unexpected perquisite tax burdens.
The Bigger Picture
In India, compliance errors around ESOPs don’t just attract penalties under Section 450 of the Companies Act — they impact funding, audit closure, and even employee confidence.
Investors increasingly insist on reviewing Form SH-6, valuation reports, and MCA filings as part of due diligence. The absence of these documents often leads to conditional funding or reissuance of shares.
For example, a Mumbai-based healthtech startup had to regrant ESOPs to 15 employees because its original option letters did not match the MCA-approved scheme. The process took six weeks and required board and shareholder re-approvals — a situation that could have been easily avoided with accurate documentation.
A Preventive Approach Saves More Than Penalties
A preventive compliance approach — drafting the ESOP scheme correctly, taking the right resolutions, filing forms on time, and maintaining records — costs less than 10% of the time and money spent fixing non-compliance later.
When done right, ESOPs become not just a reward mechanism but a credible governance signal — something investors, auditors, and employees all value.
As discussed in our earlier post on ESOP structuring in Indian startups, clarity and compliance go hand in hand. A well-documented ESOP plan tells your stakeholders that your company values transparency, employee trust, and long-term integrity.
Summary
Understanding Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Share Capital and Debentures Rules, 2014 is not just a legal formality — it’s the legal foundation for every ESOP issued by an Indian company. Proper ESOP compliance ensures your scheme is legally valid, investor-ready, and audit-proof.
In 2025, with the MCA V3 system mandating digital filings like MGT-14, PAS-3, and SH-6, every approval and allotment leaves a traceable record. This digital transparency makes non-compliance easily detectable, especially during funding, audits, or due diligence. For founders and CFOs, proactive governance and timely MCA filings are no longer optional — they’re strategic essentials for protecting employee ownership and sustaining investor trust.
FAQs
Can a private company grant ESOPs to its promoters?
No. Under Rule 12(1) of the Companies (Share Capital and Debentures) Rules, 2014, a private company cannot grant ESOPs to its promoters or to shareholders holding more than 10% equity — unless it is a DPIIT-recognised startup within 10 years of incorporation.
Detailed Explanation:
The rationale is to ensure that ESOPs truly benefit employees, not controlling shareholders. For instance, if two founders each hold 60% equity, issuing ESOPs to themselves would dilute minority shareholders without real value addition. However, startups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) are granted a temporary relaxation — allowing founders who are also employees to receive ESOPs within 10 years from incorporation. After that period, the standard restriction re-applies.
Is ESOP valuation mandatory for private companies?
Yes. ESOP valuation is mandatory both under the Companies Act, 2013 and the Income Tax Act, 1961. It ensures fair pricing of options for accounting and tax purposes, protecting both the company and employees from later disputes.
Detailed Explanation:
Under the Companies Act, valuation must be conducted by a registered valuer to determine the fair value of shares when options are granted or exercised. For taxation, Rule 11UA of the Income Tax Rules requires valuation by a merchant banker to compute perquisite tax. Without valuation, the ESOP could be considered underpriced, leading to tax liabilities and audit issues. In practice, most companies obtain both valuations simultaneously to maintain consistency and avoid scrutiny during funding or audit reviews.
What happens if ESOP shares are issued without filing PAS-3 on the MCA portal?
Issuing ESOP shares without filing Form PAS-3 (Return of Allotment) is a violation under Sections 42 and 62 of the Companies Act. It can lead to penalties, invalidate the share issue, and create problems during audits or funding.
Detailed Explanation:
Every time ESOPs are exercised and shares are allotted, the company must file Form PAS-3 within 30 days, attaching the Board resolution and allotment list.
For example, one Gurgaon-based tech startup missed PAS-3 filing for its first 15 ESOP exercises. When investors reviewed MCA data, the mismatch between issued and reported share capital delayed their due diligence by six weeks.
Such omissions appear in MCA master data, which is public — reducing investor confidence and signalling poor governance.
Are sweat equity and ESOP the same thing?
No. ESOPs grant employees the right to buy shares in the future at a pre-decided price, while sweat equity involves immediate issue of shares to employees or directors for know-how or services rendered.
Detailed Explanation:
ESOPs are forward-looking — they reward continued service through vesting and exercise over time. Sweat equity, governed by Section 54 of the Companies Act, rewards past or present contributions through immediate share allotment.
In short: ESOPs are “options”, while sweat equity is “ownership now”. Each serves different motivational and structural purposes in corporate strategy.
Detailed Explanation:
This flexibility helps group companies retain and reward key talent across structures — for example, a holding company may issue ESOPs to senior engineers of its subsidiary to maintain alignment with the parent company’s goals.
However, proper disclosure in the ESOP scheme and shareholder resolution is essential to avoid future challenges or confusion regarding eligibility.
How does MCA V3 filing affect ESOP compliance?
The MCA V3 portal has made ESOP filings completely digital and traceable. Every MGT-14, PAS-3, or SH-6 record leaves a timestamp and digital audit trail, making accuracy and timely filings more critical than ever.
Detailed Explanation:
Under MCA V3, all ESOP-related forms require Business User authentication. Delayed filings now automatically appear as date mismatches in the MCA database. For example, if a startup grants ESOPs in April but files PAS-3 in August, investors or auditors can instantly see the delay online. Thus, the portal enforces transparency and encourages better corporate hygiene.
Can an employee who leaves the company before vesting claim ESOPs?
No. Unvested ESOPs lapse automatically if the employee leaves before the vesting date, unless the ESOP scheme provides otherwise. Only vested and unexercised options may be exercised within the period defined in the scheme or offer letter.
Detailed Explanation:
The vesting schedule ensures that ESOPs act as a retention tool. For instance, if an employee is granted 4,000 options with a one-year cliff and four-year vesting, leaving after 10 months means losing all unvested options.
Companies must clearly define the treatment of options on resignation, termination, or death to avoid disputes later.
What are the penalties for non-compliance with ESOP provisions?
Non-compliance with ESOP provisions under Section 62(1)(b) or Rule 12 can attract penalties under Section 450 of the Companies Act — up to ₹10,000 per default and ₹1,000 per day for continuing default.
Detailed Explanation:
While the monetary penalty may seem modest, the reputational cost is higher. Repeated defaults appear in the company’s MCA compliance history and can trigger deeper scrutiny during investment or M&A diligence. Moreover, ESOPs issued without proper approval may be declared void ab initio, creating long-term capital structure complications.
Can ESOPs be cancelled or modified after grant?
Yes, but only if the ESOP scheme itself permits such modification and shareholders approve it through a special resolution. Any change that prejudicially affects employees’ interests requires their prior consent.
Detailed Explanation:
For instance, if a company wishes to reduce the exercise price or extend the vesting period, it must first get shareholder approval. Arbitrary cancellation or alteration can lead to legal disputes and loss of employee morale.
A well-drafted ESOP policy should therefore specify how options can be modified, forfeited, or regranted.
