Section 42 Private Placement: The ₹2 Crore Penalty Trap That Can Unwind Your Startup’s Funding Round (2026 Guide)

By CS Sapna Malpani, Practising Company Secretary, Bangalore  |  Last updated: 22 May 2026

On 5 March 2026, the Registrar of Companies, Chennai, passed an adjudication order against a company that raised money by issuing 681 compulsorily convertible preference shares — and then filed its return of allotment 46 days late. The shares were allotted, the money was in the bank, the round looked closed. The paperwork was 46 days behind, and that alone was enough to trigger a penalty on the company, its promoters and its directors. Every founder who has run a funding round has used Section 42 private placement — most of them without knowing that a single missed filing can carry a penalty extending up to ₹2 crore.

Why Section 42 Private Placement Matters for Every Founder

When a startup raises a round, the founders think in terms of valuation, dilution and the term sheet. The Companies Act thinks in terms of one provision: Section 42. Any issue of securities by a private company to people other than its existing shareholders or employees is a private placement, and Section 42 governs how it must be done. Equity shares, compulsorily convertible preference shares, compulsorily convertible debentures, convertible notes — if a new investor is putting money in, Section 42 applies.

The reason this matters is that Section 42 is not a disclosure formality. It is a strict-liability code. The contraventions that trigger its penalty are not exotic — they are the ordinary mistakes of a busy founder closing a round: spending the money before the return of allotment is filed, letting more than 200 investors into the cap table, receiving an investor cheque into the regular current account, or simply filing Form PAS-3 a few weeks late because the chartered accountant was finishing the financials.

The cost is not theoretical. The Registrar of Companies has been issuing a steady stream of adjudication orders against companies — many of them funded startups — for exactly these slips. According to commentary tracking ROC enforcement, private placement defaults are now one of the most frequently adjudicated categories, precisely because the V3 portal makes a late or missing PAS-3 filing visible at a glance.

The Section 42 Penalty — What It Actually Costs

Section 42(10) of the Companies Act 2013 sets out the headline penalty. If a company makes an offer or accepts money in contravention of Section 42, the consequence falls on three parties at once.

Two features of this penalty make it dangerous for startups. First, it is personal. The penalty is not absorbed by the company alone — it names promoters and directors, which means the founders themselves. Second, the refund obligation can effectively unwind the round. A company ordered to refund all subscription money within 30 days, after it has already spent that money on salaries and growth, is a company in a genuine crisis. The penalty is a number; the refund is existential.

The Section 42 Process — Six Steps, No Shortcuts

The cleanest way to stay out of trouble is to treat the private placement as a fixed sequence. Each step has a document and a deadline. Skip a step or run them out of order, and the contravention is built in.

Step 1 — Approvals before any offer goes out

The board must approve the private placement, and the shareholders must pass a special resolution authorising it. The valuation has to be supported by a registered valuer’s report. No offer letter can be circulated before these approvals are in place. An offer made first and ratified later is already a contravention.

Step 2 — Identify the investors and respect the 200-person cap

A private placement is, by definition, an offer to identified persons. The company records the names of the select group before the offer letter is issued. The offer cannot be made to more than 200 persons in aggregate in a financial year, for each kind of security, excluding Qualified Institutional Buyers and employees covered by an ESOP. Cross 200, and the offer is treated as a public offer — a far more serious situation than a late filing.

Step 3 — The PAS-4 offer letter

The offer is made through Form PAS-4, a private placement offer-cum-application letter. It must be serially numbered and addressed specifically to the named investor. It cannot carry any right of renunciation, which means the investor who receives it cannot pass the offer to someone else. A generic, unnumbered, broadcast offer letter is not a PAS-4.

Step 4 — A separate bank account, banking channel only

All application money must be received only through banking channels — no cash — and must go into a separate bank account opened specifically for the round. The money sitting in that account cannot be used for any purpose other than adjustment against allotment or refund. Receiving investor money into the company’s regular operating account is a contravention on its own.

Step 5 — Allot within 60 days

The company must allot the securities within 60 days of receiving the application money. If it cannot, it must refund the entire amount within 15 days from the expiry of the 60 days. Money not refunded within that window starts accruing interest at 12% per annum from the 60th day.

Step 6 — File PAS-3 within 15 days, then unlock the money

This is the step that catches the most startups. The return of allotment in Form PAS-3 must reach the Registrar within 15 days of allotment. And the company cannot use the money raised until PAS-3 is filed. A founder who closes the round, allots the shares and immediately starts paying salaries from the proceeds — before PAS-3 goes in — has contravened Section 42, even if PAS-3 is filed a week later.

The Six Mistakes That Trigger the Penalty

In practice, the Section 42 penalty is almost never the result of a deliberate decision. It is the result of speed. A round closes, the team celebrates, and the compliance steps slip behind the business steps. These are the six errors I see most often when reviewing a startup’s fundraising file.

Mistake 1 — Spending the money before PAS-3 is filed. The most common and the most avoidable. The funds are legally locked until the return of allotment is on record. Treat PAS-3 filing, not the bank credit, as the moment the money becomes usable.

Mistake 2 — Filing PAS-3 late. Founders apply the 30-day rule they remember from ordinary allotments. Private placement is 15 days. The ROC Chennai order of March 2026 turned on exactly this confusion — a 46-day delay against a 15-day window.

Mistake 3 — Investor money into the operating account. A separate, dedicated bank account is mandatory. Money received into the general current account is a contravention even if every other step is perfect.

Mistake 4 — A weak or generic PAS-4. An offer letter that is not serially numbered, not addressed to a named investor, or that allows renunciation, is not a valid PAS-4. SAFE notes and informal term sheets do not substitute for it.

Mistake 5 — Overlapping offers. A company cannot make a fresh private placement offer while an earlier offer is still open — the earlier allotment must be completed, withdrawn or abandoned first. Startups running rolling angel cheques often breach this without noticing.

Mistake 6 — Losing count of investors. Across multiple closings in a financial year, the running total of investors per security type must stay at or below 200. A cap table that grows one angel cheque at a time can cross the line silently.

Private Placement vs Rights Issue — Know Which One You Are Doing

Founders frequently confuse a private placement with a rights issue. They are different routes with different rules, and using the wrong one is itself a defect.

When a new investor enters the cap table, it is a private placement. A rights issue cannot be used to bring in an outsider. Choosing the rights-issue route to save a special resolution, and then allotting to a new fund, leaves the allotment open to challenge.

What You Must Do Now — A Founder’s Section 42 Checklist

If you are about to raise, or have just closed a round, work through this sequence.

1. Confirm the security type. Equity, CCPS, CCDs, convertible notes — all of them route through Section 42. Map each to a separate 200-person count.

2. Get the special resolution on record. File Form MGT-14 for the special resolution where required, before circulating any offer.

3. Open the separate bank account first. Do this before a single rupee of investor money moves. Give the account number to investors, not your operating account.

4. Issue a proper PAS-4. Serially numbered, named investor, no renunciation, valuation report attached. Keep the complete record of the offer as required under the rules.

5. Diarise two dates the moment money arrives. The 60-day allotment deadline and, from allotment, the 15-day PAS-3 deadline. Put both in the calendar of the founder and the company secretary.

6. File PAS-3 — pre-certified — and only then spend. For any company that is not an OPC or a small company, PAS-3 must be pre-certified by a practising CS, CA or CMA. Treat the filing acknowledgement as the green light to use the funds.

7. Reconcile the investor count every closing. Before each new tranche, check the running annual total against the 200-person ceiling per security type.

The Deeper Implication for Funded Startups

According to CS Sapna Malpani, the real damage from a Section 42 default is rarely the penalty figure itself — it is what the default does to the next round. When a Series A or Series B investor runs due diligence, the private placement file from every prior round is opened and examined. A missing PAS-3, an offer made before the special resolution, money received into the wrong account — each of these becomes a diligence finding. The finding does not always kill the deal, but it almost always slows it, and it frequently forces a compounding application or a rectification before the new money can close. A compliance slip from a ₹50 lakh angel round can stall a ₹50 crore Series B.

The forward view is straightforward. The MCA V3 portal has made every PAS-3 timeline machine-readable, and the ROC adjudication machinery is now using that visibility. The trend through 2026 is more orders, not fewer, and they will increasingly name promoters and directors personally. Founders who treat Section 42 as a same-week discipline rather than an end-of-year clean-up will raise faster and cleaner than those who do not.

Timeline — The Section 42 Clock

Frequently Asked Questions

What is Section 42 private placement?

Section 42 of the Companies Act 2013 is the route a private company uses to issue shares or other securities to a select, identified group of investors rather than to the public. Almost every startup funding round — angel, seed, Series A and beyond — is legally a Section 42 private placement. It requires a special resolution, a PAS-4 offer letter, a separate bank account, allotment within 60 days, and filing of Form PAS-3 within 15 days of allotment. Treating it as a fixed six-step sequence is the most reliable way to stay compliant.

What is the penalty under Section 42 private placement?

If a company makes an offer or accepts money in contravention of Section 42, the company, its promoters and its directors are liable to a penalty that may extend to the amount raised through the private placement or ₹2 crore, whichever is lower. The company must also refund all money to subscribers, with interest, within 30 days of the order imposing the penalty. Separately, late filing of Form PAS-3 attracts a per-day penalty for continuing default. The penalty being personal to promoters and directors is what makes a Section 42 slip so serious for founders.

What is the PAS-3 filing deadline for a private placement?

For securities allotted through a private placement under Section 42, Form PAS-3 — the return of allotment — must be filed with the Registrar of Companies within 15 days of the date of allotment. This is shorter than the 30-day window that applies to other types of allotment, and the confusion between the two is a frequent cause of penalty orders. Critically, the company cannot use the money raised until PAS-3 is filed.

Can a startup use the funding money before filing PAS-3?

No. Under Section 42 read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, a company cannot utilise the money raised through a private placement until the return of allotment in Form PAS-3 has been filed with the Registrar. Spending the money before that filing is a contravention that exposes the company, promoters and directors to the Section 42 penalty. The practical rule for founders: the PAS-3 acknowledgement, not the bank credit, is the moment the money becomes usable.

How many investors can a private placement be made to?

A private placement offer can be made to a maximum of 200 persons in aggregate in a financial year, counted separately for each kind of security. Qualified Institutional Buyers and employees holding securities under an ESOP are excluded from this count. If a company crosses 200 persons, the offer is treated as a deemed public offer, which carries consequences far heavier than a late filing. Startups running multiple angel closings should reconcile the running count before every new tranche.

Does Form PAS-3 need to be certified by a Company Secretary?

Yes. Form PAS-3 filed by a company other than a One Person Company or a small company must be pre-certified by a practising Company Secretary, Chartered Accountant or Cost Accountant before it is filed with the Registrar of Companies. The pre-certification is a professional confirmation that the allotment and the underlying private placement comply with Section 42, which is why involving a company secretary early in the round — not after — protects the founders.

Sources and References

• Section 42, Companies Act 2013 — India Code (Bare Act): indiacode.nic.in
• Companies (Prospectus and Allotment of Securities) Rules, Rule 14 — Ministry of Corporate Affairs: mca.gov.in
• ROC Chennai adjudication order, 5 March 2026 — penalty for 46-day delay in filing PAS-3: TaxGuru
• ROC vigilance on private placement provisions and penalty orders — MMJC analysis: mmjc.in
• Section 42 private placement compliance failures — SCC Online Blog: scconline.com

This article is for general information and does not constitute legal advice. Section references are to the Companies Act 2013 and the rules made thereunder. For advice on a specific transaction, consult a practising Company Secretary. Last updated 22 May 2026.