One of the overarching aims of a company is to infuse capital timely in order to ensure hassle free working. One of the many ways it could be done is through issue of shares also called the subscription of shares. The owners of the shares are called shareholders who, depending on the nature and type of shares held, have control and decision-making powers in the company. It includes the rights of the shareholders to vote on the resolutions of the company as well. This key aspect of voting rights of shareholders is of key significance because a badly voted resolution could adversely impact its business.
The traditional view of one share one vote might not be favorable to a company. This is because there will be lot of shareholders whose interest is only to make money out of their investments and not the well-being of the company. The directors, promoters or key managerial personnel of the company, on the other hand, might be more interest to frame the companies’ policies in a way that develops the company. It is therefore important to let key managerial personnel and other shareholders have the better voting right on a resolution and similarly have better control over the company. It only makes sense that people who are more inclined towards the betterment of the company should have more say in its working.
Provisions under the Companies Act and its rules
Under the Companies Act, 2013 (hereinafter “Companies Act”), Section 47 provides for the right of every shareholder of a company to vote on all the resolutions presented before the company. This is subject to the limitations if any, provided under the Memorandum of Association (hereinafter “MOA”) and Articles of Association (hereinafter “AOA”) of the company. These documents are often called the constitution of the company, for such is the importance of that document. Both MOA and AOA govern all the aspects of the company’s workings. From the name and registered offices of the company to its objects, the MOA is the go to document to know whether or not the company is legally authorized to do so. The AOA governs the ancillary aspects of the company’s workings and rights inter se its shareholders.
More often than not, these documents provide for different classes of shareholders having different voting rights in the company. Section 43(a)(ii) of the Companies Act permits such Differential Voting Rights (hereinafter “DVRs”) on dividend, voting or otherwise. Private companies can issue shares with DVRs in the manner prescribed under their AOA by exempting applicability of Section 43 and 47 of the Companies Act read with Rule 4 of the Companies (Share Capital & Debentures) Rules 2014, on such private companies. To that end, no such exemption is available to public companies when they issue equity shares with DVRs. Rule 4 inter alia prescribes certain important conditions for issuance of shares with DVRs. One such condition is that the company should have consistent track record of distributable profits for the past three (3) years. Another important condition is that the shares with DVRs should not exceed 26% of the total post-issue paid-up equity share capital. Further, Rule 4 does not permit conversion of existing shares into shares with DVRs or vice versa.
SEBI regulations and its recent consultation paper
The Securities Exchange Board of India (hereinafter “SEBI”), the regulatory body governing the securities market in India, provides for guidelines to be followed by public listed companies when they intend to issues shares with DVRs. The provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 do not permit DVRs with higher or superior voting rights. However, subject to certain conditions, DVR shares with lower or inferior voting rights are permitted. The SEBI has in view of the provisions of the Companies Act, recently in the month of March 2019, issued a consultation paper on DVRs.
This consultation paper though is lauded to be a welcome move as it has introduced a new class of shares in addition to the existing “Shares with Fractional Voting Rights” or “Shares with Inferior Voting Rights” (hereinafter “FR”). This new class called “Shares with Superior Voting Rights” (hereinafter “SR”), earlier objected by the SEBI, has now been proposed to be issued by an unlisted company to its promoters. Such unlisted company where the promoters hold SR shares are permitted to do an Initial Public Offer (“IPO”) of only ordinary equity shares provided the SR shares are held by the promoters for more than one (1) year prior to filing of the draft offer document with the SEBI.
SEBI has recommended that a public company should not be permitted to issue SR shares to any person, including to the promoters, in any manner whatsoever, including by way of rights issue or bonus issue, once its ordinary equity shares have been listed. Post an IPO, the SR shares are eligible for the same dividend and other rights as ordinary equity shares, except that they will have superior voting rights.
Notwithstanding the new proposal by SEBI, the regulation for FR remains unchanged. The regulation being that FR shares shall not exceed the ratio of 1:10, i.e., one vote as applicable to one ordinary equity share, would be voting entitlement on up to a maximum of 10 FR shares. The only catch with this new proposal is that the Companies Act cap will apply, meaning thereby, DVR shares cannot exceed 26% of the total paid-up equity share capital. Additionally, the promoter voting rights (an aggregate of ordinary, FR and SR Shares) cannot exceed 75% of the total voting rights.
SEBI cannot amend the company law or its rules, however, retaining the 26% cap on DVRs on both SR and FR considered as restrictive. The startup market in India is booming and the founders of the startups would not want to give up the control of the company while raising capital from external sources. It is in their best interest that the promoters and key managerial personnel retain their control and yet invite external capital for their startup. In such a scenario, the regulations governing DVRs needs to be eased out. It does not make sense to hobble startups when they struggle to perform this feat.
Ministry of Corporate Affairs on SEBI’s proposals
While SEBI’s consultation paper has made things tougher for many companies including startups, the Ministry of Corporate Affairs (hereinafter “MCA”) after seeking opinion from NITI Aayog (earlier Planning Commission, which is the principal law making body), has recommended SEBI to relax certain rules to make DVRs shares more attractive. One of the most sweeping proposals was to remove the ceiling, which allows shares with DVRs to be up to 26% of the post-issue capital.
Further, the proviso which made things difficult for startups – “consistent track record of distributable profits for the last 3 years” is also under consideration to be either relaxed or be done away with.
MCA has recommended that SEBI’s proposal of five year sunset after listing (extendable by another five years through a special resolution) i.e. they would lose their superior voting rights and each SR share would carry an entitlement to a single vote as if it were an ordinary equity share being too restrictive and should be removed. Additionally, MCA wants to provide right of first refusal available to co-promotors or co-founders instead of bar on transfer of these shares among promoters only.
With the Government being proactive in the issues revolving DVRs and making them more attractive, it remains to be seen as to what final shape, the recommendations of SEBI and MCA, will take. In any case, it is about time that relaxed DVRs rules, incentivizing many startups among others, see the light of the day.
The author is a Corporate and M&A lawyer at Sarin Partners Advocates & Legal Consultants. The views in the article should not be construed as legal advice. Please contact the author for any clarification.