A corporation is a web of contractual arrangements. Post the infamous Satyam case, the need of structured and democratic governance is felt by one and all. The concept of Differential Voting Rights is a traditional one and has received acceptance from other jurisdictions as well. The approach of the author in understanding the treatment of differential voting rights is three faceted. Firstly, the author seeks to analysis the present section 43 of the Companies Act, 2013 with a reference to section 86 of the Companies Act, 1956. Secondly, the author analyses the legal autonomy of Differential Voting Rights through its judicial application in recent years and lastly, the author discusses the variability of superior voting rights as interpreted by SEBI in a landmark judgement with Differential Voting Rights.
Introduction
The inter linking of votes and rights form the roots of modern democracy. The significance of power to vote in a corporation was viewed in the light of economy of a country. It is said that power always attracts the mortal and hence the differential voting rights are essential in formulation of policies after the 2013 Amendment .A major breakthrough in the corporate voting was with The Companies Amendment Act, 2000.[1] Since it changed an archaic governance structure of corporations in India, it was one of the most discussed changes of the legal avenue. Shares with differential rights or differential voting rights[2] disregard the traditional concept of “one share one vote”. The issue of DVRs can result in two types of shares that is shares that have superior voting rights and secondly, shares that have inferior voting rights but offer higher dividends meaning they are offered at a discount.[3] The clear distinction between ownership and control has lost essence in recent years. The further incorporation of differential voting rights was achieved by the amendment of Companies Act 2013 which was notified in 2014. The new Companies Act has paved a way for democratic decision making in companies. Further application of DVR’s is advantageous as it keeps the hostile take-over of companies at a standpoint. Dilution of voting rights can also be prevented through the proper application of DVR’s. Nevertheless, the politicization of voting rights in corporations is still evident.
Research Question
The author has attempted to do a refined comparative analysis between the section 86, Companies Act, 1956 and present section 43 of the Companies Act, 2013. The judicial interpretation and actual follow up by corporations is also referred. The case studies of TATA Motors and Pantaloons are analysed for the same. Further, the author has attempted to throw some light on SEBI rules through a detailed analysis of a landmark judgement.
Hypothesis
The incorporation of differential voting rights is definitely a positive approach in making the corporate environment democratic. However the strict adherence of rules and regulations of privately listed companies may become a slippery slope in the future. Since India shoulders a variety of new start-ups and privately managed firms, the requirements of the Act may be far -fetched. The road ahead is quite long and we shall have to wait a few years to observe the implementation and practical application of the differential voting rights in India.
Section 43 of Companies Act, 2013 vis-à-vis Section 86 of Companies Act, 1956.
The Companies Act has undergone a major change after the implementation of the 2013 Amendment. The Companies Act, 1956 preserved a right for private companies to issue differential voting rights to its shareholders without complying with necessary conditions and rules.[4] Under the 1956 Act, the purely private companies were completely sheltered as the provisions governing issue of shares with differential rights did not apply on them. There was therefore sufficient freedom to structure the contractual terms agreed between parties to a joint venture should they choose a purely private company as the Joint Venture vehicle.[5]
Subsequent to the 1956 Act[6], two major milestones in the stream of DVR’s have shaped the present law surrounding it. The DVR’s were put under limelight after the Companies (Amendment) Act, 2000. This Amendment was definitely a step to bring in a rational corporate governance structure in India.[7] Under the 2013 Companies Act, even a private company will need to comply with these conditions before issuing shares with differential voting rights as there is no saving section in the 2013 Act.[8] Numerous conditions specified through the 2000 Amendment Act are retained as well.
The 2013 Act makes it mandatory for a company to have only two type of share capital: equity shares (with or without differential rights to dividend, voting or otherwise) and preference share capital.[9] Sub clause (ii) of clause (a) of section 43 of the 2013 Act allows the issuing of shares with differential rights as to ‘dividend’, ‘voting’ or ‘otherwise’.[10]Essentially, these differential rights may involve multiple rights.[11] Under the 2013 Act and rules governing issue of shares with differential rights, it is specified that shares with differential rights shall not exceed 26% of the total post issue paid up equity share capital. At any point of time, the equity shares issued with these differential rights are included in this 26%.[12] The contentious issue is that most of the private companies already have shares issued more than this prescribed limit of 26%. The rule reformed in the 2013 Act, settles this by saying that such rights will have to be converted to differential rights.[13]
Section 43 has to be read harmoniously with corresponding rules, specifically, Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014, which deals with equity shares with differential rights.[14] Among others, the rule provides for certain pre-requisites for issuing shares with differential voting rights, such as that the company should have
- a consistent track record of distributable profits for the last three years,
- not defaulted on dividend payments to preference shareholders or any term loan repayment to a public financial institution among others, and
- not been penalized in the last three years by a court, a tribunal, the RBI, the SEBI or any of the other specified sectoral regulators.[15]
The Private Companies have definitely received a setback as they have to comply with all the rules laid down. Although it is a fresh step in promoting equitable corporate structures, we still have to see how this Act manifests the economic growth of the country.
A Curious Analysis
In November 2008, for the very first time, Tata Motors took the initiative of applying the amended provision. After the amendment of s.86 of the Companies Act in 2000 to include the provision for DVRs, they were issued in India, by TATA Motors in November, 2008 for the first time ever by a listed company. TATA had issued 6.4 crore such shares as per a part of the repayment of its loan for Jaguar-Land Rover acquisition.[16] Despite the level of risk adhered by the shareholders with lower voting rights, it is pertinent to observe that they lost the control in corporate governance.
Pantaloons Retail also issued DVR shares with their bonus issue in February, 2009. However they utilised the concept of differential shares to their own benefit by not issuing these shares differently. They offered one bonus share after the purchase of ten equity shares.[17] It can be observed that Pantaloons had used these shares as a medium to attract capital rather than following a general trend of consolidating power.
An interesting perspective by the SEBI was presented in the case of Ashwin K Doshi V SEBI, wherein the law was primarily stressed upon the regulations and rules of SEBI but a constructive reference on the Companies Act (Amendment) was placed. The main issue for consideration was whether the transaction in question amounted to consolidation of control which in turn was a violation of SEBI regulations as no public offer was made.[18] After referring to the Companies Act (Amendment) 2000, the judge was of the view that since a company can issue differential voting rights or non-voting rights shares therefore there is no prohibition in even transferring the control. However two guiding factors before such transfer were also recorded and that is equality of treatment and opportunity to all shareholders and protection of interests of shareholders while administering regulations.[19]
In the same year, Bombay High Court also laid down similar rules with regard to the applicability of DVR’s in the corporations. In the case of Zycus Infotech[20], the appellant had issued shares with no voting rights from his equity share capital. This precedent essentially reasserted the law defining differential voting rights when the original owners gained control over their company. Since the new amendment as per 2013 act was non- existent, hence the Companies Act, 2000 (Amendment) was applied. As per the 2000 Act, only two type of shares could be issued, “equity shares” and “preferential shares”. In equity shares, further demarcation is done, as the shares can be allotted on the basis of dividend, voting or otherwise.
The Superior Rights and SEBI
With the fear of possible misuse of “superior voting rights” by the issue of shares by the listed companies, SEBI prohibited the issue of such shares.[21] The plausible justification for prohibition was the prevention from detriment of the shareholders. The question of the hour that arises is how different the shares with “superior voting rights” are from shares with “differential voting rights”, as it is the latter term that has attained some measure of popularity under Indian law and practice.[22]
It is evident that “Differential Voting Rights or DVR’s” came into limelight after its usage in Section 86(a) (ii) of the Companies Act 1956.The validity of such shares has also been subjected to judicial determination. In Anand Pershad Jaiswal v. Jagatjit Industries Limited, the Company Law Board (CLB) upheld the validity of issue of shares with differential voting rights as being valid under Section 86 of the Companies Act as well as the Companies (Issue of Share Capital and Differential Voting Rights) Rules, 2001. Unfortunately, the CLB did not have the opportunity to delve into the details of the issues raised in that matter because it was settled through a consent order.[23]
Before dwelling further in this issue, it is significant to comprehend the interpretation of terms “superior and differential voting rights”. With the current suggestion by SEBI, it appears that while the expression “differential voting rights” is more generic in nature, “superior voting rights” means any rights that give the shareholder more than one vote per share on a poll, which is the usual norm.[24] This step justifies the prevention of people in control of a company from issuing shares to themselves which provide equal economic benefits with other shareholders (thereby requiring equal outflow of financial resources to obtain those shares), but one which gives greater voting rights and hence better control.[25] Hence, while it is possible for listed companies to issue shares with differential voting rights which provide voting rights below the normal “one-share-one-vote” rule, conferring voting rights greater than that is proscribed.
Hence, there is an apparent inconsistency between the SEBI’s current pronouncement as it definitely goes beyond the general rule of “differential voting rights”. Even in the Jagatjit case where differential voting rights were approved, the shareholders were conferred rights greater than the “one-share-one-vote” rule. Furthermore, while listed companies will now be allowed to issue differential voting entitlements only with rights inferior to one vote per share, unlisted companies will still be governed by Section 86 and the law laid down in Jagatjit whereby they have greater flexibility in issuing shares with differential voting rights, both superior and inferior.[26]
Conclusion
The corporate world’s obsession with profit has obscured the jurisprudential principle of balancing rights with reciprocal duties.[27]It is evident from the analysis of current corporate scenario in India that Indian Companies are not so enthusiastic with applying the concept of DVR’s even though it is legislated. An apparent inconsistency between SEBI and Companies Act has further created a haphazard. The general shareholders are unaware about their benefits and the advantages received by them through DVR’s. A checks and Balance system adopted by the foreign jurisdictions are definitely the need of the hour. This system would not only benefit the shareholders but also leave no scope of abuse of DVR system by the corporations. Following the footsteps of corporate countries like France and Germany, Indian companies should use DVR’s for the benefit of minority shareholders and present a positive approach.
[1] The Companies Act, (Amendment) 2000. Available at : https://india.gov.in/companies-amendment-act-2000
[2] Hereinafter DVR’s
[3]Available at : http://www.ingovern.com/wp-content/uploads/2011/12/DVRs-Differential-Voting-Rights.pdf (last visited on 19.07.2016)
[4] Prior to the amendment, the section read as under :
- New issues of share capital to be only of two kinds. – The share capital of a company limited by shares formed after the commencement of this Act, or issued after such commencement, shall be of two kinds only, namely : – (a) equity share capital ; and Page 63 of 332 (b) preference share capital.’
[5] Raj Ramachandran, Cos Act,2013 : Differential Voting Available at : http://thefirm.moneycontrol.com/story_page.php?autono=1088940 (last visited on 18.7.2016)
[6] Supra 4
[7] Abhishek Nath Tripathi, Shares with Differential Voting Rights, Available at : https://www.nls.ac.in/students/SBR/issues/vol15/1504.pdf (last visited on 19.7.2016)
[8] The shares with differential rights cannot not exceed twenty-six percent of the total post-issue paid up equity share capital including equity shares with differential rights issued at any point of time (the earlier limit was 25%).
The company must not have defaulted in payment of the dividend on preference shares or repayment of any term loan from a public financial institution or State level financial institution or scheduled Bank that has become repayable or interest payable thereon or dues with respect to statutory payments relating to its employees to any authority or default in crediting the amount in Investor Education and Protection Fund to the Central Government.
The company has not been penalized by Court or Tribunal during the last three years of any offence under the Reserve Bank of India Act, 1934, the Securities and Exchange Board of India Act, 1992, the Securities Contracts Regulation Act, 1956, the Foreign Exchange Management Act, 1999 or any other special Act, under which such companies being regulated by sectoral regulators (under 2001 rules, only three acts were mentioned- SEBI Act, SCRA, FEMA).
The explanatory statement accompanying the notice of meeting now also needs to contain the reasons or justification for the issue of shares with differential rights, the price at which such shares are proposed to be issued either at par or at premium, the basis on which the price has been arrived at, the change in control, if any, in the company that may occur consequent to the issue of equity shares with differential voting rights, the diluted Earning Per Share pursuant to the issue of such shares, the pre and post issue shareholding pattern along with voting rights as per clause 35 of the listing agreement issued by SEBI. The explanatory statement also needs to disclose the details of the total number of shares proposed to be allotted to promoters, directors and key managerial personnel in case of private placement.
[9] Raj Ramachandran, Cos Act,2013 : Differential Voting, Available at http://thefirm.moneycontrol.com/story_page.php?autono=1088940 (last visited on 19.7.2016)
[10] A Ramaiya, A guide to Companies Act, Volume 1, 18th Edition
[11] Section 43.Kinds of share capital.
The share capital of a company limited by shares shall be of two kinds, namely:—
(a) equity share capital—
(i) with voting rights; or
(ii) with differential rights as to dividend, voting or otherwise in accordance
with such rules as may be prescribed; and
(b) preference share capital:
Provided that nothing contained in this Act shall affect the rights of the preference
shareholders who are entitled to participate in the proceeds of winding up before the
commencement of this Act.
[12] Supra 9
[13] Ibid
[14] Supra 10
[15] Harini Subramani, Exemptions to Private Companies
[16] Tania Kishore Jaleel, IFCI offloads 4% Tata Motors DVR shares, The Hindu Business Line, Mumbai, September 1, 2009, Available at : http://www.thehindubusinessline.com/2009/09/01/stories/2009090151701000.htm (last visited on 18.7.2016)
[17] Pantaloon Offers bonus DVR shares, The Indian Express, Bombay, July 25, 2008, Available on http://www.indianexpress.com/news/pantaloon-offers-dvr-bonus-shares/340185/ (Last visited on 18.7.2016)
[18] the acquisition of shares of the target company by the Ambujas from the Tata Group amounted to acquisition of shares exceeding 15% or control of the target company by the Ambujas without making public offer thereby violating regulation 10 and 12 of the regulations. At this stage, it would be relevant to set out some of the provisions of the Regulations (SEBI): Reg 2(1)( c ): “control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
[19] MANU/SB/0139/2002
[20] Zycus Infotech (P) Ltd. Vs.Commissioner of Income Tax, MANU/MH/1726/2009
[21] Available at : http://www.thehindubusinessline.com/todays-paper/tp-opinion/why-blanket-ban-on-shares-with-differential-voting-rights/article1059881.ece (last visited on 18.7.2016)
[22] Siddharth Raja, A differential Dividend Story, Available at : http://indiacorplaw.blogspot.in/2009_06_01_archive.html (last visited on 19.07.2016)
[23] MANU/CL/0002/2009
[24] Ibid
[25] Ibid
[26] Ibid
[27] Supra 17
