SUPERIOR VOTING RIGHTS SHARES: A NEW INSTRUMENT FOR FUNDING

BACKGROUND

After a short consultation process, the Ministry of Corporate Affairs and the Securities and Exchange Board of India have, in quick succession, notified the new regime and regulatory requirements relating to Superior Voting Rights equity shares (SRs). Essentially, SRs are a special category of equity shares. They provide for extra voting rights in comparison with ‘ordinary equity shares’.

Generally, all equity shares are equal. They have the same right to dividends, the same rights of voting and other features. To use the common Latin term, they are all pari passu.

For private companies, there was considerable flexibility to create several categories of equity shares, each category having different rights. Typically, the differences relate to voting and / or dividends. One category of equity shares, for example, may have multiple voting rights as compared to others. This enabled the holders to exercise far more control and say, compared to the ‘economic’ interest in the company.

Availability of such flexibility helped companies and their founders / promoters to negotiate with investors. Investors may be interested in economic returns while the promoters / founders may be needed to be given assurance of control over the running and management of the company.

However, while this was well accepted in case of private companies, there was divergence of views relating to listed companies and even unlisted public companies. On the one hand, it was argued that such matters should be left for internal negotiations and decisions of the company, its promoters and investors. If they desire to have such a structure, the law should not meddle. This is, of course, so long as there is adequate disclosure of the facts. On the other hand, there was opposition to allowing any such instrument giving differential rights on the ground that it would allow a small group of shareholders to control the company even at the cost of shareholders holding otherwise majority of economic value. It was argued that such instruments went against the principle of corporate democracy and governance.

SEBI varied its view over a period of time. It had allowed the issue of one category of such instruments but there was an approval process that often took months. The result was that there were barely 4-5 companies that issued such instruments. Curiously, it was found that in most of the cases, such instruments traded at a huge discount over the ‘ordinary equity shares’. There was far less trading, too.

Recently, however, the debate arose again particularly in case of startups that extensively use technology (internet, digital, biotech, etc.). Such companies need capital and flexibility and there has been a history of companies that have seen very rapid growth. Such categories of companies need to be given a freer hand and also their promoters given a share disproportionate to the amount of money that they invest. SEBI had recently initiated a consultation process wherein the current law and practice in India and abroad was highlighted.

After debate and consultation, the Ministry of Corporate Affairs (MCA) and SEBI have both made changes in their respective regulations / rules to allow for certain types of instruments. The features of these instruments are briefly discussed here.

What type of instruments are allowed to be issued?

Equity shares with extra voting rights than other ‘ordinary’ equity shares are allowed. These rights are called superior rights and hence such instruments are referred to as ‘Superior Rights’ shares or SRs.

Which type of companies are allowed to issue SRs?

All companies are given such powers. The MCA has made generic rules applicable to all companies. However, SEBI has made further regulations applicable to listed companies.

WHAT ARE SRs?

SRs are a special category of equity shares with superior voting rights as compared to other equity shares. No other differential, whether of dividends, share in property, etc., is permitted. Thus, for example, the SRs – or ordinary equity shares – cannot be given extra or lesser dividends. It is just that when it comes to the matter of voting at general meetings, SRs would have extra voting rights.

Note that the MCA rules applicable to all companies generally provide for a wider category of instruments not merely restricted to SRs. However, the focus of this article is on SRs since SEBI has recognised and permitted only this class of instruments.

Shares with ‘inferior’ rights not allowed

Only shares with superior voting rights are allowed to be issued. Thus, a company can have a share with multiple voting rights or one voting right. It cannot have a share with voting rights less than one vote per share. At present, companies have issued shares with less voting rights. Such shares cannot be issued any more by listed companies.

Shares with other differential rights

Equity shares with lesser or more dividend rights are not permitted to be issued by listed companies. No other differential is also possible. The only differential permitted is issue of shares with superior voting rights.

Who can be issued SRs?

Unlisted companies can issue SRs to any person. However, if the company wants to list its shares on exchanges, the promoters / founders to whom SRs are issued should be acting in an executive position in the company. Further, such SRs holders should not be part of a promoter group whose collective net worth is more than Rs. 500 crores.

How much extra voting rights can be given to SRs?

SRs can be given two to ten times extra voting rights as compared to ordinary equity shares. At the minimum, thus, one SR can have twice the vote of an ordinary equity share; and at the maximum, ten times. The multiple has to be in whole numbers and not fractions (e.g., one cannot issue SRs with two and a half times voting rights of ordinary equity shares).

What are the procedures and approvals required for issue of SRs?

There are several conditions for the issue of SRs. The articles of association should permit such an issue. The companies’ rules require that an ordinary resolution has to be passed approving such issue and for this purpose, certain disclosures need to be made. However, the SEBI regulations require a special resolution with certain further disclosure requirements. Earlier, there was a requirement of having a three-year profit track record, but this requirement is now dropped. As far as unlisted companies are concerned, any company can issue SRs.

Classes of SRs

The SEBI regulations permit only one class of SRs.

‘Coat-tail’ provisions

These refer to those situations where the SRs will have the same voting rights as ordinary equity shares. In other words, SRs as well as ordinary equity shares will have one vote per share. These requirements are prescribed for listed companies by SEBI. Thus, in respect of the specified situations, which relate to important matters or where there can be major conflict of interest, etc., the extra voting rights on SRs are not available.

Sunset provisions

Sunset in this context means the period of time after which the SRs become ordinary equity shares. In other words, the extra voting rights of SRs are removed. Unlisted companies are not mandatorily required to have sunset provisions. However, listed companies need to provide that the SRs shall be converted into ordinary equity shares by the fifth anniversary of listing of the shares in the public issue of such a company. Such period can be extended by another five years if a resolution is passed by the shareholders other than SRs holders. The holders of SRs can, however, convert their SRs to ordinary equity shares earlier.

There are also mandatory sunset events where on the occurrence of such events the SRs get converted into ordinary equity shares. These include, e.g., when the SR holder resigns from the executive position, dies, etc.

Who can hold SRs? What if they transfer the SRs?

Only those promoters who have an executive position in the company can hold SRs. If the holder dies, the person to whom such shares devolve will not have any superior rights in respect of such shares. Generally, sale of SRs will result in the superior voting rights lapsing and such shares becoming like other ordinary equity shares.

Lock-in period

Under the SEBI regulations, the SRs held by the promoters shall be locked in during the period they are SRs, or for the period of lock-in in accordance with the ordinary provisions relating to lock-in for minimum promoters’ contribution, whichever is later.

Maximum percentage of voting rights

The SRs cannot have voting rights above 74% of the total voting rights. Thus, the ordinary equity shares need to have at least 26% voting rights. For listed companies, the ordinary equity shares held by SRs holders are also counted for the purposes of this limit of 74%.

Special requirements relating to corporate governance for listed companies

A company having SRs is required to ensure that at least half of its board consists of independent directors. Its Audit Committee should consist only of independent directors. And its Nomination and Remuneration Committee, its Risk Management Committee and its Stakeholders Committee should comprise of at least two-thirds independent directors.

CONCLUDING REMARKS

The positive aspect of the new set of provisions is that now, particularly in case of listed companies, SRs can be issued without formal approval of regulatory authorities like SEBI. Approval of shareholders is generally enough. The discretion and also the delay for such approval is thus eliminated.

However, it can be seen that a very narrow type of instruments is permitted to be issued and that, too, having a limited validity period. The superior rights are not applicable under several situations. Importantly, though the wording is not sufficiently clear, it appears that listed companies cannot make a fresh issue of SRs (except as rights / bonus). Shares with inferior voting rights cannot in any case be issued.

Thus, the regulators have taken a very conservative position as regards the issue of SRs. There is of course a worldwide debate on whether such shares with differential rights be allowed and under what circumstances. While many countries do allow (and many do not), some countries let companies and their shareholders / investors decide. There is thus a good argument to allow flexibility to companies and their investors to decide on what type of instruments can be issued instead of a blanket ban or very narrow permissibility.

One of the principal objections is that investors do not understand such instruments and hence may end up acquiring them to their loss. Alternatively, they may simply not invest. One would have, though, thought that after so many years of debate on such instruments, there would be knowledge for those who want to make some effort. After all, even equity investing is for informed investors, more so when the focus of regulations these days is on more and more disclosures and transparency.

Be that as it may be, there is now a narrow but fairly clear type of instrument that can be issued. Time will tell how successful it is with companies, their promoters / founders and, above all, investors.