By Jayant M. Thakur
Chartered Accountant
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.
