By Jayant M. Thakur
Chartered Accountant
Introduction
SEBI has finally issued amendments requiring that profit
sharing/compensation agreements by certain persons shall require board as well
as public shareholders approval of the listed company. These provisions
effectively have retrospective effect
of three years. The agreements covered are those that are entered into by
specified persons such as promoters, directors, key managerial personnel with
shareholders or even third parties. Such agreements would provide for
compensation/profit sharing in relation to dealings in securities. Vide
amendments made by notification dated 4th January 2017, such
agreements would require prior approval of Board and shareholders. Agreements
entered into in preceding three years, whether subsisting or expired, would
also require approvals and/or disclosures.
Background
Readers may recall that SEBI had, on 4th October
2016, issued a consultation paper on such agreements and invited public
comments. This was discussed in an earlier column of this Journal.
SEBI had expressed concerns about certain agreements in as
much as though the listed company itself may not be a party to or directly
affected by such agreements, they resulted in certain concerns about good
corporate governance. SEBI gave an example of the Promoters of a listed company
having entered into an agreement with a private equity investor. This agreement
provided for sharing of profits on appreciation earned by such investor in the
shares of the company. SEBI observed:-
“It has come to the notice of
SEBI that certain Private Equity (PE) firms have entered into side agreements
with top personnel and key managerial personnel (KMPs) of a listed entity by
which such PE firms (who were allotted shares on a preferential basis) would
share a certain portion of the gains above a certain threshold limit made by
them at the time of selling the shares and also subject to the conditions that
the company achieves certain performance criteria and the employee continues
with the company for a certain period.” ?
It was felt that such practice may be quite common. The
beneficiary of such agreement could be a promoter, director, key managerial
personnel etc of the company. The private equity investor would have invested
in the shares of the company. The agreement would provide that if the investor
earns profit on sale of the shares beyond a specified amount/rate of return, a
part of such excess would be shared with such persons. Such persons would thus
benefit by way of gains beyond what they would otherwise earn as shareholders,
key managerial personnel, directors, etc.
It was obvious that the company concerned was not directly
affected by such agreement. The company does not bear any of such costs. It is
the investor who, for motivating such
persons, bears the cost out of his gains. Hence, such agreements would not come
before the board or shareholders of the company for approval. Indeed, it is
possible that the company and the public shareholders may not be even aware of
such agreements.
However, the concerns over such agreements are easy to see.
The directors or key managerial personnel may have at least a perceived
conflict of interest in view of such agreements. Such persons also have
restrictions over their remuneration under the Companies Act, 2013 but yet they
may get further remuneration under such agreements. The tying of the Promoters
with such investors is also an area of concern.
Hence, SEBI, after due consultation, has provided for certain
requirements by introducing certain provisions in the SEBI (Listing Obligations
and Disclosure Requirements) Regulations, 2015.
To summarise, these provisions require that any new
agreement should receive prior approval from the Board of the
listed entity and from its public shareholders by way of a
resolution. In case of agreements entered into in the preceding three
years and still subsisting, approval of the board and the public shareholders
needs to be obtained at their respective forthcoming meetings. Further,
such agreements and also agreements that have expired should be disclosed to
stock exchange for public knowledge.
The following agreements analyse the new requirements in more
detail.
Regulations amended
The SEBI LODR Regulations 2015 have been amended by inserting
sub-regulation (6) in Regulation 26. These amendments have been made vide
notification dated 4th January 2017 and will also apply to
agreements entered into the preceding three years from the date when the
amendments came into effect.
To whom do they apply
The provisions apply to agreements between two sets of
parties.
On one side are employees including key managerial personnel,
directors or promoters of a listed entity. They may be acting on their own
behalf or on behalf of any other person.
On the other side are shareholders or even any other third
party.
The scope thus has been made quite wide, and it is wider even
than the proposed amendments as per the consultation paper. The party on one
side can be any employee and not merely a key managerial personnel. An apparent
ambiguity/loophole in wording the consultative paper was corrected and hence
the party can be any director and not merely directors who are employees.
Further, the promoter may be a director or employee or otherwise and can even
be a limited company.
On the other side would be any shareholders or even
non-shareholders.
The nature of the agreement
The agreement should be “with regard to compensation or
profit sharing in connection with dealings in the securities of such listed
entity”.
Prior approvals required of Board/public shareholders
Such agreements require prior approval of the
Board of Directors of the listed company.
Further, prior approval is also required of the public
shareholders of the listed company by way of an ordinary resolution. The
term “public shareholders” has been defined in Regulation 2(1)(y) of the
Regulations as ”public shareholding” means public shareholding as
defined under clause (e) of rule 2 of the Securities Contracts (Regulation)
Rules, 1957. Effectively, subject to certain further adjustments where
required, it means shareholders who are other than the promoters or promoter
group of the company or the subsidiaries/associates of the Company. However,
non-public shareholders by this definition could include directors, employees,
etc. who are not part of promoters, etc. To ensure that the voting
remains unbiased, apart from the promoters, etc. even “interested parties” are
not allowed to vote, as explained later herein.
Interested parties not to vote
It is seen earlier that the agreement would require the
approval of the public shareholders and thus promoter shareholders would not be
eligible to vote. However, there are certain other persons who also are
debarred from voting. These are “interested persons involved in the
transaction”. This term has been defined as “any person holding voting rights
in the listed entity and who is in any manner, whether directly or indirectly,
interested in an agreement or proposed agreement”.
Thus, it is not merely the parties to the agreement but
persons even otherwise interested in such agreement would be debarred from
voting.
Agreements entered into preceding three years
The new provisions also cover agreements entered into
preceding three years. For this purpose, such agreements are categorized into
those that are subsisting and those that have expired.
If such an agreement has expired, then it shall be disclosed
to the stock exchanges for public dissemination.
If such an agreement is subsisting then the following needs
to be done:-
(i) It shall be disclosed to the stock exchanges
for public dissemination.
(ii) It
shall be placed before the forthcoming Board meeting for approval.
(iii) If the
Board approves, it shall be placed before the forthcoming general meeting for
approval by the public shareholders.
Consequences of non-compliance
SEBI has wide powers to take action in case there is
non-compliance. There can be penalties, debarment, disgorgement, prosecution,
etc.
A critique
The concerns as regards such agreements are obvious – the
conflict of interest that it creates that may place self-interest over company
interest and even a special relation with certain shareholders over relation
with all shareholders generally. On other hand, considering that the profit
that is shared arises from sale of shares and not from the company or paid by
it or even the shareholders, it seems harsh that such agreements are so restricted.
Arguably, a disclosure ought to be enough. Of course, if such agreements are
entered into by Independent Directors, then the concerns may be justified.
Comparison with approval for related party transactions
The SEBI LODR Regulations also require approval under certain
circumstances of related party transactions by the shareholders. For such
approval too, there is restriction on voting by persons who have interest or
concern in the transactions. It is worth contrasting the requirements of shareholder
approval in case of related party transactions with such profit sharing
agreements.
As seen above, in case of such agreements, (i) resolution is
placed before public shareholders only (ii) approval is by way of an ordinary
resolution and (iii) persons interested in such agreements are also debarred
from voting.
In case of specified related party transactions, (i)
resolution is placed before all shareholders and not just public shareholders
(ii) approval is by way of special resolution (iii) all related parties are
debarred from voting.
Conclusion
The requirements will introduce a level of
transparency in dealings by Promoters and other persons connected with the
Company. The public shareholders and even the Board of Directors generally will
have a say in such matters and can veto it. Considering the retrospective
applicability, there are likely to be many such arrangements that would not
only require public disclosure but in case of subsisting agreements would
require the two level approval.
