By Jayant M. Thakur
Chartered Accountant
BACKGROUND
As the securities laws increasingly seek to lay down sound principles of corporate governance and also push towards greater professionalisation of company management, a question has arisen whether the unique concept of promoters in securities and corporate laws needs a close relook. So much so, that even SEBI has realised this and is considering whether this concept should be dropped or re-conceptualised.
In India, promoters have been given a central role, focus and obligations in listed companies owing to historical and other reasons. While on their own they have hardly any special rights, they have multiple and even onerous responsibilities and it is increasingly felt that they need to be reconsidered considering the changing reality. The present law is so stringent that even reclassification of a person from promoter to non-promoter is a lengthy, difficult and complicated affair. It is almost as if being a promoter is a one-way street, i.e., till death do you part!
In a recent major proposed public issue, the question came up yet again about who should be classified as a promoter and why would this status be so keenly shunned. It was reported that certain top investors / management did not desire to be termed as ‘promoters’. The question is when and how is a person deemed to be a promoter and when can he claim that he is no longer a promoter.
HOW DID THE CONCEPT OF PROMOTER COME INTO BEING?
To appreciate this, we need to understand the term and then consider how various laws define and treat promoters. Promoters, traditionally, are those enterprising persons who conceive a business idea, set up a company and seek investors to finance the business. They would run the business and later even hand it over to another management. The investors would participate in the ownership / profits / appreciation. Thus, they could be seen as persons with ideas but without the financial means to implement them. They need investors who are willing to share the risk for what they expect to be substantial rewards, without usually participating in the day-to-day management of the company.
In western countries, promoters / management typically hold a small share in the capital. Their returns would come as appreciation of such holding and remuneration for running the company. In India, traditionally, promoters are families who typically own a substantial part, usually 50% or more, of the equity. Thus, they have very substantial control in the company by virtue of their own investment. As we will see, even the law expects them to have a significant own stake, or what is termed nowadays as ‘skin in the game’. Their control over the company would usually continue through succeeding generations. Since the promoter family would have dominant control, the challenge for the regulator is more of balancing the interests of these family promoters with those of the public / minority shareholders.
Thus, a multitude of provisions under the Companies Act, 2013 and various SEBI regulations have focused on identifying these promoters and placing various responsibilities and liabilities on them.
THE LEGAL CONCEPT OF PROMOTERS AND OBLIGATIONS ON THEM
To begin with, the term is defined very widely. Persons who are in ‘control’ of the company are deemed to be promoters. The term ‘control’ is also given a very wide definition. While majority shareholding is usually enough to give them ‘control’, even certain special rights under agreements are deemed to be ‘control’. Once such promoters are identified by these criteria, specified relatives and entities connected with them in the specified manner are also deemed by law to be part of the promoter group. The list of such persons is usually quite long.
The promoters are required to have a minimum significant percentage of capital after a public issue. Thus, the public issue cannot be a means of their exit. Further, their shareholding is subject to a lock-in for one to three years. Extensive disclosures are required about the history and background of each of the promoters. They have to make regular disclosures of their shareholding and changes or charges (such as pledge, etc.) made thereon.
Interestingly, they are also the fulcrum around which the independence of directors is tested. Any person who is connected with them in any of the specified ways is deemed to be not independent. This is again an extension of the presumption that the promoters are in control and hence if one is connected with them, one loses one’s independence.
Importantly, if anything goes wrong in the company, they could be very likely seen as the primary suspects for blame and punishment. This, again, is linked with their being presumed to be in control. Of course, in many situations those who are not directly involved in the day-to-day management may not be presumed to be liable.
Deeming as promoters starts with a public issue
One facet of this subject, the complications of which we will discuss later, is that the deeming of persons / group(s) as promoters begins with a public issue under securities laws. This category becomes defined and even frozen at this stage and the persons who form part of this group are identified. Unlike being in active management, being a promoter is not necessarily a choice. Being a relative or connected in one of the many specified ways is sufficient for a person to be deemed a promoter.
EXITING FROM THE PROMOTER GROUP
While it is easy to become a promoter, often even without a choice, the difficulty is in exiting. One cannot just ‘resign’ as a promoter or exit the group through a mere declaration. Even severing of financial or other ties may not always help one to get out of the category.
It is not as if a promoter is trying to escape responsibility. There may be members of the family who have no connection with the company. There may even be separations / divisions in the family. The promoters themselves could have so low a shareholding that they have literally no say, whether as directors or shareholders. Yet they continue to be promoters and remain subject to multiple restrictions, obligations and liabilities.
Regulation 31A of the SEBI LODR Regulations lays down the procedure for declassification from promoter to non-promoter. It requires, to begin with, the fulfilling of several conditions demonstrating that the person is no more connected with the promoter or even the company. The next step is obtaining the approval of the Board of Directors of the company. Then the approval of the shareholders is required. Finally, the stock exchange has to approve the reclassification. This process may easily take months and its outcome is quite uncertain. The process becomes even more difficult if the promoters seeking exit have disputes with the other promoters, which is something that is often seen in families.
Of course, it can be argued that in cases where some of the qualifications or connections that made a person a promoter no longer exist and so the person ought to thereby become a non-promoter. However, one wished there were specific and clear provisions regarding this.
COMPANIES WITHOUT PROMOTERS
Fortunately, there are provisions in the SEBI Regulations for companies with ‘no identifiable promoters’. This is particularly so in case of companies with professional managements. However, to qualify for this one would have to escape the wide net cast by the very broad definition of ‘promoter’ and ‘promoter group’.
SEBI’S ATTEMPTS TO CHANGE THE LAW
SEBI has been making attempts to address some of these issues. Indeed, two consultation papers have been recently issued by SEBI to discuss how to simplify the reclassification and how to narrow down the definition. These, however, at best scratch the surface. So the only way out is to squarely avoid becoming a promoter. And the best way is to do this, as stated earlier, at the time of the public issue.
But even that is not easy! The definition of promoters is very wide and even persons having a significant say in management, whether by way of shareholding or by agreements or otherwise, could be classified as promoters. Litigation on this issue (e.g., the decision of SAT in the Subhkam Ventures case, dated 15th January, 2010, read with the ruling of the Supreme Court on appeal) has been inconclusive. SEBI had attempted to specify some bright line tests in this regard to lay down specific criteria / clauses in an agreement which could make a person a promoter. But nothing real came out of this either.
The problem is further complicated because multiple laws have placed requirements on promoters. These include the Companies Act, SEBI Insider Trading Regulations, SEBI Takeover Regulations, SEBI Listing Regulations, the SEBI ICDR Regulations, certain laws made by the RBI, etc. Thus, there are multiple regulators involved. All this makes a change difficult and complex.
However, such changes are now the need of the hour. As SEBI has rightly pointed out in its recent consultation paper dated 11th May, 2021 on redefining the term ‘promoter’, the holding of promoters has decreased steadily from 58% in 2009 to 50% in 2018 in the top 500 companies. More importantly, the holding of institutional investors has substantially increased from 25% in 2009 to 34% in 2018. Many companies capitalising on new technology are professionally managed companies with no identifiable promoters. Hence, now the responsibilities and obligations are increasingly sought to be placed on the Board of a company rather than on the promoters.
Robust corporate governance with active involvement of institutional investors would be a better long-term objective rather than focusing on family-centred promoters. However, considering that these consultation papers propose small changes rather than a proper overhaul, the concerns remain. Hence, for now, even if not easy, prevention would be a better strategy for management / investors of new companies than the very difficult cure.
