Corporate Governance Practices Missing from SEBI’s Proposed Structure of Differential Voting Rights
The basic principle behind the issuance of shares with differential voting rights, commonly known as ‘DVRs’ in India and dual class shares or ‘DCS’ in the international context, is to enable the companies to raise capital without dilution of control and decision-making power in company.
In promoter or founder-led companies where promoters or founders are instrumental in the success of the company, such structures enable them to retain decision-making powers and rights vis-a-vis other shareholders either through retaining shares with superior voting rights or issuance of shares with lower or fractional voting rights to public investors.
The concept was first recognised under the Companies (Amendment) Act, 2000 followed by similar provisions adopted by the Companies Act, 2013. However, the current practical scenario depicts a different picture, as the provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 do not permit DVRs with higher or superior voting rights.
Subject to certain conditions, DVR shares with lower voting rights are permitted. Till date, only five listed companies have used this structure in India. Strict pre-condition and corporate governance norms, unavailability of investors due to lack of awareness are some grounds of company’s reluctance from adopting this idea.
SEBI’s Consultation Paper to restructure the issuance of DVRs
The paper provides that the matter of issuance of shares with DVRs was deliberated in the Primary Market Advisory Committee of SEBI (Committee) and a group (DVR Group) was constituted amongst the Committee members to do an in-depth study of the proposal of introduction of shares with DVRs in India.
The consultation paper addresses the norms for issuance of shares with DVRs under two categories –
a) issuance by companies whose equity shares are already listed on stock exchanges;
b) companies with equity shares not hitherto listed but proposed to be offered to the public.
The basic objective behind allowing shares with differential voting rights is to raise equity without dilution of promoter control or to allow the promoters and founders to maintain control as they would hold shares with superior voting rights.
Therefore, considering SEBI’s proposed structure, there will be four categories of companies, which can issue DVRs:
1) Equity listed companies – as per this consultation paper;
2) Unlisted companies, which are intending to get their equity listed—as per this consultation paper;
3) Unlisted companies, not intending to list their equity shares—as per Section 43 of the Companies Act, 2013 (Act) read with Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014;
4) Private companies—exempted from applicability Section 43 of the Act, if either its memorandum or articles of association so provides—vide notification number GSR 464(E) dated 5th June 2015.
Need for DVRs in India
In order to maintain the current growth phase in India, it is necessary for companies to raise capital to sustain this growth. Companies with high leverage or asset light models, may prefer equity over debt capital. Raising DVRs will reduce the dilution of founder and promoter stake, which may otherwise be the case.
The protection of founder and promoter’s stake or control is especially relevant for new technology entities, which have asset light models, with little or no need for debt financing. However, these entities generally raise funds through equity, which dilutes the promoter’s and founder’s stake, thereby diluting control. Considering the issue, the consultation paper states that retaining founder’s interest and control in the business is of great value to all shareholders and this can be achieved by:
c) Issue of shares with superior voting rights (SR) to founders and/or
d) Issue of shares with lower or fractional voting rights (FR) to raise funds from private/ public investors.
The global market has witnessed a mixed response to the concept of DVRs, while many countries have permitted the listing of companies with dual class shares or DCS (internationally used term for DVRs), some countries like UK, Australia, Spain, Germany and China do not permit the issuers with DCS structure for listing.
Singapore and Hong Kong have recently permitted DCS structures with detailed checks and balances. Considering the international scenario, the consultation paper from SEBI has provided a detailed comparison of the issuance and listing of DCS structure in internal jurisdictions, the summary of which is presented below:
700 public companies in the US have DCS structures, predominant listed ones being Google, Facebook, Snapchat, Nike and Alibaba. There is ongoing debate in the SEC about the continuation of DCS.
Hong Kong and Singapore recently allowed DCS to encourage more new technology firms to list.
In the UK, DCS structures were used in the 1960s to protect corporations from hostile takeovers or for the Queen to have ‘golden share’, before institutional investors expressed strong opposition to such structures. DSC is presently not allowed in the UK.
Over the past decade, a number of European governments have implemented or debated the use of different voting rights.
US, Canada, HK, Singapore, Denmark, Spain, Sweden and Italy allow dual-class shares. Germany, Spain, China, Australia disallow listing of shares of companies with DCS structures.
Recommendations of the DVR Group
A company would be entitled to issue DVR Shares, subject to following pre-conditions:
issue of DVR shares must have been be authorised in the articles of association of the company; and
the issue of DVR Shares should be authorized by a special resolution passed at a general meeting of the shareholders.
for companies already listed, by way of e-voting as per Companies Act, 2013
The notice should mention specific matters, including but not limited to, size of issuance, ratio of the difference in the voting rights, rights as to differential dividends, if any, sunset clause, coattail provisions, etc., as made applicable by SEBI regulations to be notified in this regard.
Requirements for both the categories
Category I: Companies whose equity shares are already listed—issuance of FR shares;
Category II: Companies whose equity shares are proposed to be listed—issuance of SR shares.
”Coattail” Provisions for Issuance of SR Shares
Post-IPO, the SR shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one SR share-one vote) in the following circumstances:
a) provisions relating to appointment or removal of independent directors and/or auditor;
b) in case there is a change in control of the company;
c) any contract or agreement of the company with any person holding the SR Shares, in excess of the materiality threshold prescribed under Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015;
d) voluntary winding up of the company;
e) any material changes in the company’s AoA or MoA, including but not limited to, undertaking variation in the voting rights of the shareholders, changing the principal objects of the company, granting special rights in favour of a particular shareholder or shareholder groups and such other items as may be prescribed by the SEBI;
f) initiation of a voluntary resolution plan under the Insolvency and Bankruptcy Code, 2016;
g) extension of the validity of the SR shares after completion of five years from date of listing of ordinary equity shares; and
h) any other provisions notified by SEBI in this regard from time to time.
The major benefits of DVRs structure highlighted in the DVR Group Report are as follows:
1. DVRs promote fund raising without diluting control;
2. In a promoter led companies, DVR structure will enable such promoters to retain control, the decision-making powers and other rights in the company;
3. DVRs structure acts as defense mechanism for hostile takeover.
The recommendations by DVR group seems to extend a hand of opportunity to listed companies and those companies including, newly incorporated companies, who intend to issue DVRs but do not have a consistent track record of distributable profits as stated in the existing ICDR regulations for three years.
The sunset clause in case of SR shares shall keep a check on the tenure of the DVRs, however, the provisions requiring companies issuing the DVRs to observe better corporate governance practices is missing in the proposed structure of DVRs. Further, there might be instances where the interest of minority shareholders could be adversely affected by the holder of SR shares, therefore, certain checks and balances to prevent the misuse of the instruments should be imposed by SEBI to protect the interest of the shareholders as well as the genuine issuers.
(Both Nikita Snehil and Shaifali Sharma work in the corporate law division at Vinod Kothari & Co)