Compliances SEBI

New Norms of Differential Voting Rights

Differential voting rights refer to equity shares holding differential rights as to dividend. Section 43 (a) (ii) of Companies Act, 2013, allows a company limited by shares to issue differential voting rights as part of its share capital. It is introduced in 2000 for the first time; Differential voting rights are seen as a viable option for raising investments and retaining control over the company at the same time. The Securities & Exchange Board of India has recently renewed the interest in differential voting rights by releasing a consultation paper on the ‘issuance of shares with differential voting rights’ and subsequently approving the framework for the same in line with the present government plan to revive the economy.

Differential Voting Rights under the Companies Act, 2013

Section 43(1) of the Companies Act 2013 is similar to Section 86 of the Old Companies Act that allows the issuance of equity shares with differential voting rights. However, Section 47 of the Companies Act mentions that every member of the company limited by shares and holding equity share capital, must have a right to vote on every resolution placed before a company.

Thus, it gives the right to vote to shareholders of a company on every resolution presented before a company in proportion to their share in a paid-up equity share capital. However, section 47 of the Companies Act read with section 43 of the Companies Act means that companies have to issue shares with differential voting rights, notwithstanding the implicit ‘one-share-one-vote’ requirement as given under section 47 of the Companies Act.

Until 2019 August, Rule 4 of Companies (Share Capital and Debentures) Rules, 2014 (SCDR) set out certain additional requirements to be complied with by the companies who wish to issue shares with differential rights as to dividend or voting or otherwise. The requirements were:

• The company’s articles of association must authorize the issuance of shares with differential rights.
• The issue of shares authorized by an ordinary resolution passed at a general meeting of the shareholders.
• The shares with differential rights must not exceed 26% of the total post-issue paid-up equity share capital, including equity shares with differential rights issued at any point of time.
• The company has a consistent track record of profits for the last three years.
• The other 26% limit on the number of differential voting rights that can be issued was based on debatable policy considerations.

SEBI’s Consultation Paper on Issuance of Differential Voting Rights

SEBI released a consultation paper in March 2019 on the issuance of differential voting rights to address the need to enable issuance and listing of shares with differential voting rights in India. The paper highlighted the benefits of differential voting rights in light of India’s high growth phase that requires companies to raise capital to sustain this growth. Moreover, few companies with asset-light models prefer equity capital over debt capital. Issuance of shares with superior voting rights to founders or fractional voting rights to private or public investors can be seen as a viable option in order to raise equity capital. In the Consultation Paper, SEBI has proposed to regulate issuance of differential voting rights under two broad heads, namely,

• Issuance by those companies whose equity shares are already listed on stock exchanges
• Issuance by companies with equity shares not listed but proposed to be offered to the public.

Some of the key proposals of a Consultation paper with respect to companies with unlisted equity shares are as below:

Eligibility: Superior voting rights shares can be issued only to the promoters of an unlisted company. An unlisted company where the promoters hold Superior voting rights shares must be permitted to do an Initial Public Offer only the ordinary equity shares, provided the promoters own the Superior voting rights shares for more than one year prior to the filing of the draft offer document with SEBI.

Subsequent issue of Superior voting rights shares: A company shall not be permitted to issue Superior voting rights shares in any manner, including by way of rights issue or bonus issue, once the ordinary equity shares have been listed.

Face value of Special voting Right shares: The face value of a company’s superior voting rights shares must be the same as of the ordinary equity shares.

Lock-in of Superior voting rights shares: All superior voting rights shares must remain under a perpetual lock-in after the IPO.

Pledge of Superior voting rights shares: No encumbrance has to be created over superior voting rights shares, including pledge, lien, non-disposal undertaking, etc.

Voting and Other Rights on Superior voting rights shares: The superior voting rights shares will be treated at par with the ordinary equity shares in every respect, including dividends, except with respect to voting rights. The voting rights available to SR shares must not exceed the ratio of 10:1, i.e. (ten votes for every SR share held). A ratio, adopted by a company, will remain valid for any subsequent issuance of SR shares. The company can issue only one class of the SR shares.

Initial disclosures: The Company has to disclose, in the offer document, the names of all holders of superior voting rights shares, with complete details of all individual rights that have been provided to them. No change in terms of the superior voting rights shares, which are favorable to the SR shareholders, will be permitted post-IPO, other than the sunset clause.

Minimum public shareholding: The Company must comply with the minimum public shareholding requirements in terms of the Securities Contracts (Regulation) Rules, 1957, for the ordinary equity shares. The voting rights with promoters through the superior voting rights shares and ordinary equity shares must not exceed 75% of the total voting rights.

Listing and trading: All superior voting rights shares must be held in dematerialized form and shall be listed on the mainboard platform of the recognized stock exchanges. For a listing of SR shares, the exemption will be granted from Rule 19(2)(b) of the SCRR. However, SR shares cannot be traded except upon conversion into ordinary equity shares.

Post-Issue Disclosures: The shareholding pattern to be filed by the company with the stock exchanges shall provide the details of both ordinary equity shares and superior voting rights shares in the format specified by SEBI and the stock exchanges.

Approved Framework for Issuance of Differential Voting Rights

SEBI has approved the framework for issuance of a differential voting rights, along with amendments to relevant SEBI regulations to give effect in a board meeting held on 27 June 2019. It makes changes to the ICDR Regulations, the LODR Regulations, the Takeover Code, the Buy-Back Regulations, and Delisting Regulations. The terms of the Approved framework is as below:

Eligibility: Company having Superior voting rights shareholders would be permitted to do an IPO of only ordinary shares to be listed on the mainboard, subject to fulfillment of eligibility requirements as per chapter II (part I) of the ICDR Regulations and the following conditions:

• The SR shareholder has to be a part of the promoter group whose collective net worth does not exceed rupees 500 crores.
• The SR share has been issued only to the promoters/ founders who hold an executive position in the company.
• SR share has been held for a period of at least six months prior to the filing of Red Herring Prospectus (RHP).
• SR share has the same face value as of ordinary shares.

Pre-issue disclosure: Company has to disclose the names of all SR shareholders along with complete details of all special rights provided and the provisions in the offer documents required under ICDR Regulations.

Minimum promoter contribution: Superior voting rights shares will be allowed towards the computation of minimum promoter contribution requirement as by ICDR Regulations. 

Listing and Lock-in: Superior voting rights shares will also be listed on stock exchanges after the issuer company makes a public issue. However, SR shares must be under lock-in after the IPO until the conversion into ordinary shares. In case of when the early conversion of SR shares to ordinary shares, the shares will continue to be under lock-in for 3 (three) years after listing for SR shares considered for minimum promoter contribution. Transfer of SR shares among promoters must not be permitted.

Rights of SR shares: SR shares must be treated at par with the ordinary equity shares in every respect, including dividends, except in case of the voting on resolutions. The voting rights of SR shareholders, including ordinary shares, post listing, must not exceed 74%.

Enhanced corporate governance: Because of disproportionate voting rights, the companies having SR shareholders must be subject to enhanced corporate governance as follows:

• 2/3rd of the board and committees (excluding audit committee) as prescribed by the LODR regulations will comprise of Independent Directors.

Coat-tail provisions: Post-IPO, the SR equity shares must be treated as ordinary equity shares in terms of voting rights that is one SR share shall have only one vote in the following conditions:

• Appointment or removal of independent directors and auditor;
• When the promoter is willingly transferring control to another entity;
• Related party transactions in terms of the LODR regulations involving SR shareholder;
• Voluntary winding up of a company;
• Changes in a company’s article of association or memorandum-except any changes that affect the SR instrument;
• Initiation of the voluntary resolution plan under Insolvency and Bankruptcy Code;
• Utilization of the funds for the purpose of other than business;
• Substantial value transaction it based on materiality threshold as specified under the LODR Regulations;
• Passing of the special resolution in respect of delisting or buy-back of shares;
• Any other provisions as notified by SEBI in this regard from time to time.

Time-based sunset clause: The validity of SR shares can be extended once by five years through a resolution. SR shareholders shall not be permitted to vote in such resolutions. SR shareholders can convert their shares to ordinary shares at any time prior to sunset.

Event-based sunset clause: On the occurrence of the following events, SR shares must be compulsorily get converted into ordinary shares. Whenever such shares are sold by SR shareholders after the lock-in period but prior to time-based sunset.

Subsequent issues: In case the company decides the issue of bonus or split of shares, SR shareholders shall be entitled to SR shares. Similarly, SR shareholders shall be entitled to SR shares in case of a rights issue. Therefore, the rights of SR shares cannot be renounced by SR shareholders. The ratio of voting rights of all SR shares will remain the same as that adopted by the company initially. The time-based sunset for such SR shares will continue to be from the date of listing of an ordinary shares of a company.

Post-issue disclosures: SR shareholding has to disclosed in periodic disclosure of shareholding pattern.

Deviations from the Consultation Paper

The Approved Framework does not provide for the issuance of differential voting rights by companies whose equity shares are already listed on stock exchanges. The following proposals in the Consultation Paper do not find a presence in the Approved Framework:

• The Consultation Paper did not permit the issuance of SRs to any persons, including the promoters, by way of rights issue or bonus issue, once its ordinary equity shares have been listed. It has been clarified that SR shareholders shall not be able to renounce these shares.
• The Approved Framework has stated the post listing voting rights of the SR shareholders, which will not exceed 74% of the total voting power as compared to the 75% ceiling imposed in Consultation Paper.
• The Consultation Paper stated that SR shares should remain under the perpetual lock-in after the IPO. However, the Approved Framework states the SRs shall be under lock-in till after the IPO until their conversion to ordinary shares. The Approved Framework has also clarified that SR shares would be allowed towards the computation of the minimum promoter contribution requirement under ICDR Regulation.
• The Approved Framework has divided the sunset clauses into two categories on the basis of the event and time that may lead to the invocation of this clause. In the Consultation Paper, there was no restriction on the number of times the validity of SR shares could be extended. The Approved Framework gives that the validity of SR shares can be extended once by five years.

Conclusion

On 16 August 2019, the government has issued a notification to amend the SCDR. Rule 4(1) Clause (d) of the SCDR requires a company to have a consistent track record of distributable profits for the past three years in order to be eligible for issuance differential voting shares was removed. Rule 4(1) Clause (d) of SCDR which imposed a limit of 26% on the percentage of shares with differential rights out of the total post-issue paid-up equity share capital was amended, and the limit described above was increased to 74% (seventy-four percent).