Differential voting rights (“DVR”) refer to equity shares holding differential rights as to dividend and/or voting. In India, section 43 (a) (ii) of the Companies Act, 2013 (“Companies Act”) allows a company limited by shares to issue DVRs as part of its share capital. Introduced for the first time in 2000, DVRs are seen as a viable option for raising investments and retaining control over the company at the same time. Recently, there has been renewed interest in DVRs with the Securities and Exchange Board of India (“SEBI”) releasing a consultation paper on the ‘issuance of shares with differential voting rights (DVRs)’ and subsequently approving the framework for the same in line with the present government’s 100 (hundred) day agenda to revive the economy.
DVRs Prior to the Companies Act, 2013
DVRs were first introduced in India by way of an amendment[i] to section 86 of the Companies Act, 1956 (“Old Act”), which provided that the share capital of a company limited by shares shall only be of 2 (two) kinds, namely equity share capital and preference share capital. The aforesaid section 86 permitted equity share capital to have differential rights as to dividend, voting or otherwise, in accordance with such rules and subject to such conditions as would be prescribed by the government. Pursuant to this amendment, two Indian companies, namely, Tata Motors and Pantaloons Retails (now renamed as Future Enterprises Limited) issued DVRs with 1/10th (one by ten) voting rights as compared to ordinary shares in exchange for 5% (five per cent) higher dividend as compared to ordinary shares.
In a similar vein, 2,500,000 (two million five hundred thousand) preference shares (with DVRs) of Jagatjit Industries Limited were issued to a company controlled by Mr. Karamjit. This issuance of DVRs effectively raised Mr. Karamjit’s voting rights and gave him substantial control over Jagatjit Industries Limited even though his economic contribution did not reflect such a leap. While this move was challenged by minority shareholders of the company, the Company Law Board approved the allotment of preferential shares with DVRs, the same being legally permissible in light of section 86 of the Old Act.
However, shortly thereafter SEBI issued a circular dated July 21, 2009 which stated that “the company agrees that it shall not issue shares in any manner which may confer on any person, superior rights as to voting or dividends vis-à-vis the rights on equity shares that are already listed.”
The net effect of this circular resulted in companies being prohibited from issuing superior voting rights or lower voting rights with higher dividends as compared to ordinary equity shares that were already listed. Thus, as a result of the abovementioned circular, Indian companies who opted for issuance of shares with DVRs did so by issuing bonus shares with lower voting rights but carrying the same dividend rights as ordinary shares.
DVRs under the Companies Act, 2013
Section 43(1) of the Companies Act (which replaced the Old Act) is similar to Section 86 of the Old Act and allows the issuance of equity shares with differential voting rights. However, Section 47 of the Companies Act provides that every member of a company limited by shares and holding equity share capital therein, shall have a right to vote on every resolution placed before the company.
Thus, it gives every shareholder of a company the right to vote on every resolution presented before the company, in proportion to his/her share of the paid-up equity share capital. However, section 47 of the Companies Act is subject to section 43 of the Companies Act which, means that companies can issue shares with differential voting rights, notwithstanding the implicit ‘one-share-one-vote’ requirement under section 47 of the Companies Act.
Until August 16, 2019, Rule 4 of Companies (Share Capital and Debentures) Rules, 2014 (“SCDR”) set out certain additional requirements to be complied with by companies which wish to issue shares with differential rights as to dividend, voting or otherwise. These requirements were that (i) the company’s articles of association should authorise the issuance of shares with differential rights; (ii) the issue of shares is authorized by an ordinary resolution passed at a general meeting of the shareholders; (iii) the shares with differential rights shall not exceed 26% (twenty six per cent of the total post-issue paid up equity share capital including equity shares with differential rights issued at any point of time; and (iv) (d) the company having a consistent track record of distributable profits for the last 3 (three) years.
The erstwhile 26% (twenty six per cent) limit on the number of DVRs that can be issued was based on debatable policy considerations. The need to have a 3 (three) year track record of profitability restricted the number of companies eligible to issue shares with DVRs.
SEBI’s Consultation Paper on Issuance of DVRs
On March 20, 2019, SEBI released a consultation paper (“Consultation paper”) on the issuance of DVRs to address the “increasing debate about the need to enable issuance and listing of shares with DVRs in India”. Amongst other things, the paper highlighted the benefits and need for DVRs in light of India’s “high growth phase, which requires companies to raise capital to sustain this growth.” Furthermore, since some companies with asset light models prefer equity over debt capital, issuance of “shares with superior voting rights (“SRs”) to founders and/or shares with lower or fractional voting rights (“FRs”) to private or public investors may be seen as a viable option to raise equity capital.
In the Consultation Paper, SEBI proposed to regulate issuance of DVRs under two broad heads, namely, (i) “issuance by companies whose equity shares are already listed on stock exchanges, and (ii) issuance by companies with equity shares not hitherto listed but proposed to be offered to the public.” In a move towards protecting and promoting the rights of founders/promoters of a company, SEBI noted its assent for permitting the issuance of SRs and FRs, especially for “new technology firms which have asset light models, with little or no need for debt financing.” Recognising the fact that retaining the founders’ interest and control in technology companies is integral to the success of the company, issuance of DVRs will allow for growth of the business and thereby for all shareholders. The Consultation Paper also examined the rules and requirements for issuance of DVRs across various jurisdictions. The proposed regime for India borrows heavily from the regulations in vogue in jurisdictions abroad.
Some of the key proposals of the Consultation paper with respect to companies with unlisted equity shares are as follows:
Eligibility: SR shares can be issued only to the promoters of an unlisted company. An unlisted company where the promoters hold SR shares shall be permitted to do an Initial Public Offer (“IPO”) only the ordinary equity shares, provided the SR shares are held by the promoters for more than one year prior to filing of the draft offer document with SEBI.
Subsequent issue of SR shares: A company shall not be permitted to issue SR shares in any manner whatsoever, including by way of rights issue or bonus issue, once its ordinary equity shares have been listed.
Face value of SR shares: The face value of a company’s SR shares shall be the same as of that of the ordinary equity shares.
Lock-in of SR shares: All SR shares shall remain under a perpetual lock-in after the IPO.
Pledge of SR shares: No encumbrance shall be created over SR shares including pledge, lien, negative lien, non-disposal undertaking, etc.
Voting and Other Rights on SR shares: The SR shares shall be treated at par with the ordinary equity shares in every respect, including dividend, except with respect to voting rights.
The voting rights available to SR shares shall not exceed the ratio of 10:1, i.e. (ten votes for every SR share held). This ratio has to be in whole numbers from 2:1 to 10:1. A ratio once adopted by a company shall remain valid for any subsequent issuances of SR shares. A company can issue only one class of SR shares.
Initial disclosures: The company shall disclose, in the offer document, the names of all holders of SR shares, with complete details of all special rights that have been provided to them. No change in the terms of the SR shares, which are favourable to the SR shareholders, shall be permitted post-IPO, other than the sunset clause.
Minimum public shareholding: The company shall comply with the minimum public shareholding requirements in terms of the Securities Contracts (Regulation) Rules, 1957 (“SCRR”) for the ordinary equity shares that will be listed. Post-listing, the voting rights with the promoters through the SR shares and ordinary equity shares shall not exceed 75% (seventy five per cent) of the total voting rights.
Coat - tail provisions: 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:
Sunset clause/ Conversion of SR shares: The SR shares shall automatically convert into ordinary equity shares on the 5th (fifth) anniversary of the listing of the ordinary shares of the company i.e. they shall lose their superior voting rights and each SR share shall be entitled to a single vote as if it were an ordinary equity share. The validity of the SR shares can be extended by another 5 (five) years with the approval of shareholders by way of a special resolution in a general meeting where all members vote on a “one-share-one vote” basis irrespective of the nature of their shareholding. The promoters, however, may do an accelerated conversion of their SR shares into ordinary equity shares at any time prior to the 5th (fifth) anniversary or such extended period.
The SR shares shall be compulsorily converted into ordinary equity shares in the event of a merger or acquisition of the company or whenever these are sold by the identified promoters who hold such shares or in the case of demise of the promoter(s). Transfer of SR shares amongst promoters or persons of the promoter group(s), even though they are inter-se transfers between persons acting in concert, shall not be permitted.
Listing and trading: All SR shares shall be held in dematerialized form and shall be listed on the main board platform of the recognized stock exchanges. For listing of SR shares, exemption will be granted from Rule 19(2)(b) of SCRR. The SR shares, however, 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 SR shares in the format specified by SEBI and the stock exchanges.
We have omitted the proposals of the Consultation paper relating to issuance of DVRs by companies whose equity shares are already listed on stock exchanges since the framework finally approved by SEBI only provides for the issuance of DVRs by companies with unlisted equity shares.
Statutory Amendments provided by SEBI’s Consultation Paper
The Consultation Paper highlighted a few statutory provisions that might require to be amended in order to accommodate the framework surrounding issuance of DVRs:
SEBI (Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”):
SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”):
Securities and Exchange Board of India (Buy Back of Securities) Regulations, 2018 (“Buy Back Regulations”):
Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009 (“Delisting Regulations”):
Approved Framework for Issuance of DVRs (“Approved Framework”)
SEBI approved a framework for issuance of DVRs, along with amendments to relevant SEBI regulations to give effect to the framework, during a SEBI board meeting held on June 27, 2019. The Approved framework deviates from the proposals in the consultation paper in various respects and makes changes to the ICDR Regulations, the LODR Regulations, the Takeover Code, the Buy Back Regulations and the Delisting Regulations. The terms of the Approved framework are as follows:
Eligibility: Company having SR shareholders would be permitted to do an IPO of only ordinary shares to be listed on the main board, subject to fulfilment of eligibility requirements as per chapter II (part I) of the ICDR Regulations and the following conditions:
Pre-issue disclosures: Company shall disclose names of all SR shareholders along with complete details of all special rights provided and the coat tail provisions in the offer documents required under ICDR Regulations.
Minimum promoter contribution: SR shares would be allowed towards computation of minimum promoter contribution requirement of ICDR Regulations.
Listing and Lock-in: SR shares shall also be listed on stock exchanges after the issuer company makes a public issue. However, SR shares shall be under lock-in after the IPO until their conversion to ordinary shares. In case of early conversion of SR shares to ordinary shares, the shares shall continue to be under lock-in in terms of chapter II (part IV) of the ICDR Regulations i.e. for 3 (three) years after listing for SR shares considered for minimum promoter contribution and for 1 (one) year for SR shares in excess of minimum promoter contribution. Transfer of SR shares among promoters shall not be permitted. No pledge/ lien shall be allowed on SR shares.
Rights of SR shares: SR shares shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions. The total voting rights of SR shareholders (including ordinary shares), post listing, shall not exceed 74% (seventy four per cent).
Enhanced corporate governance: In view of disproportionate voting rights conferred to promoters vis-à-vis their economic holding, companies having SR shareholders shall be subject to enhanced corporate governance as follows:
Coat-tail provisions: Post-IPO, the SR equity shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one SR share shall have only one vote) in the following circumstances:
Any other provisions notified by SEBI in this regard from time to time.
Time based sun-set clause: The SR shares shall be converted to ordinary shares on the 5th (fifth) anniversary of listing. However, the validity of SR shares can be extended once by 5 (five) years through a resolution. SR shareholders would not be permitted to vote in such resolutions. SR shareholders can convert their shares to ordinary shares at any time prior to sun-set.
Event based sun-set clause: On the occurrence of following events, SR shares shall compulsorily get converted into ordinary shares.
Whenever such shares are sold by the SR shareholder after the lock-in period but prior to time based sunset.
Subsequent issues: In case company decides issue of bonus or split of shares, SR shareholders shall be entitled for SR shares. Similarly, SR shareholder shall be entitled to SR shares in case of a rights issues. However, the rights of SR shares cannot be renounced by the SR shareholder. The ratio of voting rights of all such SR shares shall remain same as that adopted by the company initially. The time based sunset for such SR shares shall continue to be from the date of listing of ordinary shares of such company.
Post-issue disclosures: SR shareholding to be disclosed in periodic disclosure of shareholding pattern.
Deviations from the Consultation Paper
The Approved Framework does not provide for issuance of DVRs by companies whose equity shares are already listed on stock exchanges, even though the Consultation Paper did envisage such a possibility. The following proposals in the Consultation Paper also do not find a presence in the Approved Framework:
Amendments to SCDR
On August 16, 2019, the government issued a notification to amend SCDR. Clause (d) of rule 4(1) of SCDR which requires a company to have a consistent track record of distributable profits for the previous 3 (three) years in order to be eligible to issue DVR shares was deleted. Clause (d) of rule 4(1) of SCDR which imposed a limit of 26% (twenty six per cent) on the percentage of shares with differential rights out of the total post-issue paid up equity share capital was amended and the aforesaid limit was increased to 74% (seventy four per cent).
This paper has been written by Vinod Joseph (Partner) and Radhika Kothari (Associate).Download Pdf
 Amended to 74% with effect from August 16, 2019
 This requirement has been deleted with effect from August 16, 2019.
Earlier known as the Institutional Trading Platform. SEBI amended the SEBI ICDR with effect from 5th April, 2019 vide notification no. SEBI/LAD-NRO/GN/2019/08 to list out the eligibility criteria for the Innovators Growth Platform.
[i]Vide the Companies (Amendment) Act, 2000
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