Listed Companies & Differential Voting Rights Framework – A forgotten tale?
Nityesh Dadhich [i]
Despite the economic havoc caused by the pandemic & a series of lockdowns and restrictions, the Indian stock market doubled itself and touched new heights in 2021. The last year proved to be the best IPO Year over the past 20 years, raising over 1.18 Trillion Rupees through IPOs. Differential Voting Right (DVR) shares (explained here) enable the promoter group of a company to raise equity without diluting their control over the company. In order to attract investments, DVRs are offered at a discount and they return higher dividends in comparison to ordinary shares. Thus, in theory, DVRs seem a lot more attractive for retail investors since they give a higher dividend provided that retail investors agree to dilute their voting powers. However, even this bullish period of the stock market coupled with various relaxations failed to attract any company to issue DVR shares.
Section 43(a)(ii) of the Companies Act (‘the Act’) allows the companies to issue equity shares having ‘differential rights as to dividend, voting or otherwise’, which are commonly known as DVR shares. DVR shares can be classified as ‘Superior Voting Right’ shares (which offer voting rights greater than the usual ‘one share one vote’ rule) or as ‘Inferior/Fractional Voting Right’ shares. DVR Shares were first introduced through the Companies (Amendment) Act, 2000; and Tata Motors was the first company to issue DVR shares in 2008. However, subsequently, the issue of ‘Superior Voting Right’ shares was prohibited by SEBI in light of possible misuse of funds by DVR shareholders. In 2019, SEBI reversed its policy and prohibited the issuance of inferior voting right shares while permitting the issuance of Superior Voting Rights (SVR) shares by listed companies.
Analysis of India’s DVR framework against International Standards
Rule 4 of the Companies (Share Capital & Debenture) Rules, 2014 prescribes certain conditions for the issuance of DVR shares. These include –
· The issuance of DVR shares must be permitted by the Articles of Association of the Company;
· DVR shares cannot exceed 26 percent of the post-issue paid-up share capital
· The company must not have defaulted on payment of declared dividend or on loan repayment.
Along with the above-mentioned requirement, the ‘SEBI Board’ 2019 enacted a framework (“Framework”) on the issuance of DVR shares, applicable to listed companies. It permits the issuance of DVR shares with voting rights from a minimum of 2:1 to a maximum of 10:1 when compared to the voting right of an ordinary share, and the total voting rights of DVR shareholders cannot exceed 74 percent of the total voting rights within the company. This calculation of 74 percent voting rights shall also take into account the ordinary shares held by the DVR shareholders.
Sunset Clause -
SEBI Regulations also introduce two ‘sunset clauses’, on the happening of which a DVR share would be converted to an ordinary share. Firstly, on completion of five years from the issuance of such shares (time-based sunset clause), and secondly, when the DVR shareholder dies/resigns, etc (event-based sunset clause). The time-based sunset clause, as adopted by India, provides no mechanism for ordinary shareholders to voluntarily discontinue DVR shares. Such a time-based sunset clause is not adopted by Singapore or Hong Kong. In the United States, companies have the choice to adopt such a sunset clause. To ensure shareholders’ protection, SEBI should relax the sunset clause requirements by allowing the shareholders to decide the duration of DVR shares or their subsequent extension and to discontinue the DVR framework if ordinary shareholders believe that the same is being misused.
Shareholders’ protection -
A variety of retail and institutional investors participate in the securities market, and the securities regulator such as SEBI in India has a duty to protect the interests of the investors (seefor instance Section 11 of the SEBI Act). In 2018, the Singapore Exchange (SGX) permitted the listing of companies that had issued DVR shares. Under the SGX’s Mainboard Rules (see rule 210), SGX considers the following factors to determine the suitability of the DVR shareholders such as the business model and track record of the company, participation of institutional shareholders, and foreign investors within the company, etc. SGX can prevent the listing of a company if there are inadequate safeguards to protect the interests of the ordinary shareholders.
SGX Mainboard Rules permit the ordinary shareholders to call a shareholders’ meeting by satisfying a reduced quorum requirement of 10 percent of total voting rights. However, such a discount regarding quorum requirements is absent in the SEBI Regulations. A commendable step towards shareholders’ protection is that SEBI Regulations require at least half of the company’s board and at least 2/3rd of members in all the committees prescribed under SEBI(LODR) Regulation, 2015 to mandatorily comprise independent directors (except the audit committee which must solely comprise of independent directors). The greater independence of the board would ensure greater objectivity, and accountability, and shall especially protect the interests of non-DVR shareholders.
In the United States, DVR shares can be converted into ordinary shares at any instance, but in India, this is prohibited under Rule 4(3) of the Companies (Share Capital & Debenture) Rules, 2014. As per the SEBI Regulations, SVR shares can be listed on the stock exchange but these shares cannot be traded/transferred by the promoters until these shares are converted into ordinary shares. Unlike this, SGX puts all the shares held by the DVR shareholder under a lock-in period of twelve months after the public listing of the shares (including any ordinary share held by the DVR shareholder). After this lock-in period, the DVR shares can be converted into ordinary shares. Thus, SGX Mainboard Rules differ from the Indian position in two major aspects. Firstly, the lock-in period extends even to ordinary shares of that company held by DVR shareholders. Secondly, SGX imposes a lock-in period of twelve months after which shares can be converted to ordinary shares and transferred, as and when wished by DVR shareholders. Whereas, SEBI’s sunset clause gives no opportunity to DVR shareholder to transfer such shares unless he/she resigns from the position of a promoter within the Company or until the fifth anniversary of its public listing. Thus, a provision enabling DVR shareholders to voluntarily convert their shares into ordinary shares should be introduced.
Attracting Companies to India’s DVR Framework
DVR Shares were first introduced in India in 2000, but even after over 21 years of existence in India, only four listed companies have issued DVR shares. In 2008, Tata Motors issued India’s first DVR shares by offering a 5 percent additional dividend compared to ordinary shareholders, and with only 10 percent of voting rights as compared to an ordinary share. For instance, an ordinary shareholder would get a dividend of 10rs and a DVR shareholder would get a dividend of 10.50rs. Thus, the benefits offered in absolute terms of dividends seem much lower when compared with the requirement to reduce 90 percent of the voting rights. In light of the ongoing discussion, I offer two suggestions for the existing DVR framework.
Firstly, it is suggested that several ex-ante restrictions such as strict regulation of DVR listing, strict sunset clauses, excessive corporate governance, etc. have reduced the popularity of the DVR framework for both companies and investors. These ex-ante restrictions have created stringent regulations and increased compliance costs deter companies from issuing DVR shares. It is suggested that greater reliance must be upon ex-post measures such as stringent penalty on violation of regulations/misuse of voting rights, private enforcement against DVR shareholders, representative proceedings on behalf of aggrieved shareholders, etc. Thus, higher penalties and punishment must be imposed in case of any violations rather than complicating the issuance of DVR shares by increasing applicable regulations.
Secondly, SEBI Regulations only permit ‘tech companies’ to get their Superior Voting Right shares listed through an IPO. A ‘tech company’ has been defined as a company having ‘intensive use of technology’. Unfortunately, there is no clarity regarding when use of technology by a company becomes ‘intensive’. This uncertainty is not limited to India. Hong Kong’s DVR framework only permits ‘biotech/innovative’ companies to issue DVR shares. As the primary aim of DVRs is to enable companies to readily raise capital, but at present this option is available only to ‘tech companies’ if they want to get listed. This comes without any explanation of underlying rational distinguishing ‘tech’ from ‘non-tech’ companies. Such artificial distinction should be done away with as it only acts as an hinderance in the growth of DVRs in India.
Globally, DVR shares have become popular due to their flexibility enabling the promoters to raise equity capital without diluting their control. In the United States, the number of listed companies that issued DVR shares increased from 33 in 2020 to 101 in 2021, which is an all-time high. Jack Ma’s Alibaba was listed in New York after its DVR listing was denied by the Hong Kong Exchange. Despite India’s timely adoption of the DVR framework, it has only received lukewarm response.
In light of this, a flexible and uniform DVR framework should be adopted. DVR shareholders should be allowed to voluntarily convert their DVR shares, after a reasonable lock-in period. Similarly, the Regulations should be amended to incentivize DVR shareholders to responsibly exercise their power. For instance, Hong Kong Exchange (HKEX) requires DVR shareholders to hold at least a cumulative economic interest of 10 percent within the organization. This ensures that DVR shareholders have a reasonable economic interest within the organization and hence, it aligns the interests of DVR shareholders with the ordinary shareholders (who contribute the majority of capital within the organization). Lastly, the complexities involved in the issuance of DVR shares must be reduced by adopting ex-post regulations such as private enforcement, stringent penalty or punishment on misuse of voting rights, etc. Such ex-post measures would make it easier for companies to issue DVR shares. In 2021, while SEBI relaxed the DVR issuing norms, but only time will tell whether these relaxations will succeed to attract companies to the DVR framework.
Nityesh Dadhich is a final year law student at National Law University Delhi. His interests lie in Corporate and Competition Law.