SEBI's Consultation Paper on Differential Voting Rights
Author: Falguni Gupta, 5th Semester Student, Hidayatullah National Law University, Raipur.
The issue of DVR shares was long permitted in Indian markets since 2000. Commonly known as DVR in India is an ordinary equity share but offering fewer voting rights to the shareholder. These shares are referred to as Dual Class Shares (“DCS”) in an international context. The issue of such shares facilitates the founders/promoters of a company to raise equity without the risk of dilution of control amongst multiple investors and also prevent a hostile takeover.
DVR shares are usually issued at a lower price, offering higher dividends in return to limited voting rights and generally traded at discount. These shares are mainly targeted at small investors or retail investors looking for better economic returns and less interested in having a say in the management of the company.
Treatment under Companies Law
Section 86 of the Companies Act, 1956 provides for the issue of only two kinds of share capital by a limited company: (a) Equity share capital and (b) Preference share capital. The section was amended in 2000 to include a provision for shares with Differential Voting Rights. The amendment introduced the new section 2(46A) in the Act defining “shares with differential rights”.
These were meant to be part of equity share capital with or without differential rights to dividend, voting or otherwise. In respect of voting rights, a company may issue two classes of shares, with one set having superior rights than the other with lower or fractional rights. The former are generally held by the founders/promoters to maintain effective control over the company while the latter is issued for raising funds from public/private investors.
The private companies were not bound by the provisions of the Companies Act, 1956 and as such were free to issue equity shares with DVRs in accordance with the terms contained in their Articles of Association. Later, the Companies Act, 2013 made the conditions and provisions for issue of DVR shares applicable upon both public as well as private companies. The Companies Act, 2013 read with rule 4 of the Companies (Share Capital and Debentures) Rules, 2014 made the issue of shares with differential rights more restrictive. Under the Act of 2013, a company is permitted to issue shares with DVRs limited to the extent of 26% of the total post-issue paid-up equity share capital, if, among other conditions, it has distributable profits and not defaulted in filing annual financial statements and returns for 3 preceding accounting years.
Section 43(a)(ii) of the Companies Act, 2013, permits only the companies incorporated under laws of India and limited by shares to have DVR shares as a part of its equity share capital.
After the amendment of section 86 of Companies Act in 2002, TATA Motors came to be the first listed company to issue DVRs in November 2008. Later in 2009, Pantaloons Retails (now Future Enterprises Ltd.) issued DVRs by way of bonus shares with ordinary shares. The Company Law Board, Delhi in the case of Anand Pershad Jaiswal v. Jagjit Industries Limited held the issue of shares with differential rights to be valid under section 86 together with Companies (Issue of Share Capital and Differential Voting Rights) Rules. Subsequently, SEBI prohibited the issue of DVR shares with superior voting rights, apprehending a possible misuse of the same to the detriment of the shareholders. Post this notification, Gujarat NRE Coke Ltd., Jain Irrigation Systems Ltd. and Stampede Capital have issued shares with DVRs. So far, only above mentioned five listed companies in India have issued DVRs to the public.
Shares with superior rights, giving the shareholder more than one vote per share, can now only be issued by unlisted companies. Astonishingly, the current statutory provisions do not confer any power upon the Securities Market Regulator SEBI to regulate the issue of DVRs. However, the existing guidelines specify the inconvertibility of DVRs, meaning that Class A shares, for instance, cannot be converted into Class B shares.
Recently in March, SEBI came up with a Consultation Paper on the “Issuance of shares with Differential Voting Rights” based on a report prepared by Primary Market Advisory Committee of SEBI and a DVR Group. The paper lists certain advantages and disadvantages of DVR structure for the issuers and investors both.
CHANGES PROPOSED BY SEBI
The consultation paper proposes to regulate the issuance of DVRs under two categories:
Issuance by companies whose equity shares are already listed on stock exchange.Companies with equity shares not hitherto listed but proposed to be offered to the public.
"For companies with high leverage or asset light models may prefer equity over debt capital. Raising equity on a periodic basis leads to dilution of founder/ promoter stake, which can be effectively addressed through use of DVRs as a mode of capital raising," SEBI's Consultation Paper on Issue of Shares with Differential Voting Rights
Taking into account the proposed structure by SEBI, there shall be a classification of companies as:
Equity listed companies – as per the consultation paper; Unlisted companies, intending to get their equity listed – as per the consultation paper;
Unlisted companies which are not intending to get their equity listed – as per Section 43 of the Act read with Rule 4 of Companies (Share Capital and Debenture) Rules, 2014;
Private companies – exempt from applicability of Section 43 of the Act, if so provided in the memorandum or articles of association vide notification number GSR 464(E) dated 5th June 2015.
While countries like USA, Canada, Denmark and Sweden allow the listing of companies with Dual Class Shares, many countries like UK, China, Australia, Germany and Spain do not permit the issuers to list with DCS structure. Recently Hong Kong and Singapore have introduced plans permitting the listing of shares of companies with DCS structure with detailed checks and balances. The consultation paper provides a detailed comparison of DCS in international jurisdiction, which may be summarized as:
700 companies in the US are listed with DCS structures, predominant ones being Google, Facebook, Snapchat, Nike and Alibaba. There is an ongoing debate in the US Securities and Exchange Commission (SEC) apropos the continuation of DCS. There is increasing investor activism against the concentration of voting rights with the management or a few founders. Hong Kong and Singapore have recently allowed DCS to encourage more new technology firms to enlist, which would be applicable only to new listers, unlike in the US, where the listing is permitted to only issuers with a pre-existing dual-class of share structure. In the UK, Dual Class Shares were used in the 1960s to safeguard the corporations from hostile takeovers or for providing the Queen with ‘golden share’, before institutional investors expressed strong opposition to such structures. Presently, DCS is not allowed in the UK. Over the past decade, a number of European governments have implemented or debated the use of different voting rights. The DVR construct in India is unique. In India, it is possible to issue shares with inferior (less than one vote per share) voting rights. Further, in the case of India, both the classes of shares are listed, whereas precedents from the US (except in a few cases such as that of Alphabet) and regulations from Hong Kong and Singapore permit listing of the ordinary shares and shares while the multiple rights, held by founders, remain unlisted.
Shares with differential rights disregard the traditional concept of ‘one share, one vote’. Under the Companies Act, 2013, even a private company will need to comply with these conditions before issuing shares with DVRs as there is no saving section in the Companies Act, 2013. Numerous conditions specified through the Amendment Act of 2000 is also retained. The DVR shares may prove to be good instruments for long term investors, typically small investors, who seek higher dividend and are, essentially, not interested in holding a voting position. However, highlighting the challenge to it, Nicole Sandford said “Knowing what might be in the best interest of the shareholders can become more difficult when shareholders do not have equal rights and benefits”.
 Company Petition no. 60 OF 2007.
 Partner, Deloitte & Touche LLP