Under the Companies Act, 1956, shareholding in an Indian company is almost entirely associated with concepts like rights, entitlements and ownership. This emanates from Section 82, which reads as follows:
The shares or debentures or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company.
Shareholding is generally not accompanied by any legal duties as such. For example, while shares entitle their holders to vote at a shareholders’ meeting, there is no obligation or duty to in fact vote. At most, there may be some indirect consequences of actions by a shareholder, such as an action for oppression or mismanagement initiated by minority shareholders.
On the other hand, the other governing body of the company, the board of directors, is subject to a whole range of duties owed to the company; directors owe the duty of care other and fiduciary duties. For example, there are specific duties relating to transactions involving conflict of interest of directors. Sections 297, 299 and 300 of the Companies Act, 1956 elaborate on conflict of interest transactions, and require disclosure of conflicts by directors and their abstention from meetings at which conflicted transactions are discussed and from voting on them.
The position relating to the differences between duties as shareholders and directors has also been recognised under case law. In the leading case of Rolta India Ltd. v. Venire Industries Ltd., [2000] 100 Comp. Cas. 19, the Bombay High Court, which was considering the validity of a pooling agreement between shareholders, focuses on this fine distinction:
21. Regarding pooling agreement, it may be noted that it is an agreement between two or more shareholders which generally provides that in exercising any voting rights, the shares held by the shareholders shall be voted as provided therein; it is a contract to the effect that the shares held by them shall be voted as one single unit. The shareholders bind one another to vote as they mutually agree. In a pooling agreement, each shareholder retains sole ownership of shares binding himself only to vote for a specific person or in a certain way. These agreements are enforceable because the right to vote is a proprietary right. …
…22. … However, a pooling agreement cannot be used to supersede the statutory rights given to the Board of Directors to manage the company, the underlying reason being that the shareholders cannot achieve by pooling agreement that which is prohibited to them, if they are voting individually. Therefore, the power of shareholders to unite is not extended to contracts, whereby restrictions are placed on the powers of Directors to manage the business of the Corporation. It is for this reason that a pooling agreement cannot be between Directors regarding their powers as Directors. There is vast difference in principle between the case of a shareholder binding himself by such a contract and the Director of the Company undertaking such an obligation by compromising his fiduciary status. The shareholder is dealing with his own property. He is entitled to consider his own interests, without regard to interests of other shareholders. However, Directors are fiduciaries of the Company and the shareholders. It is their duty to do what they consider best in the interests of the Company. They cannot abdicate their independent judgment by entering into pooling agreements. The Company works through two main organs, viz. the shareholders and the Board of Directors.
Contrast this with the position in other jurisdictions such as Delaware, the leading state for corporate law in the U.S. Here, even controlling shareholders and not merely directors are foisted with certain fiduciary duties so as to protect the interests of minority shareholders. Kahn v. Lynch Communication Systems Inc., 638 A. 2d 1110 (Del. 1994) and Kahn v. Tremont, 694 A. 2d 422 (Del. 1997) are decisions which are commonly cited on this score. Such fiduciary duties are applied specifically in cases involving self-dealing transactions by the controlling shareholders.
I have found the distinction between Indian law and Delaware law on the question of fiduciary duties of controlling shareholders to be somewhat odd. In India, although a very large number of companies have controlling shareholders (known as promoters), they are not subject to any duties under law in their capacity as shareholders, thereby exposing minority shareholders to some level of vulnerability. On the other hand, although controlling shareholding in the US is rather a rarity (as shareholding is usually diffusely held), the law nevertheless confers some protection to minority shareholders against actions of controlling shareholders, at least in such of those companies where there is concentration of shareholding.
The above discussion (which may, at first sight, appear to be without much context) has been triggered by an observation in SEBI’s order in the case of Rajkot Saher/Jilla Grahak Suraksha Mandal where SEBI was considering the practice of allotment (and often the subsequent lapse) of warrants to promoters. My co-contributor, Mr. Jayant Thakur, offered this detailed analysis yesterday regarding the merits of the order, and I do not propose to traverse the field that he has already well-covered. However, SEBI’s observation in the final paragraph of the order (that is not entirely germane to the main issue at hand) merits some closer attention. SEBI states:
… in respect of the petitioner’s request that Securities and Exchange Board of India should immediately issue regulations prohibiting the promoters from voting in the general meeting on any resolution in which they are interested in, the Securities and Exchange Board of India would take note of the same and initiate a consultative process including taking views of market participants and various others stakeholders, to suggest policy changes, if required, to address the said concern.
This is indicative of SEBI’s intention to impose conflict of interest rules at the shareholder level, which currently do not exist. In a sense, this would impose some kind of duties on shareholders in their capacity as such, which would be a significant departure from existing principles of Indian corporate law, and would shift the regime closer to that existing in Delaware where certain fiduciary duties are applicable to shareholders in addition to directors. This would be a significant step as it would augur well in protecting the interests of minority shareholders, whose interests are currently confined to remedies under the oppression and mismanagement provisions of the Companies Act. For example, if this proposal goes through, it would bifurcate the shareholder body into interested shareholders (who would be prevented from voting) and other shareholders at a general meeting.
Although this is a move in the right direction in enhancing minority shareholder interest and thereby the sanctity of the public capital markets, there could be some questions as to the manner in which this is sought to be achieved, i.e., through prescriptions by SEBI rather than an amendment to the basic company law, which is a matter that requires more detailed consideration, perhaps in a subsequent post.
The concluding observations are, in my conviction, too mild to adequately bring out or focus on the very fundamentality and seriousness of the fallacy / absurdity in the mindless manner in which the SEBI, albeit a mere regulatory authority, has chosen to doctor the referred prescriptions. For, whatever be the compulsions or justification, certainly the SEBI has no legal sanction or power to tinker with the existing position under the company law. In other words, the regulatory authority has, one would submit, acted clearly in excess of its authority or powers; in as much as it has, in a manner of speaking, encroached upon the authority and powers to make any enactment vested only in the constitutional body named, the legislature.
In this context, it needs to be pinpointed that this is not the first / singular instance of its kind in our country’s legal system. To mention one, the precedent may be found in the SEBI’s directives successively issued in the year 2006 mandating compliance with the PAN requirement by – all demat account holders and all persons transacting in the cash market, – that is, including even those who were not otherwise obligated to such compliance under the applicable provisions of the Income –tax Act. For knowing the points of issue that arose, one may read the two published articles in Taxmann’s journal, Chartered Accountants Today – (2006) 6 CAT 565 and 7 CAT 64.
vswaminathan
I have noticed on a few postings and comments on this blog the dissapproval of SEBI seeking to prohibit something in listed companies which is allowed by company law – e.g. shares with differential voting, promoters not being able to vote on certain resolutions etc.
To me SEBI's approach seems to be the correct path. I see no reason why SEBI should not prescribe higher requirements for listed companies or prohibit listed companies from doing things which are otherwise allowed under the Companies Act. This does not take away or is a violation of company law provisions but only allows a regulator dealing with listed companies to set a higher standard. This is similar to the approach adopted by botht he UKLA and SEC and in no way is unusual. It also allows flexibility since SEBI is able to amend its regulations easily without having to go through Parliament which we know is not really focussed on company law issues and is unable to act quickly – e.g. the companies bill has now been a proposal for many years without any realistic move to pass it as a law.
I for one was very pleased to see the requirement of 2/3 public shareholder vote for delisting and hope that we see similar requirements in a number of other situations where there is a conflict of interest with a controlling shareholder. At the same I believe that Indian corporate law and SEBI regulations should also provide for mechanisms for squeeze and delisting where clearly minority shareholders are being offered fair value.