Dual class share (DCS) structures are becoming more popular around the world. While they have been existent in several companies in the United States (US) for some decades now, they were accompanied sometimes by a sense of unease among investors and regulators due to the disparity they create between economic rights (level of ownership) of shareholders and their control rights (voting). Since the turn of the century, DCS structures have received further rejuvenation as companies such as Google, Facebook and Alibaba, which made mega listings, used versions of the DCS structure. More recently, jurisdictions such as Hong Kong and Singapore, which were hitherto steadfast in their resistance to the use of DCS, permitted listings with these structures on their stock exchanges.
In India, DCS, commonly referred to as shares with differential voting rights (or DVRs), made their appearance on the scene through the Companies (Amendment) Act, 2000. The legislation also imposed conditions upon which companies may issue DVRs. The broad concept and conditionalities associated with DVRs have also found their place in the Companies Act, 2013. While some companies such as Tata Motors began listing DVRs on the stock exchange, SEBI issued a pronouncement in 2009 that prohibited companies from issuing shares with “superior” rights as to voting or dividend. This effectively acted as a curb against DVR structures, and few companies resorted to this mechanism in the aftermath of SEBI’s decision.
Late last year, however, indications emerged that the Securities and Exchange Board of India (SEBI) was considering a revival of DVRs in the Indian context. This week, SEBI issued a Consultation Paper on Issuance of Shares with Differential Voting Rights, by which it seeks to bring about a reintroduction of DVRs for Indian companies. In this post, I discuss some of the key proposals in the Consultation Paper.
SEBI’s Consultation Paper begins with an analysis of the evolution of DVRs more broadly and a consideration of a benefits and disadvantages of the structure both for issuers as well as investors. It then scans the legal regime in India governing DVRs, including the Companies Act and various SEBI regulations, which is followed by an comparative overview of the legal regimes in jurisdictions such as the US, Canada, Hong Kong and Singapore. The Consultation Paper also notes that some countries like the United Kingdom and Australia do not permit DVRs.
Upon a consideration of the various issues, SEBI proposes to allow Indian companies to adopt DVR structures subject to certain conditions. Here, two routes are available: first, for companies that are already listed on the stock exchanges and wish to list DVRs (secondary listings) and, second, for companies that are unlisted but wish to list on the stock exchanges with DVR structures (primary listings).
The Consultation Paper reflects an element of uniqueness in the manner in which SEBI propose to design DVRs for India. Universally, these structures operate to create different classes of ordinary shares, each of which may carry different rights regarding voting and dividend. However, SEBI’s foray into the field in 2009 introduced the concept of “superior” rights which, as a corollary, would compel one to contemplate inferior rights. The Consultation Paper develops this concept further. It assumes that the default position or benchmark for consideration of superiority or inferiority, as the case may be, regarding voting rights is the “one-share one-vote” rule that all ordinary shares are subject to. If a shareholder were to receive voting rights which are in excess of one vote per share, that would be a share with superior voting rights (or SR Share). Conversely, if the shareholder were to receive fractional voting rights of less than one vote per ordinary share, then that would be a share with fractional voting rights (or FR Share). This distinction is crucial for the remainder of the analysis because the scheme of the Consultation Paper seeks to make a bifurcation by which FR Shares would be permitted for secondary listings and SR shares for primary ones.
Types of Listings
A company whose shares have been listed on the stock exchange for at least a year may issue FR shares. These shares are typically issued to outside investors who are willing to receive control rights in the company. While the maximum number of shares that can be issued is governed by the Companies Act, SEBI proposes that the voting rights on FR shares cannot exceed 1:10, i.e., one vote for every 10 shares. Of course, the company may decide to pay higher dividend on FR shares, which operates effectively as quid pro quo for lower control rights enjoyed by the investors holding FR shares.
On the other hand, only unlisted companies may issue SR shares and that too only to promoters. This is to ensure that promoters can maintain an additional level of control in excess of their economic rights before the company undertakes an initial public offering (IPO) to list its shares. Once the company it listed, it can no longer issue SR shares.
SR shares are accompanied by other conditions. Given that only promoters can hold them, it prevents them from creating any form of encumbrance over those shares. Similarly, SR shares are permitted to a perpetual lock-in after the IPO. SR shares shall constitute a maximum of 10:1, whereby they cannot exceed 10 votes for every share held by the shareholder.
Understandably, it is not desirable to grant superior rights on SR shares on every matter that is placed for decision before the shareholders. On some matters, all shareholders (including those holding SR shares) must be subject to the default rule of one vote per share. These are crucial matters that are fundamental to the existence and business of the company. In this regard, the Consultation Paper provides for certain “coat-tail provisions” whereby SR shares will be treated on par with other ordinary shares and will have equal voting rights along with ordinary shareholders on matters such as appointment and removal of independent director or auditor, change of control, entering into a contract with a person holding SR shares, alteration to the constitution documents, voluntary winding up of the company and a few others.
Interestingly, SR shares are subject to a sunset clause whereby they would automatically convert into ordinary shares at the end of five years from the date of listing where their voting rights become on par with other ordinary shares. However, the life of the SR shares may be extended by a further five years if the same is approved by way of a special resolution whereby all shareholders vote on a one-share one-vote basis. Promoters, of course, can accelerate the conversion to ordinary shares at their option. Such sunset provisions are a recognition that DVRs are required only at the initial stages in the lifecycle of a company where they perform the role of enabling the promoters to assume business risks without ceding control. Once that purpose runs its life, there is no longer a continued rationale for DVRs, and hence they must come to an end. This is also important from a corporate governance perspective as it prevents the promoters from exercising control by merely holding relatively small number of shares, and that too for an indefinite period of time.
Finally, SEBI’s Consultation Paper suggests amendments to the Companies Act and various SEBI Regulations such as those relating to capital issuances, continuous listing requirements, buyback and takeovers, which reflect the impact of DVRs on these legislative and regulatory provisions.
Overall, SEBI’s approach towards operationalizing DVRs is a welcome one. This is consistent with the resurgence of this instrument in other parts of the world as a means to allow companies, especially those in the “new economy”, to list on the stock exchanges. It allows founders of such companies to retain control, thereby enabling them to take business decisions without short term investor pressures. The sunset provisions, however, ensure that the DVR structure is finite and will be put to rest once the purpose is served, which is determined to be the lapse of five years from the date of listing.
One missing piece in SEBI’s design for DVRs is that it does not requirement companies that issue FR shares or SR shares to observe higher standards of corporate governance. This is a precondition in some of the other leading jurisdictions that have permitted such structures, given the greater concerns regarding the ability of promoters holding higher voting rights to adversely affect the interests of minority shareholders. If certain checks and balances are not introduced, DVR structures carry the hazard of precipitating governance implosions if issuers and investors seeks to misuse the instrument. A backlash against such episodes will affect genuine issuers of DVRs as well.