Over the last decade and, in particular, following the enactment of the Companies Act, 2013, the Securities and Exchange Board of India (SEBI) has been gradually and consistently strengthening the governance norms pertaining to listed companies. Among other measures, SEBI has sought to focus on two specific matters, viz., (i) enhancing transparency in corporate matters; and (ii) empowering shareholders, particularly the minority, in corporate decision-making. In its latest effort in that direction, SEBI issued a consultation paper on 21 February 2023 to strengthen corporate governance in listed entities by empowering shareholders. The consultation paper addresses four somewhat disparate points:
(i) agreements binding listed entities;
(ii) special rights granted to certain shareholders;
(iii) sale, disposal or lease of assets of a listed entity outside the ‘scheme of arrangement’ framework; and
(iv) ‘board permanency’ at listed entities.
The commonality surrounding these matters is that they bear the strong underlying themes of transparency and shareholder empowerment. This post briefly analyzes each of the proposals and concludes with some overarching remarks.
Agreements Binding Listed Entities
Under the present framework, the continuous disclosure norms in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the ‘LODR Regulations’) require a company to make a disclosure of agreements that are binding on the company and are outside the ordinary course of business. However, SEBI’s concerns seem to emanate from the fact that there could be agreements to which the listed company many not be a party, but such agreements may either have an impact on the management or control of the company or they may impose restrictions or create liability on the company. These could be agreements entered into by the promoters or key management of the company either among themselves or with third parties. Given that the company is not a party to these arrangements, they can be entered into surreptitiously without any form of disclosure to the shareholders of the company.
Hence, SEBI has proposed to include a requirement in the LODR Regulations whereby the disclosure requirements would extend to ‘[a]greements which, either directly or indirectly or whose purpose and effect is to, impact the management or control of the listed entity or impose any restriction or create any liability upon listed entity’. This is regardless of whether the company itself is a party to such agreement or not. If enacted, this change would bring about significant transparency in governance arrangements between the principal actors in a company, such as promoters and key management. No longer would it be possible for them to act opaquely on matters of management and control of the company by entering into contractual arrangements by simply excluding the company from being a party to them. At the same time, it imposes a significant onus on promoters, key management and any other contracting parties (such as substantial investors) to be transparent regarding their arrangements.
More importantly, the proposals take a further giant leap. Not only must such arrangements be disclosed, but they must also obtain the blessings of the board of the target company as well as its shareholders. SEBI’s suggestion is that the directors of the target company must provide its opinion on such agreements along with a detailed rationale, including on whether they are in the economic interest of the listed entity. This places considerable onus on the board of the target to take on board what is otherwise a private matter between promoters, key management or other shareholders. Furthermore, such arrangements also require the approval of the shareholders by way of a special resolution along with a ‘majority of the minority’ requirement, without which they will not be effective. Here again, private contractual arrangements among certain actors are hauled into the realm of corporate decision-making whereby the shareholders of the target (that too minority shareholders) have a say in the validity or otherwise of those arrangements.
If implemented, these measures will eliminate behind-the-scenes contractual maneuvering by key corporate actors and shine the spotlight on them by enhancing their visibility to shareholders and other stakeholders. Moreover, the ability to carry out such contractual arrangements is also subject to their acceptability to the board of the target company (who have to act subject to their duties under corporate law) and the shareholders (in particular, the minority). Given the widespread nature of the agreements and arrangements that are covered by the proposed requirements, there could be some interpretational questions as to what kinds of agreements may be covered. For example, it is altogether understandable that a shareholders’ agreement (if it is one to which the company is not a party) will squarely fall within the remit of the present suggestion as it relates to management and control of the company. But the same cannot be said for potentially other types of agreements to which the company is not a party, but which may ‘impose a restriction or create a liability’ in respect of the listed entity, as much would depend upon the object and nature of the agreement in question.
Special Rights to Certain Shareholders
The existence of special rights conferred upon certain shareholders, whether promoters or others (such as private equity investors) has been a constant bone of contention, as it militates against the principle of equal treatment of all shareholders in a public listed company. Such rights include nomination rights, veto rights, anti-dilution rights and various forms of share transfer restrictions. Although the institution of these rights (typically in the articles of association of the company) requires shareholder approval, their continued operation could potentially run into perpetuity. One of the concerns also relates to the fact that certain shareholders continue to hold these rights even after their shareholding has been substantially diluted. There is currently no system by which the lasting utility of these rights is reexamined from time to time.
In the consultation paper, SEBI has proposed that any such special rights granted to specific shareholders in a listed company shall be subject to shareholder approval within a period of five years from the date of conferment of such rights. For existing special rights, the shareholders have to approve their continuation within a period of five years from the time these new proposals are notified into law.
This measure is altogether understandable. While the institution of these rights required shareholder approval, their continuation did not, and SEBI is only seeking to fill the gap.
Sale, Disposal or Lease outside a Scheme of Arrangement
Currently, corporate restructurings of various forms are governing by section 230 to 232 of the Companies Act, 2013 which, among other things, requires the approval of the National Company Law Tribunal, under whose aegis the scheme is carried out. However, transactions such as a slump sales can be carried out other than through a scheme of arrangement, which are subject to more limited governance considerations. They essentially require the approval of the shareholders under section 180(1) of the Companies Act, 2013 by way of a special resolution. Here, SEBI’s concern appears to be that parties may engage in regulatory arbitrage by effecting transactions through the slump sale route (which is subject to more limited regulatory supervision) instead of a scheme of arrangement (which has more widespread oversight).
Hence, it has proposed two measures when a company seeks to sell, dispose or lease the whole or substantially the whole of its undertaking. The first is to ensure that there is proper disclosure ‘of the objects and commercial rationale for such’ a transaction to the shareholders. Second, and more importantly, SEBI seeks to include a requirement that, apart from a special resolution as required under section 180(1) of the Companies Act, the resolution must also be passed by a ‘majority of the minority’ (by which the votes cast by the public shareholders in favour of the proposal are more than the votes cast against by the public shareholders). Here again, minority shareholder empowerment appears to be the leitmotif of the proposal.
Under the Companies Act, 2013, section 152(6) provides that at least 2/3rds of the directors of every company must be those who retire by rotation. This enables the company to appoint 1/3rd of the directors on a permanent basis, without being liable to retire by rotation. Due to such an arrangement facilitated under corporate law, either promoters or other substantial investors tend to have their nominees on company boards on a permanent basis. Such nominees can serve in their position indefinitely regardless of their performance, which is not subject to any oversight measures with consequences. Hence, SEBI has proposed that even non-retiring directors must be subject to shareholder approval requirements on a periodic basis, i.e., at least once every five years, to be able to continue in their position.
This proposal, if effected, will eliminate the concept of non-retiring directors for all intents and purposes. Permanent directors who do not receive the continued support of the shareholders on a periodic basis have no place on corporate boards. This change will more significantly affect companies with promoter shareholding wherein the promoters or their nominees tend to be permanent directors.
The proposals of SEBI in the current round of corporate governance reforms are significant for a number of reasons. First, they amplify the degree of transparency in governance. Transactions among promoters, key management and other shareholders need to be disclosed even if the company is not a party to them, so long as they have an impact on the company’s management and control in the manner defined. Second, they empower shareholders (especially the minority) in an extensive manner. The ‘majority of the minority’ shareholder approval requirement would extend to matters such as approving specific types of agreements that impact the company as well as slump sale and similar arrangements. Third, the tenor of the proposals is such that it enhances listed company governance substantially and in ways that are the converse of what the Companies Act, 2013 requires. For instance, the ‘majority of the minority’ requirement is introduced for slump sales, which is not a precondition under the Act. Moreover, while the Act effectively recognizes the concept of a non-retiring director, SEBI’s proposals seek to jettison such an idea in favour of directors who must periodically seek shareholder mandate, thereby making them more accountable to the shareholders. Surely, there is bound to be push back from industry as the proposals significantly enhance the compliance requirements and the associated cost burdens, but it remains to be seen whether the regulator is likely to cave in to some of those apprehensions.