By Corplaw Team (firstname.lastname@example.org)
SEBI Board Meeting held on 27th June, 2019 has proposed certain amendments in various Regulations. We aim to briefly highlight the changes with analysis.
1. Framework for issuance of DVR
Company having Superior Rights (SR) shares will be permitted to do IPO of ordinary shares to be listed subject to fulfilment of conditions of SEBI (ICDR) Regulations, 2018 and with fulfilment of following conditions:
- Issuer company is a tech company having intensive use of technology.
- SR shareholder should be part of promoter group whose collective networth should not exceed Rs. 500 crore (excluding investment of SR shareholder).
- SR shares have been issued to promoters who hold executive position in the Company.
- Issue of SR shares should be authorised by special resolution.
- SR shares should have been issued 6 months prior to filing of RHP.
- SR shares should be in the ratio of 2:1 to max 10:1 compared to Ordinary Right (OR) shares.
The proposal of SEBI intends to motivate raising of money and control in the hands of founders of the company. This especially has been introduced to motivate tech startups, to raise capital without losing control. The SEBI Board Meeting has accepted most of the recommendations proposed by SEBI’s discussion paper. However, some new insertions have been introduced keeping in pace with the international practice. Such proposal includes SR shareholder to be a part of promoter group whose collective networth should not exceed Rs. 500 crore. Further, the issuance of SR shares prior to filing of RHP has been imported from Hong Kong law.
b) Listing & Lock-In
SR shares shall also be listed on Stock Exchange after the issuer company makes a public issue. However, SR shares shall be under lock-in after the IPO until their conversion to ordinary shares. Transfer of SR shares among promoters shall not be permitted. No pledge/ lien shall be allowed on SR shares.
Recommendation of SEBI’s discussion paper has been accepted.
c) Rights of SR shares
SR shares shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions. The total voting rights of SR shareholders (including ordinary shares), post listing, shall not exceed 74%.
The voting rights of SR shareholders have been capped to 74% of total voting rights, whereas, the Companies (Share Capital) Rules limits that total DVR in the Company to maximum 26% of post issued share capital of the Company. However, SEBI in its discussion paper had recommended a cap of 75% of the total voting rights.
d) Enhanced corporate governance
- Min ½ of Board and 2/3 of Committees other than audit committee shall comprise of IDs
- Audit Committee shall be comprised of only IDs
Companies with promoters having superior voting rights have been exposed to enhanced corporate governance with more independence on their Board and Committees.
e) Coat Tail Provision
SR shares shall be treated as OR shares in following circumstances:
- Appointment or removal of independent directors and/or auditor
- In case where promoter is willingly transferring control to another entity
- Related Party Transactions in terms of SEBI(LODR) Regulations involving SR shareholder
- Voluntary winding up of the company;
- Changes in the company’s Article of Association or Memorandum
- except any changes affecting the SR instrument
- Initiation of a voluntary resolution plan under IBC;
- Utilization of funds for purposes other than business
- Substantial value transaction based on materiality threshold as prescribed under LODR;
- passing of special resolution in respect of delisting or buy-back of shares; and
- Any other provisions notified by SEBI in this regard from time to time.
The matters of significant interest of the Company have been eliminated from the purview of superior rights. This is because there might be instances where the interest of minority shareholders could be adversely affected by the holder of SR shares, therefore, certain checks and balances to prevent the misuse of the instruments have been imposed by SEBI to protect the interest of the shareholders as well as the genuine issuers.
f) Sunset Clause
SR shall be converted into OR in following cases:
- SR shares shall be converted to Ordinary Shares within 5 years of listing which can be extended by 5 years through a resolution
- SR would not be permitted to vote on such resolutions.
- SR shares shall compulsorily get converted into OR on occurrence of certain events such as
- resignation of SR shareholders
- merger or acquisition where the control would be no longer with SR shareholder
The Sunset Clause in case of SR shares shall keep a check on the tenure of the DVRs and companies issuing the DVRs shall have to observe better corporate governance practices which was missing in the proposed structure of DVRs.
g) Fractional Rights Shares
Concept of fractional rights have been proposed to be done away with and may be revived only after reviewing the experience of superior rights.
2. SEBI (LODR) Regulations, 2015
The existing materiality limit for brand usage and royalty payments is proposed to be increased from 2% to 5% of annual consolidated turnover of the listed entity.
SEBI constituted committee under the chairmanship of Mr. Uday Kotak on 2 nd June, 2018 provided a report on corporate governance with certain recommendations for implementation. One of the recommendations was to insert provision pertaining to payments made for brand and royalty to related parties. In this regard, the Committee suggested that where royalty payout levels are high and exceed 5% of consolidated revenues, the terms of conditions of such royalty must require shareholder approval and should be regarded as material related party transactions. SEBI applied its discretion to make the provision stricter and subsequently reduced the limit to 2%. However, based on the representations made by the stakeholders, SEBI proposes to increase the limit to 5% of annual consolidated turnover.
3. SEBI PIT Regulations
The current language of the Code of Conduct indicated a voluntary requirement for closure of trading window from the end of quarter. Later, NSE issued a circular on April 2, 2019 to the effect that the requirement is mandatory. Accordingly, SEBI Board meeting has also clarified that during the trading window closure from the end of the quarter till 48 hours from the declaration of the results, the following trades shall be an exception to the same:
- off-market inter-se transfer between insiders,
- transaction through block deal window mechanism between insiders,
- transaction due to statutory or regulatory obligations,
- exercising of stock options,
- pledging of shares for bona fide transaction such as raising of funds and
- transactions for acquiring shares under further public issue, right issue and preferential issue, exercising conversion of warrants / debentures, tendering shares under buy-back, open offer and delisting etc. under respective regulations.
The Board meeting indicates that the trading during such period shall be allowed only if certain specified conditions are complied. The conditions are however, not mentioned in the outcome. Clarification has also been approved in relation to material financial relationship (nature of clarification not provided in the press release).
The proposed amendments were much awaited. The existing set of the PIT Regulations provide a leeway for most of these trading activities under contra-trade restrictions or trading under Regulation 4 (exemptions to insider trading). The aforesaid amendment will provide much needed clarity to stakeholders who were facing operational difficulties due to the implementation of the quarter end trading window closure. However, one needs to see the nature and extent of conditions imposed for availing the aforesaid exemption.
4. Definition and compliances w.r.t. “Encumbrance” under Takeover Regulations
- The definition of the term “encumbrance” has been made broad to include the following under the SEBI Takeover Regulations:
- Any restriction on the free and marketable title to shares, by whatever name called, whether executed directly or indirectly;
- pledge, lien, negative lien, non-disposal undertaking;
- any covenant, transaction, condition or arrangement in the nature of encumbrance, by whatever name called, whether executed directly or indirectly.
- Promoters required to disclose separately detailed reasons for encumbrance, whenever:
- the combined encumbrance by the promoters and PACs crosses 20% of the total share capital in the company; or
- 50% of their shareholding in the company.
- Stock exchanges will maintain the details of such encumbrance along with purpose of encumbrance, on their websites.
- Annual disclosure by the promoters to the audit committee and the stock exchanges stating that no other encumbrance , either directly or indirectly has been made other than those declared by them.
As we understand, the aforesaid change has been made in view of the growing concerns over the complex arrangement of fund raising by promoters. The existing definition of encumbrance was also an inclusive definition, however, the proposed amendment intends to make it wide enough to cover negative lien or even any arrangement entered for the purpose of creating restrictions on free transferability of the shares, either directly or indirectly.
Further, the obligation has been casted to report the same internally as well as to allow the same to be reflected in the public domain for ensuring transparency in the dealings whereby promoters create encumbrance over the shares of the company.