Schemes of Arrangement in Liquidation: A New Ray of Hope?

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-By Vinod Kothari

(resolution@vindokothari.com)

The recent rulings of appellate judicial and quasi-judicial authorities in India permitting the pursuit of schemes of arrangement even after initiation of liquidation proceedings may have sounded surprising to many. However, the history of schemes of compromise and arrangement is indeed replete with examples of such arrangements seeking to bail out an entity that is otherwise doomed to be liquidated. Since India stands out in the world, having enacted section 29A of the Insolvency and Bankruptcy Code, 2016, which disqualifies a promoter from submitting resolution plans or acquiring the assets of the entity in liquidation, the issue causing a lot of debate is – how does the possibility of a scheme of arrangement co-exist with this principle of promoter disqualification? Or, if the promoters, disqualified from either heading a resolution exercise or acquiring assets in liquidation, can find a surrogate route in schemes of arrangement, is there a potential of negating the very objective of insertion of section 29A? Read more →

Entity versus Enterprise: Dealing with Insolvency of Corporate Groups

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By Vinod Kothari & Sikha Bansal
(resolve@vinodkothari.com)

Present-day businesses sweep across multiple entities, such that the “enterprise” consisting of multiple entities, often in multiple jurisdictions, is referred to as a “group”. While accounting standards and securities market regulators have moved on to the concept of “business groups”, the ghost of the 19th century ruling in Salomon v. Salomon & Co continues to hover over corporate laws and, consequentially, over insolvency laws too. Read more →

Brand usage and royalty payments get a new dimension under Listing Regulations

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By Abhirup Ghosh & Smriti Wadehra (abhirup@vinodkothari.com) (smriti@vinodkothari.com)

Introduction

Usage of common brand is a common practice that we notice among companies which are part of large conglomerates. Often the brands created by one single entity of a group are used by its related parties, however, these transactions are often structured with differential pricing terms i.e. either these transactions are not charged at all or are overpriced.

Therefore, in order to increase transparency and regulate to these transactions, a Committee on Corporate Governance constituted by the SEBI under the chairmanship of Uday Kotak has proposed disclosure requirements this kind of transactions.
In this article we will primarily discuss the proposal made by the Committee threadbare. Additionally, we will also discuss the impact of indirect taxes on such transactions.

Brand usage and Royalty as per Listing Regulations

The erstwhile provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) did not provide anything for royalties or brand usage paid to related parties. However, a SEBI constituted committee under the chairmanship of Mr. Uday Kotak on 2nd 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.

As noted above, often the transactions involving usage of brands and royalty payments are structured with differential pricing terms. The Committee has noted the importance of brand usage and it also brought the importance of disclosing the terms relating to payments against these brand usages, considering the role it plays in driving the sales or margin.

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. The Listing Regulations currently prescribe a materiality limit at ten percent of annual consolidated turnover of the Company. Therefore, the Committee prescribed a stricter limit for brand usage and royalty i.e. 5% instead of the existing limit which is 5% of consolidated turnover.

SEBI applied its discretion to make the provision stricter and subsequently, made the following insertion in the Listing Regulations:

“23(IA) Notwithstanding the above, with effect from July 01, 2019 a transaction involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.”
On reading the aforesaid provisions and basis our discussion, we understand that from 1st July, 2019 transactions involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.

It is pertinent to note that all transactions entered with related party for brand usage and royalty shall always be regarded as related party transactions. However, the trigger point of qualifying such transactions as material related party transaction is when the quantum of payout exceeds two percent of the annual consolidated turnover of the listed entity.

Whether provisions applicable for payments received for Brand usage and royalties?

While the provision talks about royalty payments to be treated as material related party transactions, but what remains to be answered is whether royalty receipts would also be considered as material related party transactions.

Please note that provisions of the amendment clearly provides:
“xxx
involving payments made to a related party with respect to brand usage or royalty
xxx”

Therefore, the applicability of the provisions appears to apply only in case of payments made to related party for brand usage and royalty. However, this does not seems to be the intent of law. Every transaction has two parties, in the present case, the two parties are the receiver and the giver. It does not seem rationally correct to include one side of the coin within the ambit of the law while keeping the other side out. Therefore, ideally receipt of royalty must also be treated as material related party transaction for the purpose of Regulation 23(IA) of the Listing Regulations.

Meaning of “Royalty”

Despite insertion of a new regulation dealing with royalty payments, the Listing Regulations do not define the term royalty. The meaning of the term, however, can be borrowed from the Income Tax Act, 1961 which provides for an elaborate definition. Section 9(1) of Income Tax Act, 1961 reads as:
XXX

“royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for—

(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
XXX

Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.

Therefore, as per the aforesaid provisions, consideration for transfer of rights (including granting of a licence) in respect of a trade mark or similar property or for use of a trademark or transfer of rights (including granting of a licence) in respect of any copyright, literary, artistic or scientific work, falls under the definition of ‘Royalty’ under the IT Act. Accordingly, any transaction with the related party for the aforesaid activities shall be regarded as related party transaction for usage of royalty.

Similarly, the term ‘brand usage’ has not been defined under the Listing Regulations. In this regard, reference may be drawn from section 2(zb) of the Trade Marks Act, 1999 which identifies brand as a trade mark or label which is an intellectual property right. Accordingly, any transactions of brand usage by related party shall be regarded as related party transaction.

Impact of GST laws on brand usage transactions

After the introduction of regulation 23(1A) it is very clear the companies will have to structure the brand usage transactions properly and pricing policy of the same shall have be relooked at, however, one must not forget the potential impact GST laws can have on these transactions.
Rule 28 of Central Goods and Services Tax (CGST) Rules, 2017 states that all transactions between related persons must be carried out on arm’s length basis and should be priced at open market value. This applies to all transactions between related parties, needless to say even brand usage transactions will also be covered under this.

Therefore, if going forward the parties decide to execute the transactions without any consideration, in order to escape the provisions of regulation 23(1A), the same shall be subjected to rule 28 which provides for computation of notional value and GST will have to paid on the notional value.
However, rule 28 provides for an exception which states that if an invoice is raised by the supplier with GST on it and the recipient of the supply is eligible to claim input tax credit on the value of services, then the value quoted in the invoice shall be deemed to be the open market value of the goods or services.
Therefore, to ensure that notional value taxation does not apply, the parties must refrain from structuring transactions with nil consideration. However, if the same involves royalty payments of more than 2% of the consolidated turnover, it will have to comply with regulation 23(1A).Therefore, the companies must be mindful of both these provisions while structuring this kind of transactions henceforth.

Conclusion

While the Committee does not intend to stop brand usages in the country, all it wants to establish is a fair and transparent practise of charging royalty payments for the usage of brands. Accordingly, listed companies have to be more careful before charging for brand usages, as the same have come under the radar of materiality and have to be reported. Further, considering the tax implications, the structuring of such kind of transaction shall be important. To summarise, the Listing Regulations have introduced a new dimension to payments made for brand usages and royalties.

Adjudication of penalties under SEBI: SC ruling gives controlled discretion to Adjudicating Officer

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-Ruling of Bhavesh Pabari overrules Roofit Industries

By Smriti Wadehra (smriti@vinodkothari.com)

A three member Bench of the SC recently overruled its earlier decision in Roofit Industries Ltd vs SEBI, and provided a controlled discretion to the Adjudicating Officer in fixing penalties for offences under the SEBI Act as well Securities Contract Regulation Act (SCRA) as a result of  the ruling, the Adjudicating Officer shall not be constrained by the minimum extent of penalty laid in SEBI Act and may, where circumstances so warrant, either waive off the penalty completely or may assign a penalty less than the so called minimum. Thus, the adjudication of penalties may be expected to be more commensurate with the gravity of the offence, than was so far possible primarily due to the position arising out of Roofit ruling. Read more →

Basics about formation of Nidhi companies

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By CS Megha Saraf

corplaw@vinodkothari.com

 

Nidhi as the Hindi word denotes “sampatti” is a type of public company which may be incorporated with an exclusive object of cultivating the habit of thrift and savings amongst its members, deposits from, and lending to, its members only, for their mutual benefit. The same is a type of company which may be incorporated under Section 406 of the Companies Act, 2013, read with the applicable rules, as a public company with a minimum paid-up equity share capital of Rs. 5 lakhs. Although the activities of a Nidhi company is similar to that of a non-banking financial company, as to accepting deposits and granting loans, however, they have been exempted from the purview of the RBI Act, 1934 by virtue of the RBI Master Direction- Exemptions from the provisions of RBI Act, 1934.

Requirements for incorporating a Nidhi company

In order to incorporate a Nidhi company, it shall have:

  1. atleast 200 members;
  2. Net Owned Funds of Rs. 10 lakhs or more;

(Note: Net Owned Funds= aggregate of paid up equity share capital + free reserves – accumulated losses and intangible assets appearing in the last audited balance sheet)

  1. Unencumbered term deposits of atleast 10% of the outstanding deposits;
  2. Ratio of Net Owned Funds to deposits not more than 1:20;
  3. Issuance of shares of nominal value of atleast Rs. 10 each;
  4. To allot a minimum of 10 equity shares or shares equivalent to Rs. 100.

In order to clarify point no. 4, let us take an example; Company X has 20 equity shares of face value of Rs. 10 each. Mr. A, an individual shall be required to subscribe atleast 10 equity shares in order to deposit Rs. 2000 in the Company. Further, as evident, such subscription of equity shares shall not provide any interest to the deposit holder, but, shall form part of the shareholders’ funds of the company.

Requirements w.r.t deposits and loans

As mentioned above, the objective of a Nidhi company is to take deposits and provide loans to its members. The Ministry of Corporate Affairs (“MCA”) being the regulator of Nidhi companies has regulated the norms for taking deposits and providing loans which are as follows:

Deposits

The Nidhi company shall be allowed to accept deposits with the following timelines:

  1. Fixed deposits- 6 to 60 months
  2. Recurring deposits- 12-60 months
  • Recurring deposits relating to mortgage loans- Maximum period shall correspond to the repayment period of loans granted.

Interest rate on deposits

  1. Savings Account- Maximum 2% above the rate allowed by nationalized banks
  2. Fixed and Recurring deposits- At par with the RBI rate

Loans

A Nidhi company can provide loan to its members as per the following ceiling limits:

  1. Where total amount of deposits from its members is less than Rs. 2 Cr- Rs. 2 lakhs
  2. Where total amount of deposits from its members is more than Rs. 2 Cr but less than Rs. 20 Cr- Rs. 7.50 lakhs
  3. Where total amount of deposits from its members is more than 20 Cr but less than Rs. 50 Cr- Rs. 12 lakhs
  4. Where total amount of deposits from its members is more than Rs. 50 Cr- Rs. 15 lakhs

Interest rates of loans

The interest charged on any loan given by a Nidhi company shall not exceed 7.5% above the highest rate of interest offered on deposits by Nidhi and shall be calculated on reducing balance method.

General restrictions or prohibitions

Similar to a NBFC, there are certain restrictions or prohibitions on Nidhi companies as well.

Some of the major restrictions or prohibitions of a Nidhi company are that it shall not:

  1. carry on the business of chit fund, hire-purchase finance, leasing finance, insurance or acquisition of securities issued by any body corporate;
  2. open any current account with its members;
  3. accept deposits from or lend to any person, other than its members;
  4. carry on the business other than the business of borrowing or lending in its own name;
  5. take deposits or lend money to any body corporate;
  6. issue of advertisements in any form soliciting deposits;
  7. pay brokerage in order to mobilize deposits from members or for deployment of funds or for granting loans

Compliances to be made by Nidhi companies

Nidhi companies shall be required to do the following compliances:

  1. Filing of return of statutory compliances in e-Form NDH-1– Within 90 days of the close of first F.Y. and where applicable, the second F.Y.
  2. Filing of non-compliance with the conditions mentioned w.r.t incorporation of a Nidhi company such as minimum no. of members, Net Owned Funds etc. in e-Form NDH-2– Within 30 days of the close of first F.Y.
  3. Filing of half-yearly return in e-Form NDH-3– Within 30 days of the conclusion of each half year.

 

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Consolidation of new ECB and Trade Credit framework: RBI issues Master Direction 2019

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Vallari Dubey

corplaw@vinodkothari.com

Introduction

With the backdrop of revision of various frameworks for raising funds outside India (other than by way of equity participation), RBI has issued the Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations on 26th March, 2019, in supersession of the existing Master Direction – External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorised Dealers dated 1st January, 2016 (last updated on 22nd November, 2018).

The new Master Direction seeks to consolidate all applicable circulars and notifications in respect of the following:

  1. External Commercial Borrowing framework (ECB framework) covered in the Master Direction as Part I
  2. Trade Credit framework covered as Part II
  3. Structured Obligations covered as Part III.

The first set of changes was introduced through the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 on 17th December, 2018. Thereafter, the New ECB framework was issued on 16th January, 2019 and the Trade Credit Policy on 13th March, 2019.

New Master Direction

The erstwhile Master Direction included provisions pertaining to borrowing and lending in foreign currency, which has now been removed and is solely dealt with by Foreign Exchange Management (Borrowing and Lending) Regulations, 2018. Further, it replaces the erstwhile ECB framework and Trade Credit framework with the recently issued frameworks, separately.

The revised ECB policy and Trade Credit Policy were issued, coinciding with Foreign Exchange Management (Borrowing and Lending) Regulations, 2018.

The changes introduced pursuant to new ECB policy and Trade Credit policy have been covered by our colleagues extensively in the following write ups:

  1. RBI revises ECB framework – aligns with FEM (Borrowing and Lending) Regulations, 2018
  2. RBI revises Trade Credit Policy Framework.

Few important additions in the revised frameworks, now consolidated under the Master Directions include Standard Operating Procedure for Untraceable Entities for Ad Banks, ECB for entities under resolution under IBC, ECB for resolution applicants, Late Submission Fee for late submission of returns.

Conclusion

The revision of the Master Direction which was originally issued in 2016 was quite anticipated in light of the recent changes made by RBI. Although the new Master Direction does not introduce any additional change in the ECB and Trade Credit framework, it unifies all the applicable policy frameworks, thereby giving more clarity.

SEBI proposes to restructure the issuance of shares with DVRs

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By Nikita Snehil and Shaifali Sharma | corplaw@vinodkothari.com

Vinod Kothari & Company

The basic principle behind the issuance of shares with differential voting rights, commonly known as ‘DVRs’ in India and dual class shares or ‘DCS’ in the international context, is to enable the companies to raise capital without dilution of control and decision-making power in company. In promoter/ founder led companies where promoters/ founders are instrumental in the success of the company, such structures enable them to retain decision-making powers and rights vis-a-vis other shareholders either through retaining shares with superior voting rights or issuance of shares with lower or fractional voting rights to public investors.

The concept was first recognized under the Companies (Amendment) Act, 2000 followed by similar provisions adopted by the Companies Act, 2013. However, the current practical scenario depicts a different picture, as the provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 does not permit DVRs with higher or superior voting rights. However, subject to certain conditions, DVR shares with lower voting rights are permitted. Till date, only 5 listed companies have used this structure in India. Strict pre-condition and corporate governance norms, unavailability of investors due to lack of awareness are some grounds of company’s reluctance from adopting such idea.

SEBI’s Consultation Paper to restructure the issuance of DVRs

On December 19, 2018, Mr. Ajay Tyagi, Chairman of SEBI, had said in an interview that SEBI has made a sub-committee for reintroducing Differential Voting Rights on shares, which will make recommendation on the same by next month. Post this, SEBI on March 20, 2019, has come out with a Consultation Paper[1] on issuance of shares with Differential Voting Rights. The Consultation Paper provides that the matter of issuance of shares with DVRs was deliberated in the Primary Market Advisory Committee of SEBI (‘Committee’) and a group (‘DVR Group’) was constituted amongst the Committee members to do an in-depth study of the proposal of introduction of shares with DVRs in Indian Scenario.

The Consultation Paper addresses the norms for issuance of shares with DVRs under two categories –

  1. issuance by companies whose equity shares are already listed on stock exchanges;
  2. companies with equity shares not hitherto listed but proposed to be offered to the public.

The basic moto behind allowing shares with differential voting rights is to raise equity without dilution of promoter control i.e., to allow the promoters/ founders to maintain control as they would hold shares with superior voting rights.

Therefore, considering SEBI’s proposed structure, there shall be four categories of companies which can issue DVRs:

  • Equity listed cos – as per this Consultation Paper;
  • Unlisted cos, which are intending to get their equity listed — as per this Consultation Paper;
  • Unlisted cos, not intending to list their equity shares – as per Section 43 of the Companies Act, 2013 (‘Act’) read with Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014;
  • Private Cos — exempted from applicability Section 43 of the Act, if either its memorandum or articles of association so provides- vide notification number G.S.R. 464(E) dated 5th June 2015.

Need for DVRs in India

In order to maintain the current growth phase in India, it is pertinent for the companies to raise capital to sustain this growth. For companies with high leverage or asset light models, they may prefer equity over debt capital. Raising DVRs will reduce the dilution of founder/ promoter stake which would otherwise be a case in capital raised by equity.

The protection of founder/ promoter’s stake/ control is especially relevant for new technology entities which have asset light models, with little or no need for debt financing. However, these entities generally raise funds through equity which dilutes the promoter’s/ founder’s stake, thereby diluting control. Considering the issue, the Consultation Paper states that retaining founder’s interest & control in the business is of great value to all shareholders and the same can be achieved by:

  1. Issue of shares with superior voting rights (‘SR’) to founders and/or
  2. Issue of shares with lower or fractional voting rights (‘FR’) to raise funds from private/ public investors.

International Scenario

The global market has witnessed a mixed response to the concept of DVRs, while many countries have permitted the listing of companies with Dual Class Shares or DCS (internationally used term for DVRs), some countries like UK, Australia, Spain, Germany and China do not permit the Issuers with DCS structure for listing. Singapore and Hong Kong have recently permitted DCS structures with detailed checks and balances. Considering the international scenario, the Consultation Paper has provided a detailed comparison of the issuance & listing of DCS structure in internal jurisdictions, the summary of which is presented below:

  • 700 public companies in the US have DCS structures, predominant listed ones being Google, Facebook, Snapchat, Nike and Alibaba. There is ongoing debate in the SEC about the continuation of DCS[2].
  • Hong Kong and Singapore recently allowed DCS to encourage more new technology firms to list.
  • In the UK[3], DCS structures were used in the 1960s to protect corporations from hostile takeovers or for the Queen to have ‘golden share’, before institutional investors expressed strong opposition to such structures. DSC is presently not allowed in the UK.
  • Over the past decade, a number of European governments have implemented or debated the use of different voting rights.
  • US, Canada, HK, Singapore, Denmark, Spain, Sweden and Italy allow dual-class shares. Germany, Spain, China, Australia disallow listing of shares of companies with DCS structures.

Recommendations of the DVR Group

Ø Pre-conditions

A company would be entitled to issue DVR Shares, subject to following pre-conditions:

  • issue of DVR Shares must have been be authorized in the AoA of the company; and
  • the issue of DVR Shares should be authorized by a special resolution passed at a general meeting of the shareholders.
  • for companies already listed, by way of e-voting as per Companies Act, 2013
  • The notice should mention specific matters, including but not limited to, size of issuance, ratio of the difference in the voting rights, rights as to differential dividends, if any, sunset clause, coattail provisions, etc., as made applicable by SEBI regulations to be notified in this regard.

Ø Requirements for both the categories

Category I: Companies whose equity shares are already listed – issuance of FR Shares;

Category II: Companies whose equity shares are proposed to be listed – issuance of SR shares.

Eligibility

 

 Requirements for Category I Requirements for Category II
Conditions Cos whose shares have been listed on a SE for atleast a year, may issue FR Shares.

 

Note: listed cos are still not allowed to issue SR Shares.

 Unlisted cos may issue SRs, only to promoters.
 

First issuance of FR/ SR shares
Type of issuance Through a) rights issue; b) bonus issue pro rata to all equity shareholders; or c) a Follow-on Public Offer (“FPO”) of FR shares. An unlisted co. where the promoters hold SR Shares shall be permitted to do an Initial Public Offer (“IPO”) of only ordinary equity shares provided the SR Shares are held by the promoters for more than one year prior to filing of the draft offer document with SEBI.
 

Subsequent issues of FR Shares once FR Shares are already listed
Type of issuance A company that has already listed FR Shares shall be eligible to do:

a) rights issue; b) bonus issue; c) preferential issue; d) QIP of FR Shares of the same class;

 

 A company whose SR Shares and ordinary equity shares are already listed shall be permitted to issue FR Shares in terms of the applicable provisions for issue of FR Shares by listed companies – which means same as Category I.

 

Note: Issuance of SR shares not allowed post listing.
Depository Receipts A company whose FR Shares are listed for at least one year shall be eligible to issue depositary receipts where the underlying shares are FR Shares. —
Convertible Instruments A company can issue convertible instruments which will convert into FR Shares subject to applicable regulatory considerations. —
Voting and other rights The FR shares shall not be treated at par with the ordinary equity shares.

 

Max ratio

 

The FR Shares shall not exceed a ratio of 1:10, i.e. one vote as applicable to one Ordinary Equity Share, would be voting entitlement on 10 FR Shares. The ratio can be in full numbers from 1:2 to 1:10.

 

 

At any point of time, the co. can only have one class of FR Shares.

 The SR Shares shall be treated at par with the ordinary equity shares in every respect except in the case of voting on certain matters.

 

Max ratio

 

The SR Shares shall be of a maximum ratio of 10:1, i.e. ten votes for every SR Share held. The ratio can be in whole numbers from 2:1 to 10:1. A ratio once adopted by a company shall remain valid for any subsequent issuances of SR Shares.

 

A co. can issue only one class of SR Shares.

 

Any rights or bonus issue by the co. post-listing shall be offered only as ordinary equity shares

to the holders of the SR Shares.

 

On certain matters to be notified by regulations, the SR Shares would be treated as having only one vote. The initial list of the same is set out in the coattail provisions set out in the Committee Report (the same has been explained later in this Article).

 
Dividends The company may, at its discretion, decide to pay additional dividend per FR Share compared to dividend paid on ordinary Equity Share, which shall be higher than the dividend per

ordinary Equity Share and the same shall be stated in the terms of the offering. No dividend may be payable on FR Shares for such years where no dividend has been declared by the company for the ordinary equity shares.

 

 Post IPO, the SR shares shall be eligible for the same dividend and other rights as ordinary equity shares, except for superior voting rights.
Minimum Public Shareholding The co. should comply with the req of Securities Contracts (Regulation) Rules, 1957 (“SCRR”) and other applicable regulations formulated in this regard. The co. shall comply with the SCRR and other applicable regulations formulated, for the ordinary equity shares that will be listed.

 

Post-listing, the voting rights with the promoters through the SR Shares and ordinary equity shares shall not exceed 75% of the total voting rights.
Pricing The pricing of FR shares shall be in accordance with regulatory considerations applicable to

mode of issuance of FR Shares

 —
Face Value The face value of a company’s FR Shares shall be the same as that of its

ordinary equity shares.

 The face value of a company’s SR Shares shall be the same as of that of the ordinary equity shares.
Number of FR / SR Shares The number of FR Shares that may be issued by a company shall be subject to

provisions of the Companies Act, 2013 and the rules framed thereunder

 A company shall be permitted to issue any number of SR Shares of the same class prior to an IPO, subject to provisions of the Companies Act, 2013.
Lock-in period — All SR Shares shall remain under a perpetual lock-in after the IPO.
Pledge of shares — Creation of any encumbrance over SR Shares including pledge, lien, negative lien, non-disposal undertaking, etc. shall not be permissible.

In other words, no third-party interest may be created over the SR Shares and any instrument purporting to do so would be void ab initio.
Fasttrack issuance

 

 A company shall be eligible to issue FR Shares in a rights issue or an FPO through the fasttrack method in case it meets the eligibility criteria of fast-track issuances. —
Conversion of FR / SR shares

 

[Also known as ‘Sunset Clause in case of SR Shares]

 The FR Shares can be converted into ordinary equity shares only in cases of schemes of

arrangement.

 The validity of SR shares is 5 years from the date of listing of ordinary shares. Which means, such shares shall be compulsory converted into ordinary shares on the 5th year anniversary of the listing of such ordinary shares i.e. superior rights will fall under the standard rule of ‘one-share one-vote’. Conversion shall be done in the following manner:

 

For promoters: at any time prior to the 5th year anniversary of the listing of the Ordinary Shares or such extended period as decided by the shareholders by passing special resolution.

 

For other than promoters: on completion of the 5th year anniversary of the listing of the Ordinary Shares or such extended period of 5 years with the approval of shareholders by way of special resolution in the meeting where all members vote on one-share-one vote basis.

 

Besides the aforementioned validity of 5 years, the SR shares shall be converted into ordinary shares on the merger or acquisition of the company or sale of such shares by the identified promoters who hold such shares or in the case of demise of the promoter(s).
Extinguishment The FR Shares can be extinguished only through buy-back by the company or reduction of capital in accordance with applicable laws. —
Delisting The company can delist the FR Shares in accordance with the SEBI (Delisting of Equity Shares) Regulations, 2009. However, in the event ordinary equity shares of the company are delisted, the company shall be mandatorily required to delist the FR Shares. —
Listing and Trading The FR Shares shall be held in dematerialized form. However, FR Shares can be

issued in physical form, if such FR Shares have been issued pursuant to a bonus issue and the underlying shares are held in physical form.

 

The FR Shares shall be listed and traded on all SEs where ordinary equity shares of the co. are listed with a separate identifier from the ordinary equity shares.

 All SR Shares shall be held in dematerialized form and shall be listed on the main board platform of the recognized SEs.

For listing of SR Shares, exemption will be granted from Rule 19(2)(b) of SCRR.

 

The SR Shares, however, cannot be traded except upon conversion into ordinary equity shares.
Post-Issue Disclosures The shareholding pattern filed by the co. with the SEs shall provide the details of the FR Shares separately and in the format specified by SEBI and the SEs The shareholding pattern to be filed by the co. with the SEs shall provide the details of both ordinary equity shares and SR Shares in the format specified by SEBI and the stock exchanges.
ESOPs A co. can issue ESOPs of FR Shares post the listing of such shares, subject to applicable laws. —
Bonus issue by the co. which has issued FR shares If a co. which has issued FR shares, issues bonus shares, then it shall issue to FR shareholders bonus FR shares in the same proportion in which bonus shares are issued on ordinary equity shares. —
Applicability of other SEBI Regulations SEBI regulations in respect of buy-back, and takeovers shall apply to FR Shares, subject to such modification as may be required in the context of FR Shares. The FR Shares once listed shall not be delisted on a standalone basis and may be delisted as and when the ordinary equity shares are delisted. SEBI regulations in respect of buy-back, and takeovers shall be applicable to SR Shares, subject to such modification as may be required in the context of SR shares.

 

Ø ”Coattail”  Provisions for issuance of SR shares

Post-IPO, the SR Shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one SR share-one vote) in the following circumstances:

  1. provisions relating to appointment or removal of independent directors and/or auditor;
  2. in case there is a change in control of the company;
  3. any contract or agreement of the company with any person holding the SR Shares, in excess of the materiality threshold prescribed under Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015;
  4. voluntary winding up of the company;
  5. any material changes in the company’s AoA or MoA, including but not limited to, undertaking variation in the voting rights of the shareholders, changing the principal objects of the company, granting special rights in favour of a particular shareholder or shareholder groups and such other items as may be prescribed by the SEBI;
  6. initiation of a voluntary resolution plan under the Insolvency and Bankruptcy Code, 2016;
  7. extension of the validity of the SR Shares post completion of 5 years from date of listing of ordinary equity shares; and
  8. any other provisions notified by SEBI in this regard from time to time.

Conclusion

The major benefits of DVRs structure highlighted in the DVR Group Report are as follows:

  1. DVRs promote fund raising without diluting control;
  2. In a promoter led companies, DVR structure will enable such promoters to retain control, the decision-making powers and other rights in the company;
  3. DVRs structure acts as defense mechanism for hostile takeover.

The recommendations by DVRs Group seems to extend a hand of opportunity to listed companies and those companies including, newly incorporated companies, who intend to issue DVRs but do not have a consistent track record of distributable profits as stated in the existing ICDR regulations, i.e. 3 years.

The Sunset Clause in case of SR shares shall keep a check on the tenure of the DVRs, however, the provisions requiring companies issuing the DVRs to observe better corporate governance practices is missing in the proposed structure of DVRs. Further, 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 should be imposed by SEBI to protect the interest of the shareholders as well as the genuine issuers.

[1] https://www.sebi.gov.in/reports/reports/mar-2019/consultation-paper-on-issuance-of-shares-with-differential-voting-rights_42432.html

[2] http://www.pionline.com/article/20180216/ONLINE/180219888/sec-commissioner-calls-for-curb-on-dual-class-forever-shares#

[3] https://ecgi.global/sites/default/files/working_papers/documents/SSRN-id2138949.pdf