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