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Decoding “Control” in Pooled Investment Funds: Manager, Investors, or no one?

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– Sikha Bansal, Senior Partner and Payal Agarwal, Partner  | corplaw@vinodkothari.com 

Corporate relationships and hierarchies are prone to misuse and hence, there are regulatory prescriptions to ascertain and address the areas of conflict. This is usually done through identification of control and/or significant influence, if any, existing between the parties. If there is an element of control /significant influence, the parties may be required to follow a host of protocols – including but not limited to being identified as a promoter, to put in place related party controls, to disclose their  transactions and even go for consolidation of accounts, etc.

While in simple structures, it is still possible to objectively conclude the existence of control/significant influence (or the absence of it); in certain complex structures, particularly where unincorporated entities are involved, the determination can be quite subjective and dependent on multiple factors. For instance, in the case of pooled investment schemes (called “funds” henceforth) like mutual funds, AIFs, ReITs, InVITs, etc., the entity would often be formed as a trust which would hold the common hotchpot of funds contributed by investors. Besides investors, there would be multiple parties involved, viz., the fund sponsor, fund manager, and the trustee. Mostly, the fund may not be a legal entity[1]; however, it is segregated from the funds of either the manager or trustees. If there is any element of control or even significant influence on the funds, by any of these investors/parties, it would necessitate treatment of such funds in accordance with regulatory protocols as discussed above. Further, at the next level, if there is any element of control by such funds on other entities, then there would be concerns around indirect control of investors/parties on such other entities as well, percolating through the fund. Therefore, whether the fund is being controlled or significantly influenced by any person, becomes a pertinent question. 

In this article, we attempt to analyze the same and try to frame some guiding principles for ascertaining circumstances in which a fund would be said to be controlled or significantly influenced. 

Meaning of control

Depending on the specific nature and characteristics, pooled investment funds in India are governed by distinct SEBI regulations, such as, SEBI (Alternative Investment Funds) Regulations 2012, SEBI (Infrastructure Investment Trusts) Regulations 2014, SEBI (Mutual Funds) Regulations 1996, etc. These regulations define the terms “control” or “change in control” in the context of either the sponsor or the manager or both, but not in the context of the fund. Hence, one will have to look towards accounting standards – namely IFRS 10 which sets out guidelines for the assessment of control in the hands of a fund manager. In India, Ind AS 110 replicates the guidance provided under IFRS 10. Detailed discussion on the principles discussed under IndAS 110 is as below.

Components of control

Ind AS 110 refers to three cumulative components of control, viz.,

  1. Power over the investee,
  2. Exposure or rights to variable returns from its involvement with the investee, and 
  3. The ability to use its power over the investee to affect the amount of the investor’s returns.

As evident, the Standard assumes a relationship of investor and investee. In case of funds, while there would be investors; however, the asset manager too, may be required to hold a certain percentage in the fund as skin-in-the-game, pursuant to applicable regulations. Therefore, in the case of funds, the asset manager is also in the position of an investor, besides being in the position of a manager.

Here, it is significant to note that the “existence of power” or “exposure to returns” individually does not indicate an existence of control, unless there is a link between power and returns, that is, the power can be used to direct the relevant activities, which would affect the returns of the investee.

Component of controlTest for existence
Existence of power over the fund Ability to direct the relevant activities, i.e., activities that significantly affect the investee’s returns.
Exposure to or rights over variable returnsPotential to vary investor’s returns through its involvement as a result of investee’s performance
Link between power and returns

Ability to use its powers (of directing relevant activities) to affect the investor’s returns from its involvement with the investee, i.e., the investor shall hold decision-making rights as a principal.  

Also, note that what matters is “ability”, whether there is actual use of such power or not, becomes irrelevant.

As power arises from rights, the investor must have existing rights that give the investor the current ability to direct the relevant activities [para B14]. Such rights have been briefly discussed in the later part of this write-up.

Power to direct relevant activities of the Fund

In the context of a fund, the relevant activity would be the management of the asset portfolio of the fund. The said function is primarily performed by the fund manager, albeit, the same may be in the capacity of an agent to the unitholders. Hence, Para 18 of Ind AS 110 requires a decision-maker to determine whether it is a principal or an agent for the fund, since a delegated power cannot signify control.

Fund manager – a principal or an agent

IndAS requires that an investor with decision-making rights (called as “decision maker”), when assessing whether it controls the investee, shall determine whether it is a principal or an agent. An investor shall also determine whether another entity with decision-making rights is acting as an agent for the investor [para B58]. The investor shall treat the decision-making rights delegated to its agent as held by the investor directly [para B59].

Thus, in cases where the fund manager is acting as a mere agent of the investor (that is, the fund manager is under the control of the investor), the decision-making rights of the fund manager are treated as that of the investor itself, and control is assessed accordingly. Therefore, to say that an investor has control over the fund, it is important to establish that the investor has control over the fund manager, who in turn, is acting as an agent of the investor. Here, whether the fund manager itself is able to control the fund or not also becomes a pertinent point for determination.

Para B60 of Ind AS 110 specifies the factors that need to be considered in order to determine whether the fund manager in its capacity of a decision maker, is merely an agent to the principal (other investors) or exercises its decision-making rights in the capacity of a principal to the fund.

The primary factor, holding the highest weightage, in making such determination – is the kick-out rights available with other investors. However, where the same does not conclude fund manager as an agent, various other factors require consideration.

Determination of fund manager as a principal v/s agent

Determining ‘control’ of the investor

Various tests are relevant for determining the control of the investor over the Fund. A summary view of the same is given below:

The table below shows a detailed analysis of each relevant test for assessing the existence of control:

Sl. No.Test of controlAssessment Remarks
Power to direct relevant activities
1. Nature of rights The nature of rights shall be substantive, i.e., providing an ability to direct relevant activities and not merely protective. Protective rights apply only to protect an investor from fundamental changes in the funds’ activities or in exceptional circumstances and do not imply power over the fund.
2. Majority voting rights

An investor holding more than 50% of voting rights in the fund would generally be considered to have power over the fund, unless such voting rights do not signify substantive decision-making rights.   

Mention is also made of the SEBI Circular dated 8th October, 2024 that requires conducting due diligence for every scheme of AIFs where an investor, or investors belonging to the same group, contribute(s) 50% or more to the corpus of the scheme.

3. Ability to influence other investors into collective decision-makingWhere a right is required to be exercised by more than one party, whether the investor has the practical ability to influence other rights holders into collective decision-making is relevant in assessment of control of the said investor over the fund.
4. Contractual arrangements with other investorsVoting rights as well as other decision-making rights may arise out of contractual arrangements giving an investor sufficient rights to have power over the fund.
5. Size of an investor’s holding relative to size of holding of other parties
  • Significantly high voting rights held by one investor, and
  • Small fragmented holdings by other parties, and
  • Large number of parties required to outvote one investor 

An investor holding substantially higher stake, where other investors are holding fragmented holdings, such that a large number of parties are required to outvote the investor, will give the first investor power over the other investors, even in the absence of majority voting rights.

6. Exercise of voting rights by other investors
  • Absolute size of one investor’s holding is higher than the relative holdings of other investors, and
  • Other investors are passive and do not actively participate in decision-making

Where the stake held by an investor is relatively higher from other investors but not significantly higher to indicate existence of power, however, the other investors do not actively participate in the meetings – the same indicates the unilateral ability of the first investor to direct the relevant activities.

Exposure to, or right over variable returns
7. Dividend and distributable profits proportionate to holdingsThis is directly proportional to the holding of an investor in a fund. Where the holdings of an investor does not comprise a sizable portion of the fund, the same does not indicate a significant exposure to variable returns earned by the fund.
8. Remuneration for servicing the assets and liabilities of the fund

In the context of a fund, the fund manager provides services w.r.t. the management of its assets and liabilities. The remuneration may contain a fixed as well as a variable component, generally, a percentage based fees based on performance of the fund.   However, the same does not indicate an existence of control, if the following elements are present:

  • Remuneration is commensurate with services provided, and
  • Terms and conditions are on arm’s length as per customary arrangements for similar services
9. Returns in other formsIn addition, there might be returns available in other forms providing a right over variable returns of the Fund.

Analysis of examples contained in Ind AS 110

Below, we discuss the examples explained under Ind AS 110 in the context of funds: 

IllustrationFactsAnalysis
13
  • Defined parameters for investment decisions within which fund manager has discretion to invest
  • Fund manager’s stake in Fund – 10%
  • Market based fee for services – 1% of NAV of Fund
  • Assumption that fees are commensurate to services provided
  • No obligation to fund losses
  • No independent board in the fund
  • No substantive rights held by other investors
  • Current ability to direct relevant activities rest with fund manager since no other investor has substantive rights to affect the fund manager’s decision-making authority
  • Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal  

Fund manager is an agent, so question of holding control does not arise

14
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal  

Fund manager is an agent, so question of holding control does not arise

14A
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 2%
  • No obligation to fund losses
  • Removal of fund manager – through simple majority vote of investors, but only for breach of contract
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal
  • Removal rights with other investors are in the nature of protective rights, hence, not substantive  

Fund manager is an agent, so question of holding control does not arise

14B
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 20%
  • No obligation to fund losses
  • Removal of fund manager – through simple majority vote of investors, but only for breach of contract
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment are substantial for the fund manager to consider personal economic interests in making decisions for the Fund
  • Removal rights with other investors are in the nature of protective rights, hence, not substantive  

Decision-making rights are exercised by the fund manager in the capacity of principal. Variability of returns appears significant to conclude an existence of control. 

14C
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 20%
  • No obligation to fund losses Independent board in fund
  • Appointment of fund manager – annually through the independent board 
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment are substantial for the fund manager to consider personal economic interests in making decisions for the Fund
  • Removal rights with other investors are substantive, since fund manager’s appointment is subject to annual approval of independent board, and can be terminated without cause  

While variability of returns appears significant to indicate control with the fund manager, more weightage is given on substantive removal rights held by other investors. Hence, the fund manager is considered as an agent, and does not control the fund. 

15
  • Investments in fund through both debt and equity instruments
  • First loss protection to debt investors
  • Residual returns to equity investors
  • Assets funded through equity instrument – 10% of the value of the assets purchased
  • Fund manager decision-making within parameters set out in prospectus
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 10% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 35% of equity
  • Other investors for remaining equity and debt – large no. of widely dispersed unrelated investors
  • Removal of fund manager – without cause, by simple majority
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment, as well as significant exposure to losses on account of equity investments being subordinate to debt investments are substantial for the fund manager to consider personal economic interests in making decisions for the Fund.
  • Removal rights with other investors are without cause, still, not considered substantive, on account of the large number of investors required to exercise such rights.  

Considering the significant level of exposure to variability of returns, the fund manager is considered principal and controls the fund.

16
  • Sponsor establishes a multi-seller conduit
    • Establishes terms of conduit Manages conduit for market based fees (commensurate with services provided)
    • Approves the sellers/ transferors and the assets to be purchased and makes decisions (in best interest of investors)
    • Entitled to residual return
    • Provides credit enhancement (upto 5% of all conduit’s assets, after risk absorption by transferors)
    • Liquidity facilities provided (except against defaulted assets)
  • Transferors sell high quality medium term assets to the conduit
    • Manages receivables on market based service fees
    • Provides first loss protection through over-collateralisation
  • Conduit
    • Issues short term debt instruments to unrelated investors by a conduit
    • Marketed as highly rated medium term asset with minimum exposure to credit risk
  • Investors
    • Do not hold substantive decision-making rights
  • Current ability to direct relevant activities of the conduit
  • Exposure to variability of returns through right to residual returns of the conduit and provision of credit enhancement and liquidity facilities 

Considering the significant level of exposure to variability of returns, the sponsor is considered principal and controls the fund. The obligation to act in the best interests of the investors is not significant.

The “trust” angle

Funds are usually constituted in the form of a trust, where there is an independent trustee. Further, the investment manager is under an obligation to act in a fiduciary capacity towards the investors of AIF, in the best interest of all investors and manage all potential conflicts of interest [Reg 20(1) of AIF Regulations r/w the Fourth Schedule]. In such a scenario, can it be argued that there can be no element of control over a fund, irrespective of who the contributor is?

In SREI Infrastructure Finance Limited vs Shri Ashish Chhawchharia, the NCLAT, in view of the specific facts and circumstances of the case, held the existence of control of the contributor of the AIF over the investee company of the AIF through the AIF. The matter pertained to identification of the appellant as a related party of the corporate debtor in the context of IBC. The surrounding facts and circumstances are briefly put forth as under:

Therefore, in a given set of facts and circumstances, it might be possible to contend that the fund is being controlled by an investor/group of investors.

Conclusion

In questions involving conflict of interest, control, and relationships, Courts have often adopted purposive interpretation in such cases rather than literal interpretation. As held in Phoenix Arc Private Limited v. Spade Financial Services Limited, AIRONLINE 2021 SC 36, albeit in the context of section 21(2) of IBC would still be relevant. Referring to an authoritative commentary by Justice G.P. Singh which states that the terms may not be interpreted in their literal context, if the same leads to absurdity of law, the Supreme Court held: “The true test for determining whether the exclusion in the first proviso to Section 21(2) applies must be formulated in a manner which would advance the object and purpose of the statute and not lead to its provisions being defeated by disingenuous strategies.” Therefore, whether the fund is being controlled by any person/entity is to be seen in the light of all facts and circumstances, and there can be no straight-jacket formula to arrive at a conclusion.

Other resources on AIFs: 

[1] For example, it may be a trust. However, it is possible to envisage funds held in LLP or company format, in which case the fund becomes a separate entity. This article does not envisage a fund formed as a body corporate.

SEBI revisits the concept of Promoter and Promoter Group

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Proposes shift from ‘promoter’ to ‘persons in control’

Ajay Kumar K V | Manager (corplaw@vinodkothari.com)

Introduction

The capital market watchdog, Securities and Exchange Board of India (‘SEBI’) has come out with a consultation paper on changing the concept of company ‘promoters’, and moving towards the idea of ‘person in control’. The proposal has come in the light of a drift from the conventional Indian ownership structure to the contemporary ownership structure where more than one person or persons controls an entity. The start-up ventures and the most celebrated ‘unicorns’ of the industry have substantial investment from Institutional investors and Private Equity players (‘PE firms’) who exercises control over the decision-making process through board representation and other means.

Further, SEBI has also proposed changes to the existing lock-in period requirements, streamlining disclosures of group companies, and rationalising the ‘Promoter Group’ definition in SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR’).

In this write-up, we have made an analysis of the concept of Promoter and Promoter Group, various obligations of the Promoter under SEBI Regulations, and the rationale for the shift from ‘Promoter and Promoter Group to ‘Person in Control’

Who is a Promoter?

Generally, any person who plays a major part in forming a company or establishing its business usually the prospective owners or directors of the company is regarded as a Promoter. They bring the business idea into existence and sets the vision and growth targets.

Promoter under Companies Act, 2013

Under the Companies Act, 2013, a promoter is a person who has been named as such in the prospectus or is identified by the company in the annual return filed every year. The definition also covers person(s) who has control over the affairs of the company, directly or indirectly whether in the capacity of a shareholder, director, or otherwise. Further, those person(s) in accordance with whose advice, directions, or instructions the Board of Directors of the company is accustomed to act, except in case of a person acting in a professional capacity, would also be considered as a promoter of a company.

Promoter under SEBI Regulations

The term ‘Promoter’ is defined under ICDR and various other SEBI regulations has the reference to the definition as given in ICDR.

Promoter under ICDR

The Regulation 2 (1) (oo) of ICDR defines the term ‘promoter’. The definition is similar to the definition in the Companies Act, 2013 and provides that a financial institution, scheduled commercial bank, foreign portfolio investor other than individuals, and the other specified body corporates shall not be deemed to be a promoter merely by holding 20% or more of the equity share capital of the issuer unless such person satisfies other requirements prescribed under the regulations.

Obligations on Promoters under SEBI Regulations

The identification of promoters is crucial in the listing process as the ICDR places substantial responsibilities on the Promoters. To ensure their ‘skin in the game’ after the IPO, the ICDR place various obligations on the promoters such as a 20% minimum shareholding in the post-issue share capital of the company and lock-in restriction of three years on such shareholding. There are also onerous disclosure requirements on promoters with respect to disclosures in the prospectus so that the general public has adequate information on the company for deciding whether to invest in the IPO or not.

However, being classified as a promoter of an investee company (Company) may not be favourable for a PE investor especially for those investors targeting the IPO as an exit route from the company. Therefore, it is vital for a PE investor to understand the key responsibilities and continuous disclosure requirements when classified as a promoter under the ICDR, including disclosure requirements relating to members of promoter group entities.

Figure – 1

Freezing of Promoter holding in case of default

 Under Chapter XI, Regulation 98 of LODR provides that in case of contraventions of the provisions of LODR, the shareholding of promoter/promoter group may be frozen by the respective stock exchange(s), in the manner specified in circulars or guidelines issued by the Board in coordination with depositories.

Thus, the promoters are subject to such action by the SEBI or the stock exchange in case of contraventions which adds up to the responsibilities of the promoter/promoter group. They need to ensure that the entity is in compliance with all the rules & regulations even if they are not involved in the day-to-day management of the entity.

The concept of Promoter Group

Regulation 2 (1) (pp) of ICDR defines Promoter Group (‘PG’) based on the nature of the promoter i.e. if the promoter is an individual and if the promoter is a body corporate. The definition, essentially, includes the promoter and the relatives of the promoter (spouse, parents, brother, sister, or child of the person or of the spouse).

PG, if the promoter is an individual PG, if the promoter is a body corporate
·        a body corporate in which 20% or more of the equity share capital is held by the promoter or an immediate relative of the promoter and

·        a firm or Hindu Undivided Family in which the promoter or any one or more of their relative is a member would fall under the promoter group category.

·         a body corporate in which a body corporate as mentioned above holds 20% or more, of the equity share capital and

·        a Hindu Undivided Family (HUF) or firm in which the aggregate share of the promoter and their relatives is equal to or more than 20% of the total capital of the company.

 

 ·        a subsidiary or holding company of such body corporate

·        a body corporate in which the promoter holds 20% or more of the equity share capital; and/or

·        a body corporate which holds 20% or more of the equity share capital of the promoter

·        a body corporate in which a group of individuals or companies or combinations thereof acting in concert, which hold 20% or more of the equity share capital in that body corporate and such group of individuals or companies or combinations thereof also holds 20% or more of the equity share capital of the issuer and are also acting in concert

The promoter group will also include all persons whose shareholding is aggregated under the heading “shareholding of the promoter group” in the shareholding pattern of the company.

It should be noted that, under the proviso to the definition of the promoter group, financial institutions, scheduled bank, foreign portfolio investor other than individuals, mutual funds, and such other body corporates as provided, are not deemed to be promoter group merely by virtue of the fact that 20% or more of the equity share capital of the promoter is held by such person or entity. However, such entities will be treated as promoter group for the subsidiaries or companies promoted by them or for the mutual fund sponsored by them.

The SEBI has proposed to delete Regulation 2(1) (pp)(iii)(c) from the definition of prompter group in the case of a promoter being a body corporate. The sub-clause covers those entities in which a group of individuals or companies or a combination thereof holds 20% or more who are also holding 20% or more of the equity in the issuer. These entities could be unrelated and the financial objectives of the investors can also be different. Since the only factor connecting the two entities is the common financial investors, the data captured under the said sub-clause may not be a piece of fruitful information to the investors and in turn, adds up the compliance & disclosure burden on the listed entity.

There arises a situation where persons who are not involved with the business of the issuer are covered by the definition and are required to make disclosures merely by falling within the ambit of the definition. The said proposal of deletion of the clause will bring in much more meaningful data to the investors for better analysis and will also help the issuer in reducing its compliance burden.

The definition of promoter group under ICDR is referred to in various SEBI regulations as in the case of the definition of the promoter. The obligations of the promoter group are similar to those of the promoters in terms of continuous disclosures and compliances under various SEBI regulations.

Figure 2

The need for re-visiting the concept of Promoter

The recent studies show that institutional investors are gaining a notable share in the Indian capital market, especially in the space of Top 500 listed companies by market capitalisation. The OECD report[1] shows that institutional investors represent an estimated investment of close to USD 400 billion in the public equity market, which is around 30% of total market capitalisation in India. In the year 2018, the institutional investors held almost 34% of equity holding of the top 500 Indian listed companies by market capitalization[2].

Among the top 500 listed entities by market cap, there is a sharp increase in the shareholding by the institutional investors from 14% in 2001 to 26% in 2018.

The current growth of the Indian primary and secondary markets is also due to the growing number of foreign institutional investors who have made considerable investments in the listed and unlisted space.

Institutional ownership in Indian listed companies (2001-2018)[3]

The data shows that there is a considerable shareholding in listed companies that may not fall under the ‘promoter/promoter group’ instead appears under the ‘public’ category but is in a position to influence the management and the decision-making process.

Thus, to bring such entities and persons who are now outside the umbrella of the promoters for the benefit of the retail investors as well as to have better governance over such entities to be accountable under the various provision of the SEBI Regulations, a re-visit to the very definition of the promoter is necessary.

A paradigm shift from promoter to the person in control is essential because several businesses, including new age and tech companies, are non-family owned and/or do not have a distinctly identifiable promoter group. The typical Indian family-owned companies are slowly moving away from their “once a promoter, always a promoter” status with the change in their leadership.

Shifts in the pledge of Promoters’ shares (2001-2018)[4]

In India, the promoters of listed entities pledge their shares as collateral to secure finance from banks & financial institutions. The underlying risk factor on the pledging of promoter stake is that an instance of default would significantly affect the share prices thereby putting the market as well as the retail individual investors at potential losses.

The number of shares pledged shows an upward trend until 2016 across all listed companies. However, the market value of shares pledged has remained stable while the number of pledged shares shows a slight downward trend since 2013.

In the Financial Stability Report, December 2014” (2014), RBI stated, “a typical Indian company, the promoters pledge shares not for funding outside business ventures but for the company itself. Given the vulnerabilities in some promoter-led companies, pledging of promoters’ shares could pose risks to the financial stability.”

SEBI has made the disclosure framework in respect of pledge of shares as collateral more stringent through the SAST regulations and has also provided strict timelines for such disclosures by promoters and promoter group. The data is disseminated through the stock exchange for the benefit of the investors.

Shifts in directors who are Promoters (2001-2018)[5]

Due to the traditional family-owned business setup, the promoters also get a seat on the board of directors of the company. The above figure shows the paradigm shift in the board participation by promoters and the average proportion between promoter directors and non-promoter directors during the period 2001- 2018.

The SEBI has brought safeguards to protect the minority shareholders’ rights especially to cover the companies with promoters holding board positions. The Regulation 17 of the LODR provides that;

  • Where a regular non-executive chairperson of a listed entity is a promoter of the listed entity or is related to any promoter, at least half of the board of directors of the listed entity shall consist of independent directors.
  • The fees or compensation payable to executive directors who are promoters or members of the promoter group shall be subject to the approval of the shareholders by special resolution in the general meeting of the members where such fees or compensation exceeds the limits prescribed therein.

These are a few measures to ensure that the promoter directors do not get an undue advantage due to their ability to influence the decision-making process by the Board of directors of the company and an element of independence is involved in the Board process.

However, it is pertinent to note that, the restrictions are only attracted to the ‘promoters’ and persons ‘related to promoter’ of the company.  A shift from ‘promoter’ to ‘person in control’ may cover those persons who are currently outside the ambit of the definition of ‘promoter’ but enjoys an element of influence on the entities.

SEBI discussion paper on Brightline Tests for the acquisition of ‘Control’[6]

The SEBI had issued a discussion paper on Brightline Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations in 2016, with the intent to decide whether a numerical threshold as the current practice or a principle-based test can be conducted to determine whether a person is in control of a listed entity.

The term ‘control’ implies the ability of a person or a group of persons acting with a common objective to influence the management and policy-making process of an entity. It can be said that such person(s) is(are) in the ‘driving seat’ with a substantial influence over the key business decision making, even without involving in the day-to-day affairs of the company.

The identification of control is undemanding in the instances where the rights arise from the shareholding/voting rights in the company. The real test of control in the cases of contractual agreements becomes complex and demands elaborate consideration of facts and circumstances of the case.

Therefore, the nature of the definition of control in such cases has to be based on a set of defined principles rather than the rules. In the matter of Subhkam Ventures (I) Pvt. Ltd.[7] the Hon’ble SAT, in its judgment dated January 15, 2010, rejected SEBI’s view stating that none of the clauses of the agreements, individually or collectively, demonstrated control in the hands of the acquirer wherein SEBI argued that the rights conferred upon the acquirer, through the agreements, amounted to ‘control’ over the target company.

The essence of the order was, control, according to the definition, is a proactive and not a reactive power. The test is whether the acquirer is in the ‘driving seat’.

The SEBI’s proposal for replacing the term ‘promoter’ with ‘person in control’ would change the current regulatory framework and will align with what was intended to be amended under SAST. However, the amended definition should exclude protective rights/ veto exercised by the acquirer that are participative in nature.

The concept of Control under various other Acts, Rules & Circulars

-The Insurance Laws (Amendment) Act, 2015 provides that control shall include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements. Thus, the ambit of coverage of promoter under the Act is wide enough to include various types of business ownership structures.

-Consolidated FDI Policy Circular of 2020 has a similar definition as provided in the Insurance Laws (Amendment) Act, 2015.

-In Competition Act 2002, the concept of control includes controlling the affairs or management by one or more enterprises,

(a)either jointly or singly, over another enterprise or group;

(b)one or more groups, either jointly or singly, over another group or enterprise

-International Financial Reporting Standard (IFRS) also defines the principle of control and establishes control as the basis of determining which entities are consolidated in the consolidated financial statements. Under IFRS, the principle of control sets out the following three elements of control:

(a) power over the investee;

(b) exposure, or rights, to variable returns from involvement with the investee; and

(c) the ability to use power over the investee to affect the amount of the investor’s returns.

Whether test applied for identifying SBO under CA, 2013 is of any relevance here?

The MCA vide its Notification dated June 13, 2018,[8] has enforced the provisions of amended Section 90 of the Companies Act, 2013 and also issued the Companies (Beneficial Interest and Significant Beneficial Interest) Rules, 2018 concerning Significant Beneficial Ownership (‘SBO’).

Meaning of SBO

The Significant Beneficial Owner is an individual who alone or together with or through one or more persons or trust, holds a beneficial interest (as prescribed under the SBO Rules) in the shares of a company or has the right to exercise, or the actual exercising of significant influence or control as defined in clause (27) of section 2 of the Companies Act, 2013.

The revised SBO rules have prescribed the following definition to SBO;

Often when it comes to investments the PE investors structure their investments into a Company through multi-layered entities, with the immediate holding entity of the Company will merely act as an investment vehicle and not a substantive entity.

The premise of SBO rules is to identify the natural person behind the entity. Therefore, to identify such natural persons exercising ultimate control over the Company, the SBO rules can be applied. However, the persons in control of the entity may be a natural person or a body corporate as mentioned above. Hence, the basic principle of SBO may not be useful to identify the latter, as the SBO rules have the primary objective of identifying money-laundering activities and their related provisions under the Prevention of Money Laundering Act of 2002.

The SEBI Board meeting held on 6th August 2021, accepted the changes proposed in the consultation paper on ‘Review of regulatory framework for promoter, promoter group and group companies’. The table showing the proposals and the SEBI Board decision on the same is tabulated below:

Proposal SEBI Consultation paper SEBI Board decision
Reduction in lock-in periods for minimum promoter’s contribution and other shareholders for public issuance on the Main Board

 

 The lock-in of promoters’ shareholding to the extent of minimum promoters’ contribution (i.e. 20% of post issue capital) shall be for a period of 18 months from the date of allotment in initial public offering (IPO)/further public offering (FPO) instead of existing 3 years, in the following cases:

 

a)      If the object of the issue involves only offer for sale

b)      If the object of the issue involves only raising of funds for other than for capital expenditure* for a project (more than 50% of the fresh issue size)

c)       In case of combined offering (Fresh Issue + offer for sale), the object of the issue involves financing for other than capital expenditure for a project (more than 50% of the issue size excluding OFS portion)

* The term capital expenditure shall be clarified to include purchase of land, building and civil work, plant and machinery, miscellaneous fixed assets, technology etc.

 Accepted
Lock-in of Promoter holding in excess of  minimum promoter contribution Further, in all the above-mentioned cases, the promoter shareholding in excess of minimum promoter contribution shall be locked-in for a period of 6 months instead of existing 1 year. Accepted
Reduction in lock-in periods for other shareholders for public issuance The entire pre-issue capital held by persons other than the promoters shall be locked-in for a period of 6 months from the date of allotment in the initial public offer as opposed to the existing requirement of 1 year. The lock-in of pre-IPO securities held by persons other than promoters shall be locked-in for a period of 6 months from the date of allotment in IPO instead of existing 1 year. The period of holding of equity shares for Venture Capital Fund or Alternative Investment Fund (AIF) of category or Category II or a Foreign Venture Capital Investor shall be reduced to 6 months from the date of their acquisition of such equity shares instead of existing 1 year.
Rationalization of the definition of ‘Promoter Group’ Deletion of Regulation 2(1) (pp)(iii)(c) in the definition of promoter group The definition of promoter group shall be rationalized, in case where the promoter of the issuer company is corporate body, to exclude companies having common financial investors
Streamlining the disclosures of group companies Only the names and registered office address of all the Group Companies should be disclosed in the Offer Document.  All other disclosure requirements like financials of top 5 listed/unlisted group companies, litigation etc., presently done in the Draft Red Herring Prospectus can be done away.  However, these disclosures may continue to be made available on the websites of the listed companies. The disclosure requirements in the offer documents, in respect of Group Companies of the issuer company, shall be rationalized to, inter-alia, exclude disclosure of financials of top 5 listed/unlisted group companies. These disclosures will continue to be made available on the website of the group companies.
Shifting from concept of ‘promoter’ to concept of ‘person in control’ To revisit the concept of promoter and shift to the concept of ‘person in control’ or ‘controlling shareholders’. Agreed in-principle.

 

To this effect, the Board, advised SEBI to:

 

a) engage with other regulators to ascertain and resolve regulatory hurdles, if any.

 

b) prepare draft amendments to securities market regulations and analyse impact of the same.

 

c) further deliberate at the PMAC and develop a roadmap for implementation of the proposed transition.
Consequent to the acceptance of the proposals in the Board meeting, the SEBI notified Issue of Capital and Disclosure Requirements (Third Amendment) Regulations, 2021 on 13th August 2021, and the actionable for listed companies pursuant to the said amendment are;

The FAQs of CDSL on System Driven Disclosure in Securities Market also provides that In case of any subsequent update in the information about Promoters, members of the promoter group, director(s), designated persons, the listed company shall update the information with the designated depository on the same day.

Further, the disclosure requirements under various SEBI regulations as depicted in Figure 2 will not be applicable to such entities henceforth.

Conclusion

The Indian investor perception is evolving at a faster pace and the regulatory framework needs to align at the same pace. The move of SEBI in bringing a paradigm shift from ‘Promoter/Promoter group to ‘Person in control’ will have a substantial effect in the capital market as it would bring in considerable changes in various SEBI regulations like ICDR, LODR, SAST, PIT, etc., and would pave the way for the introduction of a more comprehensive framework for IPOs.

How will the regulator define the term ‘person in control’?  Whether the existing framework in respect of SEBI SAST would be re-designed with a rule-based as well as a principle-based test of control as discussed in the discussion paper on ‘Brightline test’? these questions could interest us as we dig deeper into SEBI’s proposal.

[1] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[2] OECD (2019), OECD Equity Market Review of Asia 2019

[3] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[4] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[5] https://www.oecd.org/corporate/ownership-structure-listed-companies-india.pdf

[6] https://www.sebi.gov.in/sebi_data/attachdocs/1457945258522.pdf

[7] https://www.sebi.gov.in/satorders/subhkamventures.pdf

[8] https://www.mca.gov.in/Ministry/pdf/CompaniesSignificantBeneficial1306_14062018.pdf

Our other article on the relevant article can be read here – https://vinodkothari.com/2020/12/sebi-proposes-liberal-provisions-for-promoter-reclassification/

Ablution by Resolution

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The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 seeks to wash out liability of corporate debtors resolved under IBC

-Sikha Bansal (resolution@vinodkothari.com)

 

Resolution under the Insolvency and Bankruptcy Code, 2016 (‘Code’) is a harbinger of fresh start of the corporate debtor, which passes into the control of a new management by the very application of section 29A. The fresh start would have no meaning if the corporate debtor or the new management thereof have to bear the brunt of offences which the corporate debtor or its officers committed prior to ablution under the Code – that is, one cannot be made to reap what they did not sow. As such, it was important to provide immunity to the corporate debtor and its assets, the successful resolution applicant and the new management personnel.

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