Amendments to Regulatory Framework for Shares with Differential Voting Rights & Debenture Redemption Reserve

Posted In:

A.       Shares with Differential Voting Rights

1.      The Companies Act, 2013 (‘Companies Act’) read with the Companies (Share Capital and Debentures) Rules, 2014 (‘Share Capital Rules’) prescribes several conditions that a company needs to satisfy prior to the issuance of shares with differential rights as to dividend, voting or otherwise (‘DVR Shares’). It may be noted that private companies which expressly provide so in their memorandum or articles of association, are exempt from the above-mentioned conditions. The Ministry of Corporate Affairs (‘MCA’) has, by way of a notification dated August 16, 2019, amended the Share Capital Rules to relax the following two conditions for issuance of DVR Shares:

(a)       the requirement of having distributable profits for the last 3 years has been done away with altogether; and

(b)      a company may issue DVR Shares subject to the condition that the voting power in respect of DVR Shares of the company must not exceed 74% of total voting power including voting power in respect of equity shares with differential rights issued at any point of time. This has replaced the earlier provision which laid down that the DVR Shares could not exceed 26% of the total post-issue paid up equity share capital, including equity shares with differential rights issued at any point of time.

2.       By way of an earlier press release dated June 27, 2019, the Securities and Exchange Board of India (‘SEBI’) had issued a framework for issuance and listing of shares with differential voting rights by technology companies (as defined with respect to the Innovators Growth Platform), subject to various conditions including additional corporate governance standards. Pursuant to the Press Release, the following amendments have been made on July 29, 2019 to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘SEBI ICDR Regulations’) and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘SEBI Listing Regulations’):

2.1.      SEBI ICDR Regulations

(a)      Definition of SR equity shares: SR equity shares have been defined to mean equity shares of an issuer having superior voting rights compared to all other equity shares issued by that issuer (‘SR Equity Shares’).

(b)        Eligibility / general conditions:

(i)        Initial public offer: A company whose shares are proposed to be listed and would have superior voting rights shares to be permitted to make an initial public offering (‘IPO’) of only ordinary shares to be listed on the main board subject to compliance with the SEBI ICDR Regulations and the following conditions:

a.         the issuer should be a tech company i.e.a company intensive in the use of technology, information technology, intellectual property, data analytics, bio technology or nano-technology to provide products, services or business platforms with substantial value addition;

b.          the holders of SR Equity Shares should not be part of the promoter group whose collective net worth is more than ₹ 500 crores (approx. US$ 73 million);

c.          SR Equity Shares should be issued only to the promoters/ founders holding executive position(s) in the company;

d.         issuance of SR Equity Shares should be duly authorised by a special resolution passed by the shareholders where the notice calling for the resolution provides for (i) the size of issue of SR Equity Shares; (ii) ratio of voting rights of SR Equity Shares vis-à-vis the ordinary shares; (iii) rights as to differential dividends, if any; (iv) sunset provisions, which provide for a time frame for the validity of such SR Equity Shares; and (iv) matters in respect of which the SR Equity Shares would have the same voting right as that of the ordinary shares;

e.         SR Equity Shares should be held for at least six months prior to filing of the red herring prospectus;

f.          SR Equity Shares should have voting rights in the ratio of 2:1 to 10:1 as compared to ordinary shares;

g.          the SR Equity Shares should have the same face value as the ordinary shares;

h.         the issuer should only have one class of SR Equity Shares; and

i.           the SR Equity Shares should be equivalent to the ordinary equity shares in all respects, except for having superior voting rights.

(ii)       Rights issue: If the issuer has issued SR Equity Shares to its promoters or founders, then such promoters or founders must not renounce their rights and the SR Equity Shares received in a rights issue must remain under lock-in until conversion into equity shares having voting rights same as that of the ordinary equity shares along with existing SR Equity Shares.

(c)        Promoter contribution: SR Equity Shares held may be included as a part of promoters’ contribution for an IPO as well as for a further public offer (‘FPO’).

(d)          Listing and lock-in:

(i)          In case of an IPO, the SR Equity Shares must be locked-in until their conversion to ordinary shares or till the expiry of (i) three years for SR Equity Shares forming part of promoters’ contribution; and (ii) one year for SR Equity Shares held in excess of promoters’ contribution, whichever is later.

(ii)          In case of an FPO, the SR Equity Shares must be under lock-in until their conversion to equity shares having voting rights same as that of ordinary shares subject to compliance with the SEBI ICDR Regulations

(iii)        Inter se transfer of SR Equity Shares among promoters and promoter group is not permitted and no pledge/ lien must be allowed on SR Equity Shares, in case of an IPO as well as an FPO.

(e)          Bonus issue: If an issuer has issued SR Equity Shares to its promoters or founders, any bonus issue on the SR Equity Shares must carry the same ratio of voting rights as compared to ordinary shares and the SR Equity Shares issued in a bonus issue must also be converted to equity shares having voting rights same as that of ordinary equity shares along with existing SR Equity Shares.

2.2.       SEBI Listing Regulations

(a)        Rights: SR Equity Shares to be treated at par with ordinary equity shares including in respect of dividend issuance, except with regard to voting on resolutions. The total voting rights of SR shareholders to not exceed 74% post listing.

(b)        Enhanced corporate governance: Companies with holders of SR Equity Shares will be subject to enhanced corporate governance wherein half of the board and two-third of committees (excluding the audit committee) should comprise of independent directors while the audit committee must comprise of only independent directors.

(c)        Coat-tail provisions: Post-IPO, in relation to certain specified items, the SR Equity Shares to be treated as ordinary equity shares in terms of voting rights (i.e., one SR share must have only one vote). Such items are: (i) appointment or removal of independent directors and/or auditors; (ii) willful transfer of control by promoter to another entity; (iii) related party transactions in terms of the SEBI Listing Regulations, involving holders of SR shareholders; (iv) voluntary winding up of the company; (v) changes to the articles of association or memorandum of associates (except changes affecting the SR Equity Shares); (vi) initiation of a voluntary resolution plan under the Insolvency and Bankruptcy Code, 2016; (vii) utilization of funds for purposes other than business; (viii) substantial value transaction based on materiality threshold prescribed under the SEBI Listing Regulations; (ix) passing of special resolutions in respect of delisting or buy-back of shares; and (x) any other provisions that may be notified by SEBI from time to time.

(d)       Sunset clauses: SR Equity Shares to be converted into ordinary shares either with the passage of time i.e. at the completion of the fifth anniversary of listing[1] or such conversion to be event based i.e., on the occurrence of certain events such as demise or resignation of shareholders of SR Equity Shares, merger or acquisition where control would be no longer with SR shareholders.

B.         Debenture Redemption Reserve

Section 71(4) of the Companies Act read with Rule 18(7) of the Share Capital Rules provided that any company that issues redeemable debentures is required to create a debenture redemption reserve (‘DRR’) of at least 25% of outstanding value of debentures for the purpose of redemption of such debentures. Further, companies were required to either deposit, before April 30th each year, in a scheduled bank account, a sum of at least 15% of the amount of its debentures maturing during the year ending on March 31 of next year or invest such sum in one or more securities enlisted in Rule 18(1)(c) of Share Capital Rules.

Rule 18 of the Share Capital Rules provided that the following classes of companies were required to comply with the provisions relating to DRR: (i) non-banking financial companies (‘NBFCs’) registered with the Reserve Bank of India (‘RBI’) under section 45-IA of the RBI Act, 1934 and Housing Finance Companies (‘HFC’) registered with the National Housing Bank (‘NHB’) issuing debentures through public issue; (ii) other listed companies coming up with public issue or private placement; and (iii) unlisted companies issuing debentures on private placement basis.

The MCA has now relaxed the requirements under Rule 18(7) of the Share Capital Rules, whereby NBFCs registered with RBI, HFCs registered with NHB and listed companies are now exempted from creation of DRR in case of public issue of non-convertible debentures as well as privately placed debentures. Additionally, the requirement of DRR has been reduced from 25% to 10% of the value of the outstanding debentures.

[1] The validity of the SR shares can be extended by five years through a resolution in which the SR shareholders would not be permitted to vote.

Date: October 30, 2019