Company Law Research Paper

SVK
M’S NMIMS, SCHOOL OF LAW

SUBJECT: COMPANY LAW RESEARCH PAPER

SEMESTER - V

“SHARE WITH DIFFERENTIAL VOTIONG RIGHTS: LEGAL POSITION IN INDIA ”

UNDER THE GUIDANCE OF KRITANSHI KAMAL MISHRA (A022)

ADV. SHREYA MADALI BBA. L.LB

SAP ID- 81022019027

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TABLE OF CONTENTS

SR NO. TITLE PAGE NO.

1. Abstract 3
2. Introduction 4
4. What is Differential Voting Right? 5
5. Comparative analysis of DVRs Prior to the Companies Act, 6
2013 and after the execution of the act
6. Legal development of DVR in India 10
7. Current position of DVR in India 10
8. Features of Shares with Differential Voting Rights 11
9. Limitations in issue of DVR 12
10. Conclusion 13

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ABSTRACT

Among the most controversial in the history of corporate control, shares with differential
voting rights (DVRs), also known as Dual Class Shares, have been the subject of furious but
inconclusive debates as to their acceptability as a legitimate device to perpetuate control of a
corporation without necessarily having a controlling percentage of equal-rights-equity.
Institutional investors around the world are violently against the principle on grounds that it
is inequitable, unethical, and unfair to the rest of the shareholders of equal-rights-equity
where cash flow rights and control rights are proportionate to their equity holding.

Although the one-share-one-vote principle is the default norm in business corporations in

most countries, it is by no means the only norm in practice. Equity shares with differential
voting rights (DVR) have always been in vogue to an extent in different countries, including
with regard to variations in the terms of differentiation. Seemingly inequitable to the
shareholders with less rights than the others, often their pricing and valuations do consider,
and largely compensate for, such erosion of power. While the average retail shareholder,
thus, may not be too worried about the implications of such shares with DVRs, there are
significant pros and cons that impact promoters major block investors, favourably
unfavourably; this quarterly briefing reviews some of these perspectives, given the recent
regulatory and legislative initiatives on DVRs in India.

KEYWORDS: – shares, equity, differential voting rights, etc.

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INTRODUCTION

Introduction

“The recent times have witnessed the promotors and founders grappling with maintaining
control over their company especially in cases where public investors are involved. With
examples like investors of HDFC Bank voting against the reappointment of Mr. Deepak
Parekh as Non-Executive Director in August 2018 and the more recent hostile takeover of
Mindtree Ltd. by the Larsen and Toubro, the promoters crave to have more power over the
decision making in the company. This has seen the emergence of several investment
instruments to help the promoters retain control over the company without eroding its capital.
One such instrument which allows the company to do so is through issuing the shares with a
differential voting right (“DVR Shares”). 

Background:

 Shares: A share is the interest of a member in a company. Section 2(84) of the

Companies Act, 2013 (hereinafter referred to as Act) “share” means a share in the
share capital of a company and includes stock. It represents the interest of a
shareholder in the company, measured for the purposes of liability and dividend. It
attaches various rights and liabilities.
 Voting Rights:  the right of a member of a company to vote in any meeting of the
company or by means of postal ballot.
 Differential Voting Rights: The term differential rights with respect to shares can be
interpreted to mean the existence of rights different in nature than the rights that are
inherently associated with ordinary shares. The holder of these shares has rights
which are different from the holder of ordinary shares. Differential Rights in
association with shares are in relation to voting rights, dividend or otherwise.

Types of share capital: The share capital is the contribution by the Owners of the Company.
As per the provisions of the Companies Act, 2013, share capitals are of 2 kinds: –

1. Equity Share Capital

2. Preference Share Capital
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Equity Share Capital: Equity shares are also known as ordinary shares. They are the form of
fractional or part ownership in which the shareholder, as a fractional owner, takes the
maximum business risk. The holders of Equity shares are members of the company and have
voting rights. Equity shares are the vital source for raising long-term capital. Equity shares
represent the ownership of a company and capital raised by the issue of such shares is known
as ownership capital or owner’s funds. They are the foundation for the creation of a company.
Equity shareholders are paid based on earnings of the company and do not get a fixed
dividend. They are referred to as ‘residual owners. They receive what is left after all other
claims on the company’s income and assets have been settled. Through their right to vote,
these shareholders have a right to participate in the management of the company. Again, the
Equity shares/ capital can be further divided into: –

1. Equity shares with voting rights

2. Equity shares without voting rights.

These shares are known as shares with Differential Voting rights related to voting power
(either more voting rights or less voting rights). Some shall carry voting rights and others
may not. The shares with lesser voting rights can carry higher divided rates and vice a versa.

Preference Share Capital:  Preference shares are the shares which promise the holder a
fixed dividend, whose payment takes priority over that of ordinary share dividends. Capital
raised by the issue of preference shares is called preference share capital. The preference
shareholders are in superior position over equity shareholders in two ways: first, receiving a
fixed rate of dividend, out of the profits of the company, before any dividend is declared for
equity shareholder and second, receiving their capital after the claims of the company’s
creditors have been settled, at the time of liquidation. In short, the preference shareholders
have a preferential claim over dividend and repayment of capital as compared to equity
shareholders.”

 What are shares with differential voting rights?

“Section 43 of the Companies Act, 2013 states that there are two types of share capitals
i.e., equity share capital and preference share capital. Further, Section 43(a)(ii) states that
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equity share capital of the company can be with differential rights as to dividend and voting.

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Simply put, DVR Shares denote those equity shares allotted to the shareholders with a
deviation from the one voting right per share rule. These shares either carry less than one
voting right per share, or more than one voting right per share. However, this concession on
the voting rights is compensated by the prospect of earning dividend at a higher rate and vice
versa.

Differential voting rights ("DVR") refer to equity shares holding differential rights as to
dividend and/or voting. In India, section 43 (a) (ii) of the Companies Act, 2013 ("Companies
Act") allows a company limited by shares to issue DVRs as part of its share capital.
Introduced for the first time in 2000, DVRs are seen as a viable option for raising investments
and retaining control over the company at the same time. Recently, there has been renewed
interest in DVRs with the Securities and Exchange Board of India ("SEBI") releasing a
consultation paper on the 'issuance of shares with differential voting rights (DVRs)' and
subsequently approving the framework for the same in line with the present government's 100
(hundred) day agenda to revive the economy.”

DVRs Prior to the Companies Act, 2013

“DVRs were first introduced in India by way of an amendment1 to section 86 of the

Companies Act, 1956 ("Old Act"), which provided that the share capital of a company
limited by shares shall only be of 2 (two) kinds, namely equity share capital and preference
share capital. The aforesaid section 86 permitted equity share capital to have differential
rights as to dividend, voting or otherwise, in accordance with such rules and subject to such
conditions as would be prescribed by the government. Pursuant to this amendment, two
Indian companies, namely, Tata Motors and Pantaloons Retails (now renamed as Future
Enterprises Limited) issued DVRs with 1/10th (one by ten) voting rights as compared to
ordinary shares in exchange for 5% (five per cent) higher dividend as compared to ordinary
shares.

In a similar vein, 2,500,000 (two million five hundred thousand) preference shares (with
DVRs) of Jagatjit Industries Limited were issued to a company controlled by Mr. Karamjit.
This issuance of DVRs effectively raised Mr. Karamjit's voting rights and gave him
substantial control over Jagatjit Industries Limited even though his economic contribution did
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not reflect such a leap. While this move was challenged by minority shareholders of the
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Vide the Companies (Amendment) Act, 2000

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company, the Company Law Board approved the allotment of preferential shares with DVRs,
the same being legally permissible considering section 86 of the Old Act2.”

“However, shortly thereafter SEBI issued a circular dated July 21, 20093 which stated
that "the company agrees that it shall not issue shares in any manner which may confer on
any person, superior rights as to voting or dividends vis-à-vis the rights on equity shares that
are already listed."

The net effect of this circular resulted in companies being prohibited from issuing superior
voting rights or lower voting rights with higher dividends as compared to ordinary equity
shares that were already listed. Thus, because of the abovementioned circular, Indian
companies who opted for issuance of shares with DVRs did so by issuing bonus shares with
lower voting rights but carrying the same dividend rights as ordinary shares.”

DVRs under the Companies Act, 2013

“Section 43(1) of the Companies Act (which replaced the Old Act) is like Section 86 of the
Old Act and allows the issuance of equity shares with differential voting rights. However,
Section 47 of the Companies Act provides that every member of a company limited by shares
and holding equity share capital therein, shall have a right to vote on every resolution placed
before the company.

Thus, it gives every shareholder of a company the right to vote on every resolution presented
before the company, in proportion to his/her share of the paid-up equity share capital.
However, section 47 of the Companies Act is subject to section 43 of the Companies Act
which, means that companies can issue shares with differential voting rights, notwithstanding
the implicit 'one-share-one-vote' requirement under section 47 of the Companies Act.

Until August 16, 2019, Rule 4 of Companies (Share Capital and Debentures) Rules, 2014
("SCDR") set out certain additional requirements to be complied with by companies which
wish to issue shares with differential rights as to dividend, voting or otherwise. These
requirements were that

(i) the company's articles of association should authorise the issuance of shares with
differential rights.
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(2010)1CompLJ509(CLB)
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SEBI/CFD/DIL/LA/2/2009/21/7

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(ii) the issue of shares is authorized by an ordinary resolution passed at a general

meeting of the shareholders.
(iii) the shares with differential rights shall not exceed 26% (twenty-six per cent4 of the
total post-issue paid up equity share capital including equity shares with
differential rights issued at any point of time; and (iv) (d) the company having a
consistent track record of distributable profits for the last 3 (three) years5.

The erstwhile 26% (twenty-six per cent) limit on the number of DVRs that can be issued was
based on debatable policy considerations. The need to have a 3 (three) year track record of
profitability restricted the number of companies eligible to issue shares with DVRs.

Initially, there was no provision for issuing DVR Shares under the erstwhile Companies Act,
1956. However, vide Companies (Amendment) Act, 2000, Section 86 of the Companies
Act, 1956 was amended to include shares having differential rights as to dividend, voting or
otherwise, as equity shares. The company issues DVRs to improve their capital structure
without diluting or losing control or management affairs of the company. This enables the
promoters to retain their control over the Company even when new investors are introduced.
The issue of normal equity shares means one share one voting right. But in case of DVRs, it
means one share may or may not carry one voting rights.”

Section 43(2) of the companies act 2013 read with Companies (share capital & Debentures
rules) 2014 provides that companies can issue equity shares with differential rights subject
to the following conditions: –

1. DVRs authorized by Articles of Association.

2. The company shall obtain approval of shareholders by passing general resolution in

General Meeting.

3. The company shall not have defaulted in filing annual returns /financial statements for the
last three years immediately preceding the financial year in which it was decided to issue
such shares.

4. The company shall not have defaulted in repayment of matured deposits or declared
dividend to the shareholders.
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Amended to 74% with effect from August 16, 2019
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This requirement has been deleted with effect from August 16, 2019.

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5. In case of listed companies, the issue of such shares shall be approved by postal ballot.

6. The company shall not have defaulted in redemption of its preference shares /debentures
which are due for redemption.

7. The company shall not have defaulted in repayment of instalment of term loan taken from
any public financial institution or state level financial institution or from a scheduled bank
that has become due and payable.

8. The company shall not have defaulted in crediting the amount in Investor Education and
Protection Fund to the Central Government.

9. the company has not been penalized by Court or Tribunal during the last three years of any
offence under the Reserve Bank of India Act, 1934, the Securities and Exchange Board of
India Act, 1992, the Securities Contracts Regulation Act, 1956, the Foreign Exchange
Management Act, 1999 or any other special Act, under which such companies being
regulated by sectoral regulators

10. The company has not defaulted in payment of dues with respect to statutory payments
relating to its employees to any authority

11. The company shall not have converted its existing equity share with voting rights into
equity shares with differential voting rights and vice versa.

“Purpose of Issue of Shares with Differential Voting Rights: Issuance of shares with

differential rights may be used as a tool for strategizing control and dilution of voting rights
in a company.

Procedure of Issue of Shares with Differential Voting Rights: Section 43(a) of the

Companies Act, 2013 provides Company can issue equity shares with differential rights as to
dividend, voting or otherwise, only if such issue of shares meets the following conditions:

 The issue should be authorised by the articles of association.

 The issue should be authorised by the shareholders of the Company by way of an
ordinary resolution; (issue of such shares of a listed company shall be approved by
shareholders through postal ballot)
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 The shares with differential rights shall not exceed twenty-six percent of the total
post-issue paid up equity share capital including equity shares with differential rights
issued at any point of time.
 The company should have a consistent track record of distributable profits for the last
three years.
 The company has not defaulted in filing financial statements and annual returns for
three financial years immediately preceding the financial year in which it is decided to
issue such shares.”

 Legal development of DVR in India

“Initially, there was no provision for issuing DVR Shares under the erstwhile Companies Act,
1956. However, vide Companies (Amendment) Act, 2000, Section 86 of the Companies
Act, 1956 was amended to include shares having differential rights as to dividend, voting or
otherwise, as equity shares. Consequently, two Indian companies, among others, issued DVR
Shares, which are, Tata Motors Ltd. and Future Enterprises Ltd.

However, on 21st July 2009 Securities Exchange Board of India (“SEBI”) issued a Circular
bearing no. SEBI/CFD/DIL/LA/2/2009/21/7 which prohibited listed companies from issuing
shares with superior rights as to voting or dividend vis-à-vis the rights on equity shares that
are already listed. Thus, listed companies were barred from issuing shares with superior
voting rights or lower voting rights with higher dividends as compared to ordinary equity
shares.”

 Current position of DVR in India

“Presently, the issue of DVR Shares is governed by Section 43of the Companies Act,
2013 read with Rule 4 of the Companies (Share Capital and Debenture) Rules,
2014 (“Rules”).

 
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On 16th August 2019, the Rules were amended vide Companies (Share Capital and
Debenture) Amendment Rules, 2019 whereby the government relaxed the norms for issue of
DVR Shares. Firstly, the government removed the requirement of distributable profits for
three (3) years for a company to be eligible to issue DVR Shares. Secondly, the limit of
maximum DVR Shares that can be issued by a company was revised from “twenty-six
percent (26%) of the total post issue paid-up equity share capital” to “seventy-four percent
(74%) of total voting power”.

Also, in June 2019, SEBI released a Framework for Issuance of Differential Voting Rights
Shares for a) companies whose equity shares are already listed on stock exchanges and b)
companies with equity shares not hitherto listed but proposed to be offered to the public.”

  

 Features of Shares with Differential Voting Rights

“The following may be kept in mind while taking decisions regarding issue of DVR Shares: 

(i) Prevents Dilution of Voting Rights- Since DVR Shares can separate economic
interests with voting rights, promoters are able to exercise greater control over the
company even when other investors have contributed more capital. Consequently,
this prevents hostile takeovers.
(ii) Better Rate of Dividend- Shares having inferior voting rights offer a better rate
of dividend than other equity shares. This is beneficial for those strategic investors
who are primarily interested in the returns, without getting involved in the
management and affairs of the company.
(iii) Less transparency-With promoters having greater control over the company,
even while making lesser economic contribution, there is a major risk of the DVR
Share structure making the corporate governance standards in the company less
transparent and leading to potential oppression of minority shareholders.
(iv) Thinly traded DVR Shares-Due to relatively low popularity, trading volume of
listed DVR Shares is generally lower in comparison to the ordinary shares of the
company and the DVR Shares are traded at a lower price. Thus, the liquidity of
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DVR Shares has not been good.”

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 Limitations in Issue of DVRs

“The Companies (Share Capital and Debentures) Rules, 2014 was amended. The

amendment provided that the condition for the issue of shares with differential voting rights
should not exceed 74%, including equity shares with differential rights at any point in time.
Earlier to the amendment, the rules provided that the condition for the issue of shares with
differential voting rights should not exceed 26%.

Now, the companies can have up to 74% of differential voting right equity shares in the total
post issue paid-up share capital. This amendment which increased the limit for the issue of
shares with differential voting rights up to 74% is beneficial to the start-ups.

The amendment removed the condition that the company should earn distributable profits in
the last three years to issue DVRs. However, the shares with superior voting rights must be
held for a period of at least six months preceding the filing of the red herring prospectus.”

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L CONCLUSION

DVR Shares may be used by the promoters who are unable to provide for the company’s
increasing requirement for funds, by seeking investment from other investors without the fear
of losing control over the business decisions. With the recent amendment removing the
requirement of distributable profits for three years for a company to be eligible to issue DVR
Shares, several newly incorporated companies especially start-ups would be keen on issuing
DVR Shares to its investors. However, the question that how significant and effective the
DVR Share structure proves to be in this struggle for power between the promoters and the
investors, that only time will tell.

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