Differential voting rights may finally be accepted

Companies that issue shares with differential voting rights (DVR) give those shares increased or decreased voting rights, compared to simple equity issues with one share carrying one vote

Regulation(s) have been relaxed for the issue of DVR shares to help such companies to retain existing control while raising equity capital. Amended rule 4 of the Companies (Share Capital and Debentures) Rules, 2014 (Share Capital Rules), raised the permitted percentage of shares with DVRs from 26% of the total voting power to 74%. Companies no longer have to show distributable profit for the previous three years. A company with superior voting rights shares are now subject to enhanced corporate governance. The intention was to increase the attraction of Indian companies and deep-pocketed investors worldwide have indeed shown interest in acquiring control of companies undertaking cutting-edge innovation and technology development.

Section 43 of the Companies Act, 2013 (act), divides share capital into two classes, one being equity share capital, which may be subdivided into equity shares with simple voting rights, and equity shares with differential rights; the second being preferential share capital. Section 43(2) of the act read with rule 4 of the Share Capital Rules, sets out conditions for the issue of DVRs, which can be of two classes: shares with superior voting rights, and shares with fractional voting rights. Shares with superior voting rights carry greatly increased voting rights compared to ordinary shares. These are usually issued only to promoters. The ratio for shares with superior voting rights should not exceed 10 votes for each equity share. The ratio for fractional shares is one vote held by 10 equity shares. These amendments enable promoters to retain control of their companies as they pursue growth and long-term value for shareholders, by raising equity capital from global investors.

In 2015, the Ministry of Corporate Affairs excluded the application of section 43 to private companies, their own memorandums and articles permitting. Private companies could design their share capital model as they saw fit. Concern arises when such a company converts to an unlisted public company. It is not clear whether the DVRs issued while it was a private company remain valid or whether it will have to comply with section 43 and rule 4. If the issuing company proposes to list, the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure) Regulations require that all convertible shares and options are converted into equity shares.

The question is whether the regulations cover DVRs. Rule 4(3) of the Share Capital Rules specifically bars conversion of equity shares into DVRs and vice versa. As they have no fixed term (like preference shares or debentures) and cannot be converted, the only way for a company to cancel issued DVRs is to buy them back, which is cumbersome, or to reduce share capital, which is even more complicated. They may be converted into ordinary shares through a scheme of arrangement.

In 2018, Singapore and Hong Kong amended their listing rules, possibly to help startups to unlock value, but also to persuade multibillion-dollar IPOs not to list elsewhere. Alibaba listed in New York after the Hong Kong stock exchange denied it a dual share listing. Hong Kong recognized the changed circumstances and recently listed the Xiaomi Corporation with DVRs. Three companies listed in India have DVR shares: Tata Motors Limited, from 2008, Jain Irrigation Systems Limited and Future Enterprises Limited. A fourth is suspended due to liquidation proceedings.

DVRs help startups to unlock value through IPOs but maintain control, so in 2019 SEBI issued a framework on the issue of DVRs. This restricted DVRs to shares with superior voting rights in technology companies seeking listing. Only promoters or founders who hold executive positions can hold DVR shares, which should have been held for at least six months before the red herring prospectus is issued.

Investors’ recognition that DVRs do not reduce their economic rights, even if they have no, or inferior voting rights. Thus, in a liquidation, DVRs have equal rights with other equity shareholders with no subordination. Once this is understood and accepted, volumes will pick up and reduce present discounts.

Nisha Mallik is a partner and Neha Mirajgaoker is a senior associate at Samvad Partners

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