Context
Even after the ‘right to property’ was abolished as a fundamental right by the 44th Amendment to our Constitution[1], it has continued as a ‘constitutional right’ by virtue of Article 300-A, which provides that – “No person shall be deprived of his property save by authority of law”.
It is a well-established principle of company law that the right to vote attached to a share is a ‘property’[2]. As noted in the celebrated English case of Pender v. Lushington[3], the right to vote is a ‘right of property’, belonging to a shareholders’ interest in the company. Section 47 of the Companies Act, 2013 (“Act”), which corresponds to Section 87 of the Companies Act, 1956 (“1956 Act”), provides statutory recognition to this common law principle, with Section 47(1) stating as follows:
“Subject to the provisions of provisions of section 43, sub-section (2) of section 50 and sub-section (1) of section 188,—
(a) 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; and
(b) his voting right on a poll shall be in proportion to his share in the paid-up equity share capital of the company”.
This company law provision sets in stone the cardinal principle of corporate democracy. Every equity shareholder of the company has one vote, when voting is done by show of hands and on poll, his voting right is proportionate to his share in the paid-up equity share capital of the company.
Both under the 1956 Act and the Act, any provision in the Articles of Association (“Articles”) of a public company, which is repugnant to this provision is void. The above rule will not apply to a private company, if the Articles of the company so provide.
Notably, Section 47(1) was amended by the Companies (Amendment) Act, 2017 to grant legal sanction to the imposition of restrictions on a related party’s voting rights for a material RPT under Section 188.
The right to vote is arguably the most ‘fundamental’ of all right that an equity shareholder has under the scheme of the Act. The nature of an equity shareholders’ voting rights assumes significance in the context of SEBI’s recent amendments to the regulatory architecture for listed companies – where provisions relating to shareholders’ approval by a ‘majority of minority’ vote has been introduced for aspects like related party transactions[4] (“RPTs”) and schemes of arrangement[5].
To illustrate this ‘majority of minority’ construct, reference may be made to Regulation 23(4) of the LODR Regulations, which provides that for any material RPT, no related party shall vote to approve the resolution, irrespective of whether or not it is a party to the transaction. This implies that majority shareholders are disenfranchised from voting to approve the transaction under all circumstances, and approval of the ‘majority’ of the minority shareholders of the listed entity will be required.
A similar construct is applicable for schemes of arrangement undertaken by listed entities, where the scheme provides for allotment of shares to the promoter/ promoter group, involves the listed entity and a promoter/ promoter group entity, and so on[6]. SEBI had also floated a consultation paper recently which proposed the introduction of a ‘majority of minority’ approval for (a) agreements impacting management or control of a listed entity, irrespective of whether the listed entity is a party; and (b) business transfer agreements (“BTAs”) undertaken outside the scheme route[7]. (The proposed changes have not been notified as on the date of publication of this blog).[8]
It is relevant to note that this construct for ‘majority of minority’ approval has been brought in by way of delegated legislations (i.e., the LODR Regulations and the Scheme Circular), and not by way of an amendment to the SEBI Act, 1992 (“SEBI Act”), or the Securities Contracts (Regulation) Act, 1956 (“SCRA”).
Such a construct for ‘majority of minority’ approval effectively deprives a majority shareholder of his right to vote, which forms part of his ‘right to property’ under Article 300A of the Constitution. This begs the question on whether there is any ‘authority of law’ under which SEBI can provide for ‘majority of minority’ approval? Moreover, does this requirement fall foul of the manifest arbitrariness and proportionality tests under Articles 14 and 19(1)(g) of the Constitution?
In this blog, the authors delve deeper into these questions and examine potential arguments in favour of, and against the constitutional validity of SEBI’s ‘majority of minority’ construct.
“Authority of law” under Article 300-A
In Bishambhar Dayal Chandra Mohan v. State of U.P[9], the Supreme Court of India (“SC”) held that the word “law” in the context of Article 300-A “must mean an Act of Parliament or of a State legislature, a rule, or a statutory order, having the force of law, that is positive or State made law”.[10]
While the expression ‘law’ under Article 300-A can include a ‘delegated legislation’, such deprivation of property can be undertaken by a delegated legislation only if there is an ‘enabling authority’ conferred by the parent statute. In other words, the source of power must be a parent statute, and the power to deprive a person of his property cannot emanate from a delegated legislation.
In this context, reference may also be made to the decision of the learned Single Judge of the Gujarat HC in Alka Synthetics Ltd. v. SEBI[11], which was in the context of whether SEBI’s action of impounding/ forfeiting money received by stock exchanges fell foul of Article 300-A, or whether this can be traced to SEBI’s powers under Section 11-B of the SEBI Act. The Learned Single Judge held that the expression ‘law’ under Article 300-A may include subordinate legislation, if the parent statute (under which the subordinate legislation is framed) specifically authorises such deprivation of property[12].
Basis the well-established meaning of ‘law’ under Article 300-A, it is clear that imposition of a ‘majority or minority’ shareholders’ approval requirement through a delegated legislation will meet the Article 300-A test only if the Act, or the SEBI Act/ SCRA specifically authorises such deprivation of voting rights.
Is there a ‘source of power’ for SEBI under the Act, SEBI Act/ SCRA?
Section 24 of the Act lays down clear boundaries of allocation of powers/ jurisdiction between the MCA and SEBI under Chapters III and IV of the Act. Section 47, dealing with “voting rights” is under Chapter IV of the Act, which is clearly under the jurisdiction of the MCA even for listed companies. Therefore, there is no source of power for SEBI to legislate on voting rights under the Act.
The LODR Regulations have been notified pursuant to Sections 11(2), 11A and 30 of the SEBI Act, read with Section 31 of the SCRA. Unlike Section 47 of the Act (which authorises imposition of voting restrictions for RPTs under Section 188), there is no provision in the SEBI Act or the SCRA, which authorises SEBI to restrict or curb the voting rights of a majority shareholder. Notably, Section 47 only provides that an equity shareholders’ voting rights are subject to restrictions that may be imposed under Section 188. It does not authorise voting rights restrictions through regulations framed by SEBI.
While the SCRA and the LODR Regulations provide that all words and expressions used but not defined therein shall have the meaning assigned to it under the Act, it may be noted that this is limited to ‘words’ and ‘expressions’ only – and in the absence of specific enabling provisions in the SEBI Act and the SCRA, it may not be permissible to trace the source of power by directly borrowing provisions of the Act.
Moreover, it is well-settled that fiduciary duties apply only at the Board level, and while casting a vote at a general meeting, a shareholder is entitled to act as he thinks fit – and give primacy to his own individual interest of safeguarding his investment in the company. [13] The SEBI Act/ SCRA does not contain any provision that authorises SEBI to curb the exercise of this right.
Manifest Arbitrariness and Proportionality
In its current form, the ‘majority of minority’ construct disenfranchises majority shareholders even if there is no conflict of interest vis-à-vis the transaction. Moreover, with effect from April 1, 2023, any person/ entity holding 10% or more of equity shares of a listed entity will be regarded as related party (“10% Shareholding Test”). By virtue of the 10% Shareholding Test, even financial/ institutional investors would be disenfranchised from voting to approve a material RPT, even if they do not have any direct or indirect conflict of interest, vis-à-vis the transaction.
Test of Manifest Arbitrariness under Article 14
The equality code under Article 14 prescribes substantive and not formal equality. In Sharma Transport v. Govt. of Andhra Pradesh[14], it was held that a delegated legislation can be shown to be manifestly arbitrary, if it is established that the delegated legislation is framed in a manner that is capricious, or without adequate determining principle, or is done without sound reason or judgment. The manifest arbitrariness test has also been reiterated in the context of plenary legislation, in Shayara Bano v. Union of India[15]which held that ‘manifest arbitrariness’ is something that has been done by the legislature “capriciously, irrationally and/or without adequate determining principle”.
As SEBI’s framework provides for disenfranchisement even if there is no actual or potential conflict of interest, it can be argued that the voting restrictions are not founded on any adequate determining principle, and suffers from the vice of ‘manifest arbitrariness’ under Article 14.
Proportionality
As noted by the SC in its judgements in K.S. Puttuswamy[16] and Modern Dental College[17], the ‘proportionality test’ under Articles 14, 19 and 21 requires a constitutional court to evaluate whether the impugned measure complies with the following four-pronged test:
(a) A measure restricting a right must have a legitimate goal (legitimate goal stage).
(b) It must be a suitable means of furthering this goal (suitability or rational connection stage).
(c) There must not be any less restrictive but equally effective alternative (necessity stage).
(d) The measure must not have a disproportionate impact on the right-holder (balancing stage).
A less restrictive but equally effective alternative would perhaps have been for SEBI to impose voting restrictions only when a shareholder has a conflict of interest vis-à-vis the proposed contract/ arrangement/ transaction, and not otherwise. A blanket restriction arguably has a disproportionate impact on the majority shareholders’ fundamental rights under Articles 14 and 19(1)(g) – and fails to achieve a balance between this fundamental right of majority shareholders and the regulatory objective of empowering the minority.
Further, the objective of empowering the minority may itself remain unfulfilled if a financial/ institutional investor meets the 10% Shareholding Test – as this would disenfranchise them from voting on a material RPT. Hence, it appears that the ‘majority of minority’ construct may not pass muster under the proportionality test.
Corporate Democracy
The cardinal principle of ‘corporate democracy’ (governance by majority) prevalent in England for over 300 years and in India for over 100 years was recognised by the SC in its celebrated decision in LIC v. Escorts[18], wherein the specific factual context of the case, it was held that a minority of shareholders, cannot, in the ‘saddle of power’, pursue a policy of venturing into a litigation to which the majority was opposed.
Corporate democracy recognises that a majority shareholder (who controls the company’s affairs by virtue of his shareholding) should have the final say on governance and management. Whilst the statutory protections available to minority shareholders can continue to be strengthened given India’s changing investment landscape, this cannot come at the cost of turning the principle of corporate democracy upside down. It is worthwhile to note that several provisions[19] of the Act already provide an elaborate framework for protecting the interests of minority shareholders.
Potential Defences
In the event of a constitutional challenge, SEBI may trace the source of power by referring to Section 11(1) of the SEBI Act, which provides that subject to the provisions of the SEBI Act, it shall be the duty of SEBI to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit.
The markets regulator may argue that Section 11(1) is a ‘catch-all’ provision that confers it with wide discretion to formulate measures for safeguarding minority shareholders’ interest. Given that approximately 75% of Indian listed companies are promoter-controlled, SEBI could argue that the regulatory intent was to provide minority shareholders with an effective voice on key transactions/ corporate actions that could have implications from a governance standpoint.
Reliance could also be placed on SC’s decision in SEBI v. Ajay Agarwal[20], where it had held that the SEBI Act is a social welfare legislation, and should be interpreted in a manner that furthers its purpose, and does not ‘frustrate’ its operation. A similar view was also taken in the recent SC decision in Prakash Gupta v. SEBI[21](“Prakash Gupta”), where it was held that the SEBI Act should be interpreted in a manner that furthers the statutory role of SEBI, “rather than one which thwarts its considered course of action”. Significantly, in Prakash Gupta, it was also observed that as an expert regulatory body for the securities market, SEBI’s views must be treated with greater deference.
Concluding Thoughts
If the constitutional validity of the ‘majority of minority’ approval requirements are challenged, there are compelling arguments that can be made from both sides of the spectrum. However, even if viewed strictly through the lens of Article 300-A, which requires a specific enabling provision for ‘deprivation of property’, it appears that the general provisions under Section 11 of the SEBI Act may not amount to a sufficient statutory basis for imposing restrictions on a majority shareholders’ voting rights.
Given that the Act, SEBI Act/ SCRA does not contain any provision that is similar to Section 47 of the Companies Act, Courts could potentially be of the view that the source of SEBI’s power to disenfranchise majority shareholders cannot be traced to the Act, the SEBI Act or the SCRA – and in any case, it fails to withstand scrutiny under Articles 14 and 19(1)(g).
Irrespective of how a potential constitutional challenge may pan out, one must not lose sight of the fact that such blanket disenfranchisement (that applies even if there is no conflict of interest) goes against corporate democracy, and it is counter-productive to confer a small body of shareholders with a veto over key aspects that could potentially affect stakeholder interest at large. The regulators should note that empowering minority shareholders cannot come at the cost of completely disenfranchising the majority shareholders. It is a well-drawn “Lakshman-Rekha”[22] for the last over 100 years and it should not be crossed if India wants to retain its status as an attractive investment destination.
A wider stakeholder debate on the desirability of having such provisions is paramount, as depriving majority shareholders of their voting rights militates against the cardinal principles of company law, and is of doubtful constitutional validity.
[1] The Constitution (Forty-fourth Amendment) Act, 1978.
[2] Mahaliram Santhalia v. Fort Gloster Jute Manufacturing Co. Ltd., 1954 SCC OnLine Cal 151: (1953-54) 58 CWN 715 : AIR 1955 Cal 132 : (1954) 24 Comp Cas 311. See also Balkrishan Gupta v. Swadeshi Polytex Ltd., (1985) 2 SCC 167.
[3] (1877) 6 Ch D 70.
[4] This has been introduced under Regulation 23(4) of the LODR Regulations.
[5] A Majority of Minority Shareholders’ Approval for certain types of schemes of arrangement undertaken by listed entities has been introduced by the SEBI Master Circular on Schemes of Arrangement, dated November 23, 2021 (“SEBI Scheme Circular”).
[6] SEBI Scheme Circular.
[7] SEBI Consultation Paper dated February 21, 2023, titled – “CONSULTATION PAPER ON STRENGTHENING CORPORATE GOVERNANCE AT LISTED ENTITIES BY EMPOWERING SHAREHOLDERS – AMENDMENTS TO THE SEBI (LODR) REGULATIONS, 2015”.
[8] While the SEBI has approved amendments to the LODR Regulations at its Board Meeting held on March 29, 2023, the specific amendments have not been notified, as of date.
[9] (1982) 1 SCC 39.
[10] See also, Jilubhai Nanbhai Khachar v. State of Gujarat, 1995 Supp (1) SCC 596& Hindustan Times v. State of U.P.,(2003) 1 SCC 591.
[11] 1997 SCC OnLine Guj 258 : (1999) 95 Comp Cas 663
[12] While a Division Bench of the Gujarat HC has overruled the judgment of the Learned Single Judge, the SC has, in its recent decision in Franklin Templeton Trustee Services (P) Ltd. v. Amruta Garg, (2021) 9 SCC 606, favourably referred to the views of the Single Judge, with regard to interpretation of Section 11-B of the SEBI Act, 1992.
[13] Pender v. Lushington, (1877) 6 Ch D 70; Re: Imperial Chemical Industries, (1937) AC 707; Greenwell v. Porter, (1902) 1 Ch 530.
[14] (2002) 2 SCC 188
[15] (2017) 9 SCC 1
[16] K.S. Puttaswamy (Aadhaar-5J.) v. Union of India, (2019) 1 SCC 1.
[17] Modern Dental College & Research Centre v. State of M.P., (2016) 7 SCC 353.
[18] (1986) 1 SCC 264.
[19] The key provisions of the Act that provide for minority protection include – (a) Section 27 (Variation of terms of contract or objects in prospectus); (b) Section 48 (Variation of shareholders’ rights); (c) Section 100 (Calling of extraordinary general meeting); (d) Section 108 (Voting through electronic means); (e) Section 109 (demand for poll); (f) Section 151 (Appointment of directors elected by small shareholders); (g) Section 160 (Right of persons other than retiring directors to stand for directorship); (h) Section 169 (removal of directors); (i) Section 230 (Power to compromise or make arrangements with creditors and members); (i) Section 236 (Purchase of minority shareholding); and (j) Sections 241 – 244 (which sets out the legal framework dealing with remedies in case of oppression and mismanagement).
[20] (2010) 3 SCC 765.
[21] 2021 SCC OnLine SC 485.
[22] “Lakshman Rekha” refers to a sacrosanct boundary which should not be crossed.
