India – DVR Shares – A Timeline.

27 September, 2019

 

Prior to 2001, the Companies Act, 1956 provided for equity shares as being ordinary equity shares, carrying 1 vote per share and pari passu rights as to dividends and was silent in relation to equity shares carrying differential rights as to voting or dividend. However, in the year 2001, the Companies (Amendment) Act, 2000 ("Amendment Act"), effective from December 13, 2000, for the first time introduced the concept of shares with differential rights by inserting a definition of "shares with differential rights"[1]. Pursuant to the Amendment Act, Section 86 of the Companies Act, 1956, which deals with categories of share capital, was also amended to include a new category of equity share capital being equity share capital with differential rights as to dividend, voting or otherwise ("DVR Shares"). Thereafter, on March 9, 2001, the Central Government notified the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001, prescribing conditions for issuance of DVR Shares. With the advent of the Amendment Act, Indian companies were permitted to issue, along with the traditional equity shares and preference shares, DVR Shares, carrying differential rights as to voting or dividend.

 

Position of DVR Shares in listed companies

 

Subsequent to the introduction of the concept of DVR Shares by the Amendment Act, Tata Motors was the first listed company that came up with a rights issuance of DVR Shares in 2008. Thereafter, in 2009, Pantaloons Retail (India) Private Limited issued DVR Shares to its existing shareholders by way of a bonus issue. The DVR Shares issued by both Tata Motors and Pantaloons Retail (India) Private Limited, carried 5% higher dividend rights and 1/10^th of the voting rights as compared to their respective ordinary equity shares. Other listed Indian companies which have issued DVR Shares include Gujarat NRE Coke Limited, Jain Irrigation Systems Limited and Stampede Capital.[2]

 

The issuance of DVR Shares by listed companies assumed significance in Anand Pershad Jaiswal v/s Jagatjit Industries Limited[3], where the petitioner, holding 11.5% of the issued share capital of the company filed a petition of oppression and mismanagement under section 397 and 398 of the Companies Act, 1956. One of the many issues in this case also included validity of DVR Shares issued by the company to its promoters. However, the Company Law Board upheld the validity of the same since the DVR Shares were issued to the promoters in accordance with the provisions of the Companies Act, 1956, and the rules prescribed thereunder. Nonetheless, this judgement triggered concerns of the potential misuse of DVR Shares carrying superior voting rights to promoters. With the objective of curbing a possible misuse of superior voting rights, protecting investor interest and promoting better regulation of the securities market, pursuant to a circular issued in July 2009, SEBI amended the listing agreement by introducing a new Clause 28A, which prohibited Indian listed companies from issuing equity shares which conferred superior rights as to voting or dividend[4].

 

In view of the aforesaid, while unlisted companies in India continued to be permitted to issue DVR Shares, listed Indian companies were prohibited from issuing DVR Shares with superior rights as to voting or dividend.

 

Provisions under Companies Act, 2013

 

The issuance of DVR Shares by Indian companies under the Companies Act, 2013 is governed by Section 43 of the Companies Act, 2013, read with Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014. Section 43 has broadly categorised share capital of an Indian company into equity and preference share capital, of which equity share capital is further categorised as (i) equity share capital with voting rights and (ii) equity share capital with differential rights as to dividend, voting or otherwise, issued in accordance with the prescribed rules. Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014, stipulates certain additional conditions to be complied by the Indian companies prior to the issuance of DVR Shares, some of which conditions are set out below:

 

• DVR Shares cannot exceed 26% of the total post-issue paid up equity share capital;
• the issuing company should have a consistent track record of distributable profits during the last three years;
• the issuing company should not have defaulted in filing its financial statements and annual returns for the immediately preceding three financial years.

 

There has been a recent amendment to the Companies (Share Capital and Debentures) Amendment Rules, 2019 on August 16, 2019 ("Companies Amendment Rules") pursuant to which few of the aforesaid conditions have been amended or dispensed with. The condition of the shareholding threshold of 26% of the total post-issue and paid up equity share capital has been modified to a threshold of 74% of the total voting power of the company. In view thereof, voting power in respect of DVR Shares cannot exceed 74% of the total voting power including voting power in respect of DVR Shares at any point of time. Further, the Companies Amendment Rules have dispensed with the requirement of the issuing company having a consistent track record of distributable profits during the last three years.

 

SEBI’s New Framework on DVR

 

In order to promote technology/ promoter driven firms and match up to the global practice of issuance of dual class shares, SEBI, on June 27, 2019, approved and adopted a new framework on DVR Shares. In view thereof, SEBI introduced an array of modifications and notified the SEBI (Issue of Capital and Disclosure Requirements) (Third Amendment) Regulations, 2019 and SEBI (Listing Obligations and Disclosure Requirements) (Fourth Amendment) Regulations, 2019, on July 29, 2019 ("SEBI Amendments").

 

The SEBI Amendments have, amongst others, introduced the concept of 'SR equity shares' and stipulated eligibility criteria and conditions to be complied by an Indian company proposing to come out with an initial public offer of its ordinary equity shares in light of the 'SR equity shares' already issued by such company. 'SR equity shares' have been defined to mean equity shares of an issuer company having superior voting rights vis-à-vis the other equity shares of such issuer company.  Some of the eligibility criteria prescribed by SEBI for unlisted companies that are desirous of listing its ordinary shares and having issued SR equity shares are set out below[5]:

 

• the issuer companies should be intensive in the use of technology which adds substantial value to the product, services or business (viz. biotechnology or nanotechnology, intellectual property, data analytics etc.);
• the promoters/founders holding SR equity shares must have executive positions in the company.

 

The SEBI Amendments also provide a sunset period of 5 years from the date of listing within which the SR equity shares are mandatorily required to be converted into ordinary equity shares. While on one hand the SEBI Amendments have permitted certain type of companies to issue SR equity shares, the SEBI Amendments have also introduced additional measures to ensure a stronger corporate governance in such companies.

 

The SEBI Amendments also prohibit listed companies from issuing shares with superior or inferior rights as to dividend or voting vis-à-vis the rights of the already listed equity shares. However, listed Indian companies are permitted to issue SR equity shares to the existing holders of such shares, by way of, amongst others, bonus or rights issue.[6]

 

Conclusion

 

DVR Shares have long since been utilised as a structuring instrument considering that they can provide a balance between investment and retention of control. For instance, DVR shares with superior voting rights issued to the promoters enable the promoters to retain and exercise control over the management of the company even upon receipt of investment from investors. DVR Shares issued with inferior rights (such as shares carrying only right to dividend) enable an investor to acquire stake in a company without participating in its management. Further, DVR Shares with superior dividend rights can also fetch higher returns for investors. DVR Shares thus, continue to remain a viable investment and structuring option for investors and promoters alike.

 

The recent amendments introduced, by way of the SEBI Amendments and the Companies Amendment Rules, will assist in providing an impetus to eligible companies to receive investments and at the same time enable structuring of investments in a manner that would ensure that promoters continue to remain in control of the company. This will in turn boost investments in, and growth of, technology driven companies, more particularly the start-ups/other companies which are primarily driven by the knowledge and expertise of the promoters and may also be looking to list their shares without the promoters being required to cede control upon such listing. Further, considering that the start-up companies take around 2 to 3 years to break-even, the dispensation of the requirement of having a consistent track record of distributable profits during the last 3 years under the Companies Act, 2013, will enable even start-up companies to issue DVR Shares.