6 May 2021
The Indian business landscape mainly comprises of family run businesses. Keeping in mind the close-knit joint family culture in the country, Indian regulators have been particularly cautious of family members owning and controlling a business together. The Securities and Exchange Board of India (SEBI) has, in Regulation 2(1)(pp) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, given a broad definition of “promoter group”, which includes any immediate relatives of the promoter and entities where such relatives have more than 20% stake. Being a member of the promoter group of a listed company entails rigorous disclosure and compliance obligations under various SEBI regulations. In fact, SEBI has in its Consultative Paper dated November 23, 2020, made a noting that there is a need for further clarification under Regulation 31 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR), with regard to disclosing names of persons in promoter/ promoter group who hold even ‘Nil’ shareholding in the listed company.
Despite the general perception, not all is always merry among Indian families. Owing to disputes or otherwise, families often separate businesses amongst themselves, where family members disassociate themselves completely from each other’s businesses. Particularly, when a family member is running a business independently, other relatives prefer not to be liable for the compliances and liabilities imposed on the promoter group. However, in case of listed companies, it is challenging for the family members of the promoter to be excluded from being categorised as “promoter” or “promoter group” even if they have no association with the company.
Regulation 31A of the LODR provides the procedure for promoters/ persons belonging to the promoter group of listed companies to be reclassified as public shareholders. Such reclassification can be permitted only if the promoter seeking reclassification and ‘persons related to the promoter seeking re-classification’[1] (i) together do not hold more than 10% voting rights, exercise control over the affairs (directly or indirectly) or have any special rights through formal or informal arrangements, including shareholders agreement, and (ii) are not represented on the board of directors, or acting as key managerial personnel.[2] Subsequent to the re-classification, the conditions specified in (i) and (ii) above will have to be maintained perpetually and for a period of at least three years, respectively, from the date of reclassification, failing which, such person is to be automatically reclassified as promoter/ persons belonging to the promoter group.
The promoter seeking re-classification is required to make an application to the Board of Directors of the listed company, giving rationale for the reclassification and how the aforesaid conditions are satisfied. Based on the recommendations of the Board of Directors, the shareholders of the listed company (other than the promoter seeking reclassification and persons related to the promoter seeking reclassification) will have to approve the proposal through an ordinary resolution. Thereafter, an application has to be made to the stock exchanges, which can approve the proposal, subject to the promoter seeking reclassification having complied with conditions specified in Regulation 31A.
The conditions for reclassification have to be satisfied, not just by the promoter seeking reclassification only, but by cumulatively taking into account the shareholding percentage, control rights, etc., of persons who are related to the exiting promoter/ promoter group member. Though Regulation 31A(3) of the LODR contemplates that even a single person belonging to the promoter group can be eligible to seek reclassification, however, in cases where one member of the promoter family seeks to be reclassified and the remaining members continue to hold upward of 10% shareholding or exercise control or have managerial roles in the company, the exiting promoter group member will be unable to prove that he/ she is compliant with Regulation 31A(3)(b) of the SEBI LODR, thereby rendering them ineligible to even kickstart the reclassification process.
In the absence of an objective criteria to allow reclassification of promoter family members, contradicting precedents have arisen over the last two years. On the one hand, SEBI has issued an informal guidance to Mirza International Limited, rejecting the reclassification of two married daughters of the promoter (who collectively will hold more than 10%, but did not have any involvement in the management of the listed company) on the ground that the daughters, together with their immediate relatives (i.e. the father and mother), would continue to hold more than 10% of the total voting rights in the company[3], whereas on the other hand, in the matter of CERA Sanitaryware Limited, reclassification of the brother of the existing promoter (controlling shareholder of the company) was allowed by the stock exchanges. In this second case, the brother inherited the shares of the company in terms of the will of his deceased mother, after 15 years of being separated from the business. The reclassification was permitted by the stock exchanges, even when technically, the brother was not even eligible to kickstart the process to seek reclassification, as in terms of Regulation 31A(3)(b), his immediate relative (i.e. the controlling shareholder) continued to hold more than 10% of the voting rights in the listed entity. Whilst it is understandable that SEBI may not be inclined to give flexibility of reclassification to promoter families where there is no separation, however, in genuine cases like family disputes, the legal regime becomes a hurdle to reclassification.
The issue of family settlement among promoters has been historically discussed in SEBI’s Discussion Paper on Reclassification of Promoters as Public, 2015 (2015 Discussion Paper). The 2015 Discussion Paper had evaluated an example of reclassification of a joint promoter, who had decided to enter into a registered family separation agreement due to a family dispute and transferred majority of his holding in some of the family’s companies to the other joint promoter. The 2015 Discussion Paper inter alia proposed that in case of a separation agreement between the members of promoter group, a member of the promoter group should be able to reclassify its shareholding to public category if the separation agreement is duly registered under the Registration Act, 1908, or the material terms of the separation agreement are disclosed to the stock exchanges, prior to the reclassification. However, this proposal does not seem to have seen the light of the day under any of the SEBI Regulations.
The LODR continues to be silent on the issue of family settlement agreements even after multiple rounds of amendment to Regulation 31A. Recently, SEBI in its board meeting dated March 25, 2020, has approved various amendments to Regulation 31A of the LODR, with a view to rationalise the existing framework for reclassification of promoters. However, based on publicly available information, it does not appear that SEBI has considered bringing about a separate process to address the issue of family settlement agreements.
Prior to the amendment to Regulation 31A in 2018, there was a specific provision allowing SEBI to relax any condition for reclassification in specific cases, if it was satisfied about non-exercise of control by the outgoing promoter or its persons acting in concert. However, with the deletion of the specific provision, the only recourse available in such cases is to either seek an informal guidance from SEBI and hope for a positive feedback before initiating the reclassification process, or seek a formal exemption under Regulations 102 of the LODR from strict compliance with the provisions of Regulation 31A, prior to making an application to the company to initiate the process of reclassification.
To rule out subjectivity, SEBI could consider introducing specific carve-outs from the compliance requirements of Regulations 31A(3)(b) for exiting promoter family members, pursuant to a formal separation agreement with the remaining promoter(s). Since the safeguards of stock exchange approval and provision of automatic reclassification in case of violation of Regulation 31A(3)(b) are already in place, persons found in breach of the terms of the separation agreement can always be reclassified as promoters. This small amendment could go a long way in helping genuine reclassification requests arising out of formal family separations.
For further information, please contact:
Sourav Kanti De Biswas, Partner, Cyril Amarchand Mangaldas
sourav.biswas@cyrilshroff.com
[1] The term ‘persons related to the promoter’ has been defined with reference to the definition of “promoter group” under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and includes the following categories, in case of an individual:
(a) an immediate relative of the promoter which means any spouse of that person, or any parent, brother, sister or child of the person or of the spouse;
(b) any body corporate in which 20% or more of the equity share capital is held by the promoter or an immediate relative of the promoter or a firm or HUF in which the promoter or any one or more of their relative is a member;
(c) any body corporate in which a body corporate as provided in point (b) above holds 20% or more, of the equity share capital; and
(d) any HUF or firm in which the aggregate share of the promoter and their relatives is equal to or more than 20% of the total capital.
[2] In terms of Regulation 31A(1) of the SEBI LODR read with Regulation 2(1)(pp) of the SEBI ICDR.
[3] Informal Guidance issued to Mirza International Limited dated June 10, 2020, SEBI/HO/CFD/CMD1/OW/2020.
