In this blog post, Poonam Sharma, an Advocate in Bangalore and a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, analyses the validity and procedures involved with the issuance of shares with respect to differential voting rights.
The common law rule of one share, one vote is considered convenient for corporate governance, both from the point of view of the shareholders and the management of a company. But there are instances where a company intends to have better control over its decision-making powers or processes rather than share such powers with shareholders who have a minimal shareholding in the company. In order to structure such intentions, Company law provides for shares with differential rights as to voting, dividend or otherwise.
Shares with differential voting rights are ordinary equity shares only with a variation in the voting rights. Such class of shares may have fewer voting rights as compared to a regular class of equity shares in a company. Shareholders who hold a small percentage in a company and only concerned with returns on their shares would prefer to opt for shares with differential voting rights as this reduces the obligation on them with regard to the management of the company and satisfies them in financial aspects.
Issuance of Shares with Differential Voting Rights
Section 86 (ii) of Companies Act, 1956 read with Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001 provided for a company to have equity share capital with differential rights as to dividend, voting or otherwise in accordance with rules as prescribed. Such rules had various conditions included but not limited to the requirement of a company having distributable profits for three financial years preceding the year in which it had decided to issue shares with differential voting rights, company making no default in filing annual accounts and annual returns for three financial years immediately preceding the year in which it had decided to issue shares with differential voting rights, no failure by the company in the repayment of its deposits or interest on the due date or date of redemption thereon and authority to issue such shares with differential rights by the Articles of Association of the company. The issue of such shares must not exceed 25% (twenty-five percent) of the share capital issued. These were the conditions to be complied with in order to issue shares with differential voting rights until the introduction and enforcement of the Companies Act, 2013 in this regard.
Section 43 (a) (ii) of the Companies Act, 2013 (“Act”) states that a company may issue equity shares with differential voting rights provided it is in accordance with Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014 (“Rules”). Initially in order to issue equity share capital with differential voting rights Section 43 (a) (ii) and its corresponding stringent Rules were mandatorily applicable to both private and public companies, but on and from the date of June 5, 2015, the Ministry of Corporate Affairs has vide its notification exempted private companies from the applicability of Section 43 and Rules, and private companies are now free to structure their share capital in a manner they deem best in the interests of the company.
However, public companies have not been exempt and are still required to comply with the conditions under the Rules. In order to ensure a public company can issue shares with differential voting rights, the following conditionsand procedure under the Rules need to be mandatorily fulfilled:
- the Articles of Association of the company must authorize the issue of shares with differential rights;
- the issue of shares must be authorized by an ordinary resolution passed at a general meeting of the shareholders:
Provided that where the equity shares of a company are listed on a recognised stock exchange, the issue of such shares shall be approved by the shareholders through postal ballot;
- The shares with differential rights shall not exceed 26% (twenty-six percent) of the total post-issue paid up capital including equity shares with differential rights issued at any point in time;
- The company must have a consistent track record of distributable profits for the last three years;
- The company must not have 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;
- The company should not have any subsisting default in the payment of a declared dividend to its shareholders or repayment of its matured deposits or redemption of its preference shares or debentures that have become due for redemption or payment of interest on such deposits or debentures or payment of dividend;
- The company should not have defaulted in payment of dividend on preference shares or repayment of any term loan from a public financial institution or State level financial institution or scheduled Bank that has become repayable or interest payable thereon or dues with respect to statutory payments relating to its employees to any authority or default in crediting the amount in Investor Education and Protection Fund to the Central Government;
- The company should not have 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.
The Board’s report for the financial year and the explanatory statement annexed to the notice of the general meeting to be issued to shareholders of the company must contain details such as the total number of shares to be issued with differential rights, details of such issue, percentage of shares with differential rights to the post issue paid up equity capital at any point of time, the reasons for issue, price at which such shares are proposed to be issued either at par or premium, basis on which the price is arrived at, details of the total number of shares proposed to be allotted to promoters, directors and key managerial personnel and other persons in case of private placement or preferential issue, percentage of voting rights such class would carry, the diluted Earnings Per Share pursuant to such issue and the pre and post issue shareholding percentage as per clause 35 of the listing agreement. The company must ensure that it shall not convert its existing equity share capital with voting rights into equity share capital carrying differential voting rights and vice versa. The holders of equity shares with differential rights shall enjoy all other rights such as bonus shares, rights shares which the holders of equity shares are entitled to, subject to the differential rights with which such shares have been issued. Upon such issue, the company shall maintain a Register of Members under Section 88 to record all the relevant particulars of the shares issued along with the details of the shareholders.
It is pertinent to note that the Rules have clarified that existing equity shares with differential rights will continue to have the rights that have been provided at the time of their issuance and have accordingly been grandfathered. Shares with differential voting rights would be valid provided a company has the powers to issue and structure such class of shares under the Articles of Association of the company.
When it comes to the instrument and rights of a shareholder, they have the freedom to enter into any arrangement with a company, provided it is in accordance with applicable company law. Although shares with differential voting rights may seem disadvantageous to a shareholder due to reduced management control over the company, a company could structure it such that it proves beneficial to such a shareholder with a higher rate of dividend or a discounted rate of trading for these shares. Tata Motors in 2008 became the first company to issue shares with differential voting rights as it issued 6.4 crore shares with differential rights at INR 305 per share to fund the acquisition of Jaguar Land Rover wherein these shares carried one-tenth the voting rights of ordinary shares and thereafter three other companies including Pantaloons Retail India, Gujarat NRE Coke and Jain Irrigation Systems have followed suit. Pantaloons issued bonus shares with differential voting rights with an additional 5% dividend but one-tenth voting rights to ordinary equity shares. Gujarat NRE Coke and Jain Irrigation Systems also issued similar bonus shares with differential voting rights. Although not a popular choice, such shares are highly beneficial to those shareholders who are only looking to get rich and have minimal obligations towards a company.
 Rule 3(1), Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001.
 Rule 3(2), Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001.
 Rule 3(3), Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001.
 Rule 3(4), Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001.
 Rule 9(d), Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001.
Enforced with effect from April 1, 2014.
 G.S.R 464 (E), Exemptions to private companies notification, Ministry of Corporate Affairs, June 5, 2015.
Rule 4(1) (a) – Rule 4(1) (h), Companies (Share Capital and Debentures) Rules, 2014.
 Rule 4(4), Companies (Share Capital and Debentures) Rules, 2014.
 Rule 4(2), Companies (Share Capital and Debentures) Rules, 2014.
Rule 4(3), Companies (Share Capital and Debentures) Rules, 2014.
 Rule 4(5), Companies (Share Capital and Debentures) Rules, 2014.
 Rule 4(6), Companies (Share Capital and Debentures) Rules, 2014.
 Explanation to Rule 4, Companies (Share Capital and Debentures) Rules, 2014.
 ‘How to benefit from shares with differential voting rights’, Business Standard, March 2013.