This article is written by Sharanya Ramakrishnan pursuing a Certificate Course in Capital Markets, Securities Laws, Insider Trading and SEBI Litigation. This article has been edited by Ojuswi (Associate Lawsikho) and Ruchika Mohapatra (Associate, Lawsikho).

This article has been published by Sneha Mahawar.

Introduction 

A share denotes a right to a definite amount of share capital of a company and has certain rights and liabilities attached to it.  Then what is the class of a share? The term “class of shareholders”, “class of members,” “class of shares” is used in several sections of the Companies Act, 2013 (hereinafter referred to as “the Act”). The shares having uniform rights and privileges can be considered as one class irrespective of the different nomenclature used for them. 

As per Section 43 of the Act, the share capital of a company is broadly divided into two types; equity shares and preference shares.  However, the Act permits the issuance of equity shares with differential rights as to dividend, voting, or otherwise. On the other hand, preference shares can be cumulative (dividends are accumulated), convertible (possess an option/right whereby they can be converted into ordinary equity shares), participating (additional benefit of participating in ‘surplus profits’ or ‘surplus assets’ of a company) and redeemable (repaid on the maturity date). 

Accordingly, each class of shares have rights attached to them. For instance, equity shareholders have the right to vote on resolutions placed before them in general meetings, the right to appoint directors, the right to transfer shares, the right to inspect statutory registers, etc. Preference shareholders have preferential right to receive a fixed amount of dividend and preferential right to be repaid the amount of the capital paid up on such share in the event of winding up.

There may be certain situations wherein a company may seek to vary certain rights attached to these classes of shares. The law regarding the variation of shareholders’ rights is provided under Section 48 of the Act.

This article discusses the concept of variation. It seeks to explain the manner in which variation of rights can be carried out, how such variation may be cancelled and the detailed procedure for such cancellation. 

Conditions for variation of shareholders’ rights

As per Section 48(1) of the Act, where a share capital of the company is divided into different classes of shares, the rights attached to the shares of any class may be varied on compliance with any one of the following two conditions:

• With the consent in writing of the holders of not less than three-fourths of the issued shares of that class; or
• with the sanction of a special resolution passed at a separate meeting of the holders of the issued shares of that class.

Further, the variation of rights of shareholders can be effected only:

• If the provision pertaining to such variation is provided in the Memorandum or Articles of Association of the company; or
• In the absence of any such provision in the Memorandum or Articles of Association of the company, if such a variation is not prohibited by the terms of issue of the shares of that class.

The proviso to Section 48(1) of the Act further provides that, if variation by one class of shareholders affects the rights of any other class of shareholders, the consent of three-fourths of such other class of shareholders shall also be obtained and the provisions of this section shall apply to such variation.

The section, therefore, provides for two routes of approval; the consent route and the special resolution route. The consent should be from 3/4th of the issued shares of that class and not paid-up share capital. Thus, it does not matter if the calls are paid or not. The special resolution needs to be taken at a meeting of the class of shareholders. In the special resolution, 3/4th majority of votes is required, which includes only the shareholders who are voting and attending the meeting. Whereas in the case of consent, 3/4th majority consent is required from the entire class of issued shares of that class.

Furthermore, the Act provides that approval is required not only from the class whose rights are varied but also from the class whose rights are affected. Thus, the legislative intent behind inserting this proviso is to safeguard the rights of other shareholders who may be prejudiced by such variation. 

Cancellation of variation of shareholders’ rights

Section 48(2) of the Act provides that where the holders of not less than 10% of the issued shares of a class did not consent to such variation or vote in favour of the special resolution for the variation, they may apply to the National Company Law Tribunal (hereinafter referred to as “the Tribunal”) to have the variation cancelled, and where any such application is made, the variation shall not have effect unless and until it is confirmed by the Tribunal.

The proviso to the section also provides that the aforesaid application shall be made within 21  days after the date on which the consent was given or the resolution was passed, as the case may be, and maybe made on behalf of the shareholders entitled to make the application by such one or more of their number as they may appoint in writing for the purpose.

The decision of the Tribunal on consideration of such application shall be binding on the shareholders. [Section 48(3)]

The Act does not require a member to object to the variation or raise an objection at the meeting as a pre-condition for filing an application under Section 48(2). However, raising the objections at the stage when consent is sought shows the bona fides of the members objecting to the variation. Further, the law always favours a person who is vigilant about his rights and their infringement. Thus, by taking steps at the right time when the company proposes the question of variation and raising objections then will help a member put forth a strong case before the Tribunal.

The Act, therefore, defers the date on which the variation will become effective in the event an application challenging the same is filed. If the application is not filed, the variation will become effective on the date when consents are received or the special resolution is passed.

Once an application for cancellation of variation by the requisite number of shareholders is made, the Tribunal, after considering the say of all parties, must make an informed decision whether to allow such application or to reject it. The Tribunal may cancel the variation if it is of the opinion that the variation was not in the interest of shareholders of that class. 

The legal position on cancellation of variation of shareholders’ rights

Section 48 of the Act is a modified version of Section 106 and Section 107 of the Companies Act, 1956. To understand the concept of variation and the rights of dissentient shareholders, one needs to analyse and compare the old law and decisions with the new provisions.

What constitutes variation

While the term ‘variation’ has a wide connotation, the courts in England took a very narrow stand as regards variation. A similar stand was found to be taken by the Indian judiciary. In order to understand what constitutes variation, it is necessary to understand what has been held not to be “variation”.

1. In the case of Adelaide Electric Supply Co. Ltd vs Prudential Assurance, Adelaide Electric Supply Co. Ltd. (Adelaide) was a company incorporated under the English Companies Act, 1869, having its registered office in London and a branch office in Adelaide where it carried on its business. Prudential was an English company holding preference shares in Adelaide. Subsequently, the whole conduct and control of Adelaide’s business were transferred to Australia and it was provided that all dividends should be declared and paid in and from Australia.  The respondents thus suffered a reduction in dividends equal to the exchange rate and objected to the same. The House of Lords interpreted that alteration of the place of payment of dividend to preference shareholders from England to Australia did not vary the rights of preference shareholders notwithstanding that the Australian Pound is lesser in value as compared to the English Pound.
2. In White vs Bristol Aeroplane Co, a provision in the company’s constitution provided that the rights attached to any class of shares might be “affected, modified, varied, dealt with, or abrogated in any manner with the sanction of class meetings”. The company proposed to make a bonus offer of new ordinary and preference shares. The existing preference shareholders objected stating that reducing their proportion of the class of preference shares (by issuing the bonus of preference shares) was a variation of class rights to which they had not consented. It was held that an increase of one class of shares was held not to vary the rights of another class even though it would change the voting equilibrium. 
3. In Essar Steel ltd vs Unknown, the court expressly stated that the variation contemplated in Section 106 of the Companies Act 1956, only deals with variation which is detrimental to the interests of any class of shareholders and not any variation adding to or increasing rights of any class. The sanction under this section needs to be taken only where a variation involves the restriction of the rights of any class or classes of shareholders. The court, therefore, held that cancellation of shares or increase or reduction of capital does not amount to variation.
4. In the case of Girish Kumar Kharia vs Industrial Forge and Engineering Co. Ltd. and Ors, the board of directors of the respondent company issued 80,500 equity shares of Rs 10 each pursuant to the resolution adopted at an extraordinary meeting of the members to the son and heir of one late B. K. Jain, former director of the company, who had sanctioned an unsecured loan of Rs. 8.5 lakhs. As the company could not repay that loan, at a meeting of the board of directors, it had been decided to issue equity shares to his son Sanjay Jain worth Rs. 8.5 lakhs. 

The petitioner filed a petition objecting to such an issue on the ground that it would hamper his right to receive a proportionate share therein and, as such, has significantly varied and affected his right to manage the affairs of the company. Rejecting the contention, the court held that a variation that affects the enjoyment of right without modifying the right itself is not a variation within the meaning of Section 106 of the Companies Act, 1956 and thus, an increase in the number of shares of any kind for raising capital or otherwise, though it affects the voting power of existing members by diminishing it in number, in no way amounts to a variation of their right. 

In lieu of the provisions of the present Act, the term ‘variation’, must be seen in a broader sense. In the past, the courts have taken a very narrow approach as regards what constitutes variation. Thus, shareholders who could challenge the same were also limited as the erstwhile provisions of the 1965 Act restricted this right only to that class of shareholders whose rights were varied. However, as per Section 48 of the Act, shareholders whose rights are affected as a consequence of the variation must also consent to the variation for it to be approved. Thus, they will also have a right to approach the Tribunal in case they object to the variation. In view of these changes, the applicability of past case laws will have to be considered in a new light. 

Variation vs Merger and amalgamation

The rights of shareholders can be varied in numerous circumstances. Section 48 provides only one of the alternate routes available for variation when there are different classes of shares. However, that route does not prevent variation of class rights by other routes like merger and amalgamation where such variation is not prohibited. 

In Hindustan Commercial Bank Ltd vs Hindustan General Electrical Corporation Ltd, the board of directors of the company proposed a scheme of arrangement between several classes of shareholders which also involved the reduction of capital. As a result, the directors convened separate class meetings of the preference, ordinary and deferred shareholders for passing special resolutions for reduction of capital and also an extraordinary general meeting of the three classes of shareholders for approval of the scheme of the arrangement, wherein they received the consent for the same. At the extraordinary general meeting, the scheme was however opposed by the appellants.

The scheme of arrangement wiped out the arrears of the 5% cumulative preferential dividend for the preceding twelve years. The preference shareholders were allowed to retain 30% of their paid-up capital while the ordinary and deferred shareholders were allowed to retain 20% of their paid-up capital. The scheme, therefore, abrogates, modifies and affects the right of preference shareholders to the preferential return of capital.

The appellants argued that the variation of the special rights attached to the preference shares could only be made with the sanction of the majority of the holders of three-fourths of the issued preference shares in accordance with Section 106 of the Companies Act, 1956, and as the sanction of the requisite majority was not obtained, the scheme of arrangement as a whole including the reduction of capital cannot be sanctioned by the Court.

The court held that the word ‘arrangement’ is of wide import and the court has the power to sanction a scheme of arrangement though the scheme modifies the special rights attached to a class of shares. As per the court, although the majority required by Section 391(2) of the Companies Act, 1956 (Corresponding provision to Section 230 of the Act) is the majority in number representing 3/4th in value of the class or members present and voting at the meeting whereas the majority required by the provision referred to in Section 106 is the majority of the 3/4th of the issued shares of the class. Considering that the majority required by Section 391(2) is less than the majority required by the provision referred to in Section 106, the Court is bound to scrutinise this scheme of arrangement with care. However, the absence of approval of the scheme by the majority required by the provision referred to in Section 106 is no bar to the sanction of the scheme of arrangement under Section 391.

In what circumstances can one apply under Section 48(2) of the Act

The remedy to approach the Tribunal under Section 48(2) of the Act is available only when class rights are varied under Section 48(1) of the Act and not otherwise. As seen above, if class rights are varied under a scheme of merger or a scheme of reduction, then the remedy under Section 48(2) cannot be used and the members will have to take recourse available under those provisions. 

The Karnataka High Court confirmed this point of view in the case of State of Karnataka vs Mysore Curing Works Ltd, wherein the court held that Sections 106 and 107 of the Companies Act, 1956 provide for a particular class of shareholders to move the court whenever the rights attached to that class of share were sought to be altered by the company, and in no other circumstances. The rights attached to ordinary equity shares include a right to vote, the right to receive dividends, the right to freely transfer shares without restrictions, etc. Thus as per the court, unless the said rights are altered by the company by resolution of the shareholders in terms of Section 106 of the Act, no action lies under Section 107. 

Procedure for cancellation of variation of shareholders’ rights

Rule 68A read with other relevant provisions of National Company Law Tribunal Rules, 2016 (NCLT Rules, 2016) specifies the procedure for cancellation of variation to be followed by a person entitled and eligible to object on being aggrieved by the said variation.

1. Eligible shareholders under Section 48(2) of the Act shall present the application in Form No. NCLT 1 within 21 days after the date on which the consent was given or the resolution approving the variation was passed.
2. The application in Form No. NCLT 1. Shall be accompanied by documents required for the purposes of the case and shall set out:

1. the particulars of registration;
2. the capital structure, the different classes of shares into which the share capital of the company is divided and the rights attached to each class of shares;
3. The provisions of the memorandum or articles authorising the variation of the rights attached to various classes of shares.;
4. The total number of shares of the class whose rights have been varied;
5. The nature of variation made, the number of shareholders of the class who gave their consent to the variation or voted in favour of the resolution for variation and the number of shares held by them;
6. The number of shareholders who did not consent to the variation or who voted against the resolution, and the number of shares held by them;
7. The date on which consent was given or the resolution was passed; and
8. The reasons for challenging the variation.

3. In cases where an application to cancel a variation of the rights attached to the shares of any class is made on behalf of the shareholders entitled to apply for such cancellation by a letter of authority signed by them, authorising the applicant or applicants to present the application on their behalf, such letter of authority shall be annexed to the application, and the names and addresses of all the shareholders, the number of shares held by each of them, the aggregate number of shares held and the percentage of issued shares of that class shall be set out in the Schedule to the application.
4. On filing the application and supporting documents, if the Tribunal finds substance, it shall serve a notice to the opposite party directing it/them to show cause against the application on date of hearing to be specified in the Notice in Form No. NCLT. 5 along with a copy of the application.
5. If the company and the concerned persons against whom orders are sought, fail to appear on the date specified in Form NCLT 5, then the Tribunal may dispose of the application ex-parte with such order as it thinks fit.
6. If the company and other respondents contest thereto, it may file a reply along with copies of such documents on which it relies, on or before the date of hearing and such reply and copies of documents shall form part of the record.
7. The reply shall be served on the applicant and the applicant shall get an opportunity to re-join his application.
8. The Tribunal shall inform the parties, of the date of hearing of the petition.
9. The applicant shall at least 14 days before the date of filing the petition, advertise the application in Form No. NCLT 3A at least once in a vernacular newspaper being the principal vernacular language circulating in the district where the registered office of the company is situated and at least once in an English newspaper circulating in that district. The advertisement shall contain details such as:

1. Date of presentation of the application.
2. Name and address of the applicant.
3. Nature and substance of the application.
4. Date of hearing.

10. It is possible that objections are received from persons whose interest is likely to get affected by the proposed application. If the applicant receives such objections, he/it has to serve a copy of the objections to the Registrar of Companies or the Regional Director. The said objections have to be conveyed to them on or before the date of the hearing.
11. Where on the date fixed for hearing the application or on any other date on which such hearing is adjourned, the applicant appears and the respondent doesn’t appear, the Tribunal may adjourn the hearing or hear and decide the application ex-parte in the exercise of the power conferred on it under Section 424(2)(f) of the Act. However, if the applicant fails to appear in such a manner, the application may be dismissed.
12. The Tribunal at the time of the hearing may decide who all needs to be heard. As per the principles of natural justice, it is the applicant and the opponent who needs to be heard. However, if any objections are received from other parties or any other person seeks the permission of the Tribunal to intervene in the matter, then the Tribunal may allow such a party to be heard if its finds that such person is interested in the outcome of the application.
13. After hearing the parties, if the Tribunal is satisfied that based on the facts and circumstances of the case, the variation would unfairly prejudice the shareholders of the class represented by the applicant, it may disallow the variation. If, however, the Tribunal is of the opinion that the variation should be allowed and is not satisfied with the contentions of the opponents, it may confirm the variation.
14. The Tribunal may, at its discretion, make such orders as to cost as it thinks fit.
15. The tribunal shall send a copy of every order passed to the parties concerned.
16. The Tribunal shall decide every application as expeditiously as possible on perusal of documents, affidavits and other evidence if any, and after hearing such oral arguments as may be advanced.
17. The company shall, within 30 days of the date of the order of the Tribunal, file a copy thereof to the Registrar of Companies.
18. If any person is aggrieved by the order of the Tribunal, that person may file an appeal with the National Company Law Appellate Tribunal.

Conclusion

Section 48 of the Act becomes applicable when the share capital of a company is divided into different classes of shares and within such different classes, only rights attached to any selected class of shares are varied. The members have to give their approval either by the consent route or by the special resolution route. In addition, it also mandates the consent of other classes of shareholders in cases where variation by one class affects their rights. The Section empowers a class of members to object to variation of their rights and to seek cancellation of such variation in circumstances where they are prejudicially affected. In such cases, the detailed procedure as provided in the Act and the NCLT Rules, 2016 has to be followed. When an application challenging the variation is filed, the variation will not be effective until the Tribunal confirms it.

References

• https://vlex.co.uk/vid/adelaide-electric-supply-company-793933865 
• https://judgements.lawnigeria.com/2018/05/11/3plr-white-v-bristol-aeroplane-co-ltd/ 
• https://indiankanoon.org/doc/1201701/ 
• https://indiankanoon.org/doc/1428390/ 
• https://indiankanoon.org/doc/401/ 
• https://indiankanoon.org/doc/595360/ 

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