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Issue of Share Capital with Differential Voting Rights

This article is an attempt at analyzing the issue of shares by companies with differential rights as to voting, dividend etc., Introduction:

The Companies Act, 1956 (hereinafter referred to as the “Act”) was amended in the year 2000, with effect from 13.12.2000, whereby issuance of shares with differential voting rights (“DVR's”) was introduced by inserting Section 86. Accordingly the definition of “shares with differential rights “ was inserted in Section 2(46A) of the Act.

The amended provisions stand as follows: 2(46A). “Share with differential rights” means a share that is issued with differential rights in accordance with the provisions of Section 86. Section 86. New issue of share capital to be only of two kinds- The share capital of a company limited by shares shall be of two kinds only, namely:- (a) equity share capital-
  1. with voting rights; or
  2. with differential rights as to dividend, voting or otherwise in accordance with such rules and subject to such condition as may be prescribed.
Interpretation:

The equity shares issued "with differential rights as to dividend, voting or otherwise" would mean having rights different than the rights attached with the equity shares with voting rights. Such rights may be different in nature as regards dividend, as regards voting, or as regards "otherwise".

Sections 87 and 92 of the Act deal with voting rights of the shareholders of a company. As per section 87(1) every member of a Company limited by shares and holding any equity share capital therein shall have a right to vote in respect of such capital on every resolution placed before the company and his/her voting rights on a poll shall be in proportion to his/her share of the paid up equity capital of the company. Sub-section (2) relates to the holders of preference share capital being not a subject matter, hence it has been left out. As per section 86 amended by the Amendment Act, every member of a public company limited by shares and holding any equity share capital therein shall have a voting right which may be differential with other equity share capital. But, there would not be any equity share capital without voting rights. Under section 92 of the Act, it is provided that a company can accept the uncalled up capital from its shareholders but such members shall not be entitled to any voting rights in respect of the money so paid on any shares held by them although no part of that amount has been called up.

As per section 2(46A) a share with differential rights means a share that is issued with differential rights in accordance with the provisions of section 86 of the Act. The equity shares with differential rights include equity shares with differential rights as to—

  1. voting;
  2. dividend; and
  3. otherwise.
Neither the Act nor the Rules define the term—"otherwise", which may include any other right attached to equity shares.

A company can issue shares with higher or lower voting rights. For example, it can issue shares where the voting right is one for every three shares. Again, it is also capable to issue shares where the voting right is five votes per share. The management of the company generally issues such shares where the capital is raised without much dilution in the voting power. In a way, the controlling management can have fewer shares but a greater effective control in managing the company. Also, if the shares are issued with reduced voting rights, they are likely to be available at a lower price as well.

Section 86 of the Companies Act permits the issue of equity shares with DVRs, subject to conditions prescribed under the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001

The Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001:

The Central Government notified The Companies (Issue of Share Capital with Differential Voting Rights) Rules (hereinafter referred to as “Rules”) in the year 2001 in pursuant to the powers conferred by sub-clause (ii) of clause (a) of Section 86 read with clauses (a) and (b) of sub-section (i) of Section 642 of the Act. Rule 3 of the Rules prescribes certain terms and conditions for a company to issue shares with different rights as to dividend, voting or otherwise. The conditions are:

Every company limited by shares may issue shares with differential rights as to dividend, voting or otherwise, if-
  1. The company has distributable profits in terms of Section 205 of the Companies Act, 1956 for * three financial years preceding the year in which it was decided to issue such shares.
  2. The company has not defaulted in filing annual accounts and annual returns for three financial years immediately preceding the financial year in which it was decided to issue such share.
  3. The company has not failed to repay its deposits or interest thereon on due date or redeem its debentures on due date or pay dividend.
  4. The Articles of Association of the company authorizes the issue of shares with differential voting rights.
  5. The company has not been convicted of any offence arising under, Securities Exchange Board of India Act, 1992, Securities Contracts (Regulation) Act, 1956, Foreign Exchange Management Act, 1999.
  6. The company has not defaulted in meeting investors’ grievances.
  7. The company has obtained the approval of share holders in General Meeting by passing resolution as required under the provision of sub-clause (a) of sub-section (1) of section 94 read with sub-section (2) of the said section.

  8. The listed public company obtained approval of share holders through Postal Ballot.
  9. The notice of the meeting at which resolution is proposed to be passed is accompanied by an explanatory statement stating –
    1. the rate of voting rights which the equity share capital with differential voting right shall carry;
    2. the scale or in proportion to which the voting rights of such class or type of shares will vary;
    3. the company shall not convert its equity capital with voting rights into equity share capital with differential voting rights and the shares with differential voting rights into equity share capital with voting rights;

    4. the shares with differential voting rights shall not exceed 25% of the total share capital issued;
    5. that a member of the company holding any equity share with differential voting rights shall be entitled to bonus shares, right shares of the same class;

    6. the holders of the equity shares with differential voting rights shall enjoy all others rights to which the holder is entitled to excepting right to vote as indicated in (a) above.

Register:

Every company referred to in rule 3 shall maintain a register as required under section 150 of the Act containing the particulars of differential rights to which the holder is entitled to.

Can a Company issue Non Voting Shares

An important question that comes up is, whether a company can issue non-voting shares, One may argue that section 87 offers every member a right to vote and therefore, a company cannot issue non-voting shares. It is felt that a company can issue non-voting shares since section 86 permits companies to issue shares with voting rights or with differential rights. In other words, a company may either issue shares with voting rights or without voting rights, but having differential rights as to voting or otherwise.

Pursuant to section 90(2) of the Act, the provisions of sections 86 of the Act are not applicable to a private company unless it is a subsidiary of Public Company. As such private companies which are not subsidiary of public companies, are entitled to issue any kind of share capital equity, preference or others with differential rights as to voting , dividend and also non-voting shares even. But in no case, a public company is empowered to issue Non-voting shares at all.

Advantages

Shares with DVR comes to the management’s rescue at the time of take-over threats. DVR can be used to thwart hostile takeovers since, for all practical purposes, they decouple economic interest (dividend rights) and voting rights.

Shares with DVR are mainly targeted at passive investors. In most cases, small or retail investors, hardly exercise their voting rights or know enough to influence corporate actions. They look only for economic returns when they invest in a company and are not interested in running it or having any say in its management. So, they give away their voting rights in favour of those investors who run the company and have management control.

In a situation like that prevailing in India, where minority retail investors do not intend using their voting rights in a company, such shares allow investors to acquire shares at lower prices with prospects of higher dividends in return for surrendering their voting rights.

Companies can issue shares with lower voting rights to public shareholders. That would automatically bump up the promoters’ voting rights. Investors are compensated for lower control, so companies give them higher dividends. Companies issue DVR shares for prevention of a hostile takeover and dilution of voting rights. It also helps strategic investors who do not want control, but are looking at a reasonably big investment in a company. At times, companies issue DVR shares to fund new large projects, due to fewer voting rights, even a big issue does not trigger an open offer. The Act permits a company to issue DVR shares when, among other conditions, the company has distributable profits and has not defaulted in filing annual accounts and returns for at least three financial years

Disadvantages

One of the major disadvantages of these types of shares is the possible misuse of voting power by the promoters. The management may act against the interests of the other shareholders since they have voting power disproportionate to the economic ownership in the company like expropriating funds from those holding lesser voting.

Next comes the issue of accountability of the management with superior voting rights. The controlling shareholders can tend to preclude the ordinary shareholders from taking action against them, thus making them unaccountable for their actions. This will ultimately result in lack of transparency vis-à-vis day-to-day affairs of the company.

Issue of shares with DVRs in India:

The issue of shares with differential voting rights has not been used a great deal by Indian Companies. Lack of awareness about these instruments has not attracted the investors so much. In 2008, Tata Motors was the first company to issue equity shares with differential voting rights wherein the shares with differential voting rights carried lesser voting rights than the ordinary shares. After the issue by Tata Motors Ltd., Pantaloon Retail (India) Ltd. in February 2009 offered bonus shares with differential voting rights to the existing shareholders of the company. specified date. The new shares were called Class B shares which entitled the shareholders to an additional 5 percent of the dividend over the dividend payable to Class A shares payable to shareholders in any financial year. However, ten Class B shares would carry one vote.

Conclusion

For an investor, who believes in being a part of the company’s decision processes, DVR shares are not attractive due to limited voting rights.

However, if one is a minority investor and isn’t concerned much with voting rights per se, then investing in the DVR would certainly be an attractive proposition. DVRs mostly trade at a discount, largely due to the fewer voting rights they enjoy. However, at times, the gap between DVR and ordinary shares is large, providing good opportunity to investors. Not only does an investor stand to gain from capital appreciation in a scenario where the price difference between the ordinary and the DVR share reduces over a period as a result of rising awareness about the product, he will also be entitled to higher dividends. Furthermore, he can always invest back in ordinary shares by exiting DVRs once the differential narrows. Thus, the risk reward ratio of investing in DVRs looks somewhat skewed towards the latter. The only caveat is that before investing in a DVR, investors need comfort about the company’s fundamentals and prospects, and more importantly, its management.

Disclaimer: The entire contents of this document have been developed on the basis of relevant information and are purely the views of the authors. Though the authors have made utmost efforts to provide authentic information however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.

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