What Are Differential Voting Rights (DVRs) And What Recently Changed?

Differential voting rights according to section 43 (a)(ii) of Companies Act, 2013 are those rights which allows differentiation between shares among its other classes in term of Dividend & Voting. Every shareholder of a company requires right related to their shareholding when we talk about voting and issuing dividends. Usually, Major Shareholders are inclined towards possessing voting rights whereas minority Shareholders towards Dividend rights.

Promoters are more concerned about voting rights as it allows them to play an important part in governing their company. The concept of DVRs is letting promoter retain control over the company without dilution of rights, by allowing shares with superior voting rights (SR) or lower or fractional voting rights to public investor. Previously, Tata Motors & Pantaloons issued DVRs with 1/10th fractional voting rights as compared to ordinary shares in exchange for 5% higher dividend as compared to ordinary shares.

SEBI by circular dated July 21, 2009 prohibited companies from issuing any sort of shares in any manner which may confer on any person, superior rights as to voting or dividends vis-à-vis the rights on equity shares that are already listed.

Countries like US, Canada, Hong Kong also allows issuance of shares with superior voting rights.

As per Rule 4 of The Companies (Share Capital and Debenture) Rules, 2014, no company shall issue equity shares with differential voting rights unless it complies with the following conditions:

1. Article of association of a company should authorize the issue of shares with differential rights.
2. Permission from shareholders in the general meeting by passing an ordinary resolution.
3. The voting power in respect of shares with differential rights of the company shall not exceed 74% (earlier 26%) on post-listing of shares (including ordinary shares).
4. There has been no default in filing of annual returns & financial statements for 3 financial years immediately preceding the financial year in which shares are being issued.
5. The company has not endured any default in payment of dividend to shareholders or repayment of debenture holders or preference shareholders on their maturity & redemption 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.
6. The company has not been penalized in last 3 years of any offence under Reserve Bank of India Act, 1934, the Security and Exchange Board of India Act, 1992, the Securities and Contract Regulation Act, 1956, the Foreign Exchange Management Act, 1999 or any other Special Act.

Framework Of Issuance
Company consisting superior voting rights shareholders shall be allowed to do an Initial Public Offering (IPO) of only ordinary shares to be listed on the main board with following conditions:

Eligibility

1. Issuer company should be a tech company as per innovators growth platform which is intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology/nano-technology to provide products, services or business platforms with substantial value addition.
2. The superior right holder should be a part of promoter’s group whose net worth should not exceed Rs. 500 Cr excluding the shares held by SR shareholder of share company.
3. The SR shares can only be issued to executive positions such as of promoter or founder.
4. The issues of SR shares can only be issued through a special resolution passed at a general meeting of shareholders.
5. SR shares must be been held by the holder at least for a period of 6 months prior to the filing of Red Herring Prospectus.
6. SR holders shall have the voting rights in ratio of minimum prescribed 2:1 to maximum 10:1 in compared to ordinary shareholder.

List-in and Lock-in

Shares having superior voting rights must be listed on stock exchange after public issue and there will be a perpetual lock-in until conversion into ordinary shares. There shall be no transfer of such shares among the promoter and those shares must be free from any sort of lien or charges neither can they be pledged.

Rights of Superior Voting Right Shares

Shares possessing superior voting rights shall always be treated at par in compared to ordinary shares in every respect, including dividend, except in case of voting on resolutions. The total voting rights of SR shareholders including ordinary shares post listing must not exceed 74% of total voting power.

Enhanced Corporate Governance

2/3 of the board and committees (excluding audit committee) must comprise of Independent Directors as prescribed by SEBI (LODR) Regulations and Audit Committee shall compromise of only independent directors.

Coat-Tail Provisions

Post IPO, superior right shares will be considered as ordinary shares in terms of voting under following situations:

1. Appointment/removal of independent director and/or auditor.
2. In case promoter is willingly transferring the control to other company.
3. Related party transactions as per SEBI (LODR) regulations involving SR shareholder.
4. Voluntarily winding up of company.
5. Changes to be done in MOA and AOA except any change affecting SR instrument.
6. Initiation of voluntarily resolution plan under IBC.
7. Utilization of funds for purposes other than business.
8. Passing of special resolution in respect of buy back of shares or delisting.

Sun-Set Clauses

On certain event SR shares shall convert automatically into ordinary shares:

1. On the demise of promoter holding such shares.
2. On resigning of shareholder holding such shares from executive position.
3. In case of M&A, where shareholder of having SR shareholder where the control would be no longer with him.

Fractional Right Shares

SEBI has stated, the issuing of fractional right shares by existing listed companies won’t be allowed as of now unless enough experience has been gained from the concept of issuing Special Right shares.

Amendment
Clause (d) rule 4(1) of SCDR, which requires companies in order to issue DVRs must have a profitable track record of previous 3 years has been deleted and previous limit of 26% on percentage of shares of differential rights out of post issue paid-up equity share capital has been revised to 74%.

Conclusion
New framework of DVR will help entities in raising capital for their business and will also allow promoters gain substantial control over the company which in past at many instances had been diluted with the rights of other shareholders resulting in loss of control over the business and in decision making. It will prevent promoters and major shareholders from the dilution of shareholdings and hostile takeovers which will also benefit to minority shareholders who are not interested in voting rights and are satisfied with other rights involved into bonus issues, dividends, ESOPs etc.