To broaden the scope and simplify the process for re-classification of shareholders of listed companies, SEBI has issued a consultation paper titled ‘
Provisions pertaining to Re-classification of shareholders’.
The consultation paper has proposed a much needed amendment to Regulation 31A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR), which has been in force since September 2, 2015.
Under securities laws, promoters of companies are
inter alia subject to strict disclosure requirements and are put to a high degree of accountability. For instance, stock exchanges have been empowered by SEBI to freeze shareholdings of promoters when companies fail to comply with disclosure requirements under the LODR.
These standards will also apply to individuals who exercise no control or influence over a company but are classified as ‘promoters' or members of the ‘promoter group' as defined under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations). Further, the actions of a promoter can have consequences on a company as well.
For instance, if SEBI debars a promoter from accessing the capital market, under the ICDR Regulations, irrespective of whether the said promoter had any control over the company, the company will be barred from making any public or rights issues of specified securities. Therefore, it is important to have a comprehensive law on re-classification of shareholders which allows promoters to be reclassified in the appropriate circumstances. The proposed amendment to Regulation 31A of the LODR (Proposed Reg 31A) is a step towards rationalising and simplifying this process.
Presently, Regulation 31A of the LODR (Reg 31A) permits re-classification of shareholders under three limited scenarios. These include cases of i) transmission/succession/inheritance of shares by an inheritor; ii) a new promoter replacing the previous promoter subsequent to an open offer or in any other manner and; iii) a company becoming professionally managed without an identifiable promoter. Except for the first scenario, such re-classifications are permitted pursuant to satisfaction of several conditions.
These include the requirement that the outgoing promoter must not be exercising control or enjoying special rights in the company and must obtain a shareholders’ approval for the reclassification. As Reg 31A encapsulates only limited scenarios for re-classification of shareholders, companies in the past have approached SEBI under the SEBI (Informal Guidance) Scheme, 2003, seeking approval to re-classify promoters as public shareholders.
SEBI taking into consideration the recommendations of
inter alia the Uday Kotak Committee Report on Corporate Governance has now proposed a uniform process for re-classification of shareholders and a single set of conditions for all situations of re-classification of shareholders. The basic process for re-classification shareholders is provided below:
Pursuant to receiving a request for re-classification from a company, the stock exchange shall approve a request provided all other terms and conditions specified in the Proposed Reg 31A are satisfied. These conditions include the requirement that the promoter must not be holding more than 10 percent of the total voting power of the company and must not be exercising any control or having special rights over the company.
Unlike Reg 31A, the Proposed Reg 31A, does not allow the concerned promoter to act as “key managerial person” in the company for any period of time after the re-classification. Additionally, the Proposed Reg 31A has introduced conditions on listed companies making a request for re-classification of shareholders. These conditions include requirement that the company must be complaint with the minimum public shareholding requirements, and its shares must not be suspended from trading on the stock exchanges. Further, SEBI is empowered to relax any of the condition for re-classification in specific cases, if SEBI is satisfied about the non-exercise of control by the outgoing promoter or persons acting in concert.
However, there are certain concerns that may be brought to light with respect to the Proposed Reg 31A.
Is shareholders’ approval necessary in all circumstances?
As provided in Reg 31A, the Proposed Reg 31A mandates obtaining a shareholders’ approval for all cases of re-classification of shareholders, except for cases of transmission/succession/inheritance of shares. This requirement may not be necessary for all circumstances. For instance, if the outgoing promoter holds less than 10 percent of the voting power and does not exercise control of a company which has another controlling promoter, and all other conditions specified in the Proposed 31A are satisfied, seeking the approval of the shareholders might have no relevance. Further, this requirement under the Proposed Reg 31A is contrary to the stance taken by SEBI in several of SEBI’s informal guidances, wherein SEBI had allowed promoters with nominal shareholdings to be re-classified as public shareholders without seeking a shareholders’ approval.
Why should only promoters be allowed to initiate the process of re-classification?
Unlike Reg 31A, the Proposed Reg 31A allows the process of re-classification to be initiated only by a promoter and therefore, a company will be unable to re-classify promoters holding nominal shareholdings, in the interest of the company. As discussed earlier, if a promoter holding nominal shares and having no control or special rights over the company is declared as a ‘wilful defaulter’, the company will be barred from making a public issue of equity shares under ICDR Regulations. In such scenarios, the company should be given the power to initiate the process for re-classification of the concerned promoter to a public shareholder.
Bar on ‘wilful defaulters’ and cooling off period.
SEBI has not provided any reasons for imposing a blanket bar on ‘wilful defaulters’ from being re-classified as public shareholders. As discussed earlier, imposing such a restriction may be against the interest of the company. Further, SEBI has not provided any reason for having a six-month cooling off period between the board meeting of the directors and the shareholders’ meeting with respect to the process of re-classification of shareholders. On account of the six-month cooling off period, the process of re-classification will be delayed and the recommendations of the board of directors may become obsolete and redundant by the time the shareholders are to consider the proposed re-classification and take a decision on the matter.
To summarise, SEBI’s attempt to amend Reg 31A is a move in the right direction as it will broaden the scope and simplify the process of reclassification of shareholders. It will be interesting to see if SEBI further modifies the Proposed Reg 31A in the future based on comments received from market participants.
Sandeep Parekh is a partner and Rahul Das is an associate at
Finsec Law Advisors