Thursday, October 31, 2013

Transfer of Voting Rights, Without Transfer of Shares: Part 1

[The following post is contributed by Aditi Jhunjhunwala, Senior Associate at Vinod Kothari & Co. She can be contacted at]

The moment one possesses a share of a company, along with it also comes a bundle of rights such as the right to vote, receive dividend, transfer, bonus, rights issue, to share in the surplus, if any, on liquidation, to elect directors etc. These rights then become the property of the shareholder who is entitled to deal with them in any manner as he thinks fit. Once the share is transferred, all the rights and obligations attached to it also get transferred. A share in a partnership reflects the partner’s proprietary interest in the partnership assets: the assets are jointly owned by the partners. In the case of a company, it is not the shareholders but the company that owns the corporate assets, and the concept of a share serves somewhat different functions. In the first place, it is a fraction of the capital, denoting the holder’s proportionate financial stake in the company. Secondly, it is a measure of the holder’s interest in the company as an association and the basis of his right to become a member and to enjoy the rights of voting, etc. so conferred. And, thirdly, it is a species of property in its own right, a rather complex form of chose in action, which the holder can buy, sell, charge, etc., and in which there can be both legal and beneficial interests.

This post discusses, analyses and takes the position that can a shareholder unpack these bundle of rights and thereafter deal with any of the elements in a manner suitable to him, i.e. can he transfer any one of the rights and still retain the beneficial interest in those shares, or that can he transfer any part of such rights without parting with the shares. This write up specifically deals with transfer of voting rights without any transfer of shares.

Ways of transfer of voting rights

Concept of Voting Trust

Voting trust is whereby persons owning shares with voting powers retain ownership while transferring the voting rights to the trustees. The Voting Trust Agreement is an agreement whereby a voting trust is created and the shares in a company of one or more shareholders are legally transferred to a trustee for a certain period of time. In the Voting Trust Agreement, the trustee appointed is granted additional powers such as the ability to sell the shares. At the termination of the term of the trust, the shares held by the trustee would be transferred back to the shareholders. The concept is usually prevalent in US and offshore jurisdictions.

Section 153A of the Companies Act, 1956 (the Act) provided that the Central Government may appoint a person as public trustee to discharge the functions and to exercise the rights and powers conferred on him by or under the Act. This was however withdrawn and the trustees were now to directly exercise voting rights. Therefore the provisions of law also had a concept and permitted separation of the voting element from the bundle of rights.


If a shareholder appoints a proxy to vote on behalf of such shareholder in a meeting, can that be called separation of voting rights and ownership rights? The answer is no. In case of a proxy the shareholder is merely appointing a person to act on its behalf whereas in case of a transfer of voting right it has separated the bundle and set aside one of the elements. Surely, the shareholder need not execute a transfer deed to appoint a proxy. The Act recognizes a power of attorney for the purpose of transfer of voting rights as has been cited below.

In Cousins v. International Bricks Co. Ltd., (1931) 2 Ch 90 at 101: (1932) 2 Com Cases 108 (CA) it was discussed that a shareholder may give an irrevocable power of attorney to a person to cast votes on his behalf in the general meeting and also sign proxy forms on his behalf as constituted attorney. The constituted attorney’s position is that of a proxy and he can attend and vote at the meeting. If the shareholder himself attends the meeting, the power of attorney shall stand revoked thereby.



Is a pledge is a mode of transfer of voting rights without transfer of shares? The answer is yes. Pledge is very common for raising funds, where shares are pledged as collateral towards raising working capital or a term loan, to increase their holding or to fund an acquisition. The pledgor or the borrower will continue to receive dividend on the pledged shares. The pledgee or the lender will get the benefits only if a pledge is invoked and on record date the shares are in the lender’s account. The securities arising out of corporate actions like split, mergers, consolidation, etc. will be credited to the account of the pledgor with pledge marked in favour of the lender. Moreover, the lenders also get the right to sell the shares pledged by the promoters in case of default made by the promoters.

A pledgee or the lender may contractually enjoy voting rights over such shares in spite of the fact that in reality there is no actual transfer of shares by execution of transfer deed. All the rights and benefits attached to the shares otherwise are transferred to the pledgor.

In the case of Mohini Mohan Chakravartty v. Mohanlal Thalia[1], it was held by the Hon’ble Calcutta High Court that the shares when pledged with the pledgee, only create a special property in the shares and the pawnee of shares in a company cannot be treated as the holder of shares nor is he entitled to receive any dividend on the shares.

Disclosure for Pledge

In India, until recently when Securities and Exchange Board of India (SEBI) made it compulsory for promoters to disclose their pledged shares vide insertion of Regulation 8A in SEBI (Substantial Acquisition and Takeover) Regulations, 1997, there were no disclosure norms. However, post Satyam debacle, SEBI has made it mandatory for promoters and promoter groups to disclose the details of pledging of shares of their listed entities.

The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the Takeover Code) has made it mandatory for the promoters and their persons acting in concert to make all disclosures relating to any “encumbrances” created by them on their securities. The term “encumbrance” has been specifically used to widen the scope of the disclosures to be made by the promoters. Regulation 28(3) of the new Takeover Code provides an inclusive definition of “encumbrance” as, “it shall include a pledge, lien, or any such transaction, by whatever name called.” Thus, disclosure will have to be made in case of pledge of shares. Further, in case the pledgee gets voting rights also or has the right to cause the shareholder to vote as per the instructions of the pledgee, the transaction would well amount to acquisition of control and hence, triggering the Regulation 3 for making public announcement as well.

Under clause 35 of the listing agreement, a disclosure regarding the shareholding pattern of the company and the “promoter and promoter group” has to be made while under clause 41, the company is required to submit its financial results of every quarter. Both the clauses though existed earlier too, have been amended to include within its ambit necessary disclosure of shares pledged by the promoter and promoters group by virtue of the change in the Takeover Code.

(to be continued)

- Aditi Jhunjhunwala

[1] AIR 1964 Cal 470

Wednesday, October 30, 2013

Doing Business Rankings 2014: Status Quo for India

The Doing Business Rankings 2014 have just been published by the World Bank and IFC. Nothing much has changed in the case of India. It has dropped three places from 131 to 134 out of a total of 189 countries. While the entire report is available here, India’s country report is available here.

India’s rankings on various specific parameters are as follows:

- Starting a business: 179
- Dealing with construction permits: 182
- Getting electricity: 111
- Registering property: 92
- Getting credit: 28
- Protecting investors: 34
- Paying taxes: 158
- Trading across borders: 132
- Enforcing contracts: 186
- Resolving insolvency: 121

On several of these parameters, India’s ranking has remained constant over the years, suggesting that reforms have had minimal impact. On an optimistic note, however, the raising of financing through equity and debt seems to have been eased given that the performance on accessing credit and protecting investors is quite high.

Of course, these rankings have been subjected to some amount of critique, but they nevertheless provide a comparative perspective on doing business in various countries and their importance cannot be discounted altogether. It remains to be seen whether recent reforms on company law, land acquisition, foreign investment, etc. will reflect in improved rankings next year once they are assimilated into the business environment.

Tuesday, October 29, 2013

Alternative Business Forms

The current issue of the Economist has two interesting pieces (here and here) detailing forms of business that are acquiring prominence in the US markets and posing a challenge to the dominance of corporations (or companies) as the main form of business vehicle. Referring to this phenomenon as “distorporation”, it primarily alludes to the master limited partnership (MLP).

The details are described as follows:

The “master limited partnership” (MLP) combines the limited liability of a corporation, the tax advantages of a partnership and the governance of a private firm. MLPs do not pay corporate taxes so long as profits are passed on to investors each year. They also pay less attention to shareholder rights. A tidal wave of capital is washing towards these and other, similar “pass-through” structures ... Together, they represent a mere 9% of the number of listed companies in America, but in 2012 they took in 28% of the equity raised on public markets and paid one-third of Wall Street fees.

There are two key drivers behind the emergence of these types of vehicles. First, they minimize the tax burden. Second, they do not fall within the purview of details rules regarding corporate law and governance. While this facilitates the establishment of businesses more efficiently, there could be issues regarding loss of revenue and limited protection to minority investors.

The Economist adopts the position that such distortions in business vehicles can be avoided if taxes are streamlined and regulatory aspects of governance are loosened. However, it is not clear if the regulatory response would be on similar lines. In any event, such occurrences seem to have triggered a race to the bottom when it comes to competition between different business forms as far as governance and minority protection are concerned.

Saturday, October 26, 2013

SEBI issues draft settlement Regulations for comments

SEBI Act and related laws were amended recently to provide specific legal backing for settlement by consent orders. The background of this and some issues were discussed here (which post has reference to earlier posts and other links too). One point made was that the new law requires that such settlement should be on basis of Regulations that are prescribed.

SEBI has now issued a consultation paper giving also draft Regulations. It may be recollected that Guidelines are already in place as issued in 2012, replacing the Guidelines issued in 2007. But since the new law requires Regulations, these draft Regulations will pave way for the final version to be notified. SEBI has invited comments to be sent latest by 30th October 2013.

The draft Regulations on first impression are, like old wine in new bottle, the existing Guidelines in form of Regulations in terms of structure and broad outline, though there are several points of note, some of which are highlighted below.

The draft Regulations provide that the terms of settlement and certain related matters shall be provided through Guidelines. Thus, there will be flexibility since the Guidelines can be more easily changed from time to time. It is quite possible that the existing Guidelines may be re-issued without substantial changes, except removing those portions that are already incorporated in the Regulations.

A curious three level approval procedure has been laid down with SEBI having elaborate say in the matter of approving/rejecting settlement. Firstly, the application for settlement will go to the Internal Committee (IC) of SEBI. It would finalise the settlement terms giving a chance to the applicant to submit revised terms. It may of course reject the application outright at this stage if the nature of violation is of such a specified nature or otherwise if the settlement terms are not acceptable. If otherwise acceptable, the application is forwarded to the independent High Powered Advisory Committee (HPAC), which, after possibly another round of revision of terms, will give its recommendations. However, interestingly, whatever the recommendation of HPAC maybe, the SEBI Panel (not the IC) has an option to accept or reject it. In other words, even if HPAC accepts the proposal, SEBI may reject it. And vice-versa.  It can also ask the IC to consider a revision of settlement terms and gives its fresh recommendations and begin the procedure all over again.

An interesting question will be whether an order rejecting an application can be appealed before the Securities Appellate Tribunal. Prima facie, the answer seems to be yes. In that case, what will be more interesting would be the role of SAT – whether it can only require SEBI to reconsider it, whether it can give guidelines for making the order holding some part of the order to be wrong, or whether it can even settle the terms itself?

The cooling period for an application for another settlement is two years. But this period of two years commences not from the date of last default, but from the date of last settlement order. This effectively vastly increases the practical gap between two defaults that can be settled. Further, an applicant can, in one lifetime, can make only two settlements.

If a criminal complaint has been filed under specified provisions for the default, then an application cannot be made.

A fees of Rs. 5000 would have to be paid with the application, which appears to be non-refundable irrespective of the outcome of the application.

There are other ambiguous and even seemingly contradictory provisions in the Regulations. However, one awaits the final Regulations and revised Guidelines for the final framework of this law that has helped curbed prolonged litigation, even as the settlement process becomes more complicated, discretionary and non-transparent.

Monday, October 21, 2013

The Resurgence of REITs

More than 5 years ago (in December 2007), SEBI had issued a consultation paper and draft regulations with a view to paving the way for the introduction of real estate investment trusts (REITs) in the Indian markets (which we had the opportunity to discuss here). However, the plan seemed to have gathered moss for a number of years.

Earlier this month, it was revived when SEBI issued another consultation paper and a draft of the proposed SEBI (Real Estate Investment Trusts) Regulations, 2013, seeking public comments (which are due on October 31, 2013).

REITs are an attractive instrument for financing in the real estate sector. It benefits promoters or sponsors of existing real estate projects by providing an exit option from their investments. It also enables investors who may be interested in investing in real estate as an asset class. Despite the perceived advantages of REITs, and their prominence in developed markets, the idea received limited attention in India. It is also not surprising that a handful of Indian real estate companies sought to list their securities in overseas markets. This is all set to change with the proposed regulations.

According to the consultation paper, REITs would be available primarily for completed, revenue generating real estate projects. In other words, under-construction projects as well as trading in real estate or undeveloped land would not fall within the purview of REITs, primarily due to the uncertainties involved.

In terms of the investment structure, the REITs will have to be set up as a trust, with a trustee, manager, sponsor as well as the valuer. The REIT will have to be registered with the SEBI before it can operate.

REITs’ units shall be initially issued through an initial public offering, following which the listing off the units shall be mandatory. In order to ensure that this facility is available only to large, and well-recognised projects, the minimum asset size is fixed at Rs. 1000 crores.  Similarly, there is also a minimum offer size as well as a minimum public float. At the outset, the idea appears to be to offer the units only to high net worth individuals and institutions. This is to ensure that only sophisticated investors with the requisite capacity to bear the risk are able to invest.

While there are customary responsibilities imposed on the trustee, manager, etc., there is a great emphasis on matters of governance, disclosure and transparency. For example, there is a detailed treatment of related party transactions that the trust may undertake. Moreover, there is a detailed focus on the valuation of the real estate assets held by the trust, and also appropriate disclosures regarding the same. This is important given the levels of fluctuation that real estate assets may experience from time to time. Clearly, the proposed regime seems to contemplate the possible risks in the real estate sector, and seeks to address them to the extent possible.

Overall, the proposed introduction of REITs in the Indian markets is timely. While the proposed regulations are fairly balanced in that they are on the one hand facilitative in nature, but on the other hand they are also protective of investors and markets (implemented through the imposition of several conditions on the establishment and operation of REITs).

At the same time, other issues need to be addressed as well. We have discussed this in our earlier post, and they continue to be relevant at the present moment as well:

There are other issues (that fall outside the direct ambit of the draft Regulations) that need to be ironed out before REITs can be implemented in practice. First, there are several industry-specific problems underlying the real estate sector. One important legal issue is the absence of clear title and the existence of incomplete contracts that plagues several real estate transactions in India. This enhances risks borne by investors in REITs. Therefore, it is imperative that there be stringent disclosure norms for issuance of securities by REITs that make it mandatory for issuers to qualitatively disclose these risks to investors. In other words, the offer document requirements to be prescribed by SEBI for REITs should encompass all industry-specific issues and matters that are associated with the real estate sector.

There is also a need for clarity on the position regarding taxation of REITs themselves as well as their investors, as also any stamp duty implications on the issue and transfer of the REITs securities. This is required to ensure smooth implementation of the regulations.

While SEBI’s announcement of REITs cannot be more timely, there is evidently a need for a comprehensive review of all aspects that have a bearing on REITs transactions before the mechanism can be put in place, so as to make its implementation successful.

Added to this list is the need for streamlining the foreign direct investment (FDI) regime if this sector is to attract foreign capital, which may be necessary given the potentially large sizes of offerings.