Much ink has already been spilt over the last three days following the revelation that the chairman of the Tata Sons board, Mr. Cyrus Mistry, has been “replaced”, and that Mr. Ratan Tata has returned to helm the affairs as interim chairman for a period of four months until a successor can be found. This has not only sent the sprawling corporate group into crisis mode, but it has led to considerable speculation on whether a high-stakes corporate litigation is likely to ensue.
Broad Nature of Company Law Issues
From a technical perspective, the legal issues surrounding Mr. Mistry’s replacement may not be all too complicated. First, Tata Sons Limited is an unlisted company, and hence governed by the provisions of the Companies Act, 2013. It is not subject to the slew of corporate governance norms and securities regulation dispensed and implemented by the Securities and Exchange Board of India (SEBI). Tata Sons is a closely held company with about 65% of the shares held by two Tata Trusts controlled by Mr. Ratan Tata, with about 18.5% being held by the Shaporji Pallonji Mistry group, to which Mr. Mistry belongs.
Second, the Tata Sons’ board has only replaced Mr. Mistry as the “chairman”, while he continues to be a non-executive director of the company. Although the Companies Act envisages roles and functions for a chairperson of a company, it does not stipulate the precise mechanism for appointment and removal of such a chairperson. That is indeed left to each company to frame in its articles of association. Hence, the likely bone of contention has veered towards whether the board of Tata Sons complied with its articles of association while replacing Mr. Mistry as its chairman. Based on news reports (here and here), it appears that following Mr. Mistry’s assumption of chairmanship, the articles of association of Tata Sons were amended to restrict the powers of the chairman and to enhance the oversight and control exercised by the Tata Trusts. In that sense, the board (including the directors nominated by Tata Trusts) may very well have possessed the appropriate powers to replace Mr. Mistry as the chairman.
This being the case, it is as yet unclear whether the dispute will end up in litigation. In a letter issued by Mr. Mistry to the board of Tata Sons, he has alleged that the directors have failed to “discharge the fiduciary duty owed to stakeholders of Tata Sons and of the group companies”. While available in theory, any action surrounding breach of directors’ duties through a shareholder derivative action ought to be brought in a civil court, and may not only be difficult to establish, but may be inefficient given the costs and time involved in successfully bringing such an action. A more appropriate action in such a case would be one for oppression and mismanagement under section 241 of the Companies Act, 2013. Any shareholder holding 10% of the shares of a company (in this case the Shaporji Pallonji Mistry group satisfies the requirement) can bring an action before the National Company Law Tribunal (NCLT) on the ground that the affairs of the company are being conducted in a manner “prejudicial or oppressive” to a shareholder, or that a material change has taken place in the management or control of a company, which is likely to cause prejudice to shareholders. The NCLT possesses wide-ranging powers to pass various kinds of orders in an action involving oppression and mismanagement. Even here, the bar to bring an oppression action is quite high, and ultimately it will boil down to the specific facts and circumstances whether such an action can be successfully availed of.
These and other issues will certainly be the subject matter of debate in the legal circles in the days to come.
Impact on Corporate Governance
My larger focus in this post is on the impact this episode has on corporate governance in Indian companies generally. It would be too simplistic to treat the Tata Sons boardroom crisis as one involving an unlisted company that is bereft of public shareholders. Tata Sons is the promoter (or controlling shareholder) of several listed companies within its fold, and which in the aggregate represent about 7.5% of the market capitalization on BSE. In such a scenario, the corporate governance issues surrounding Tata Sons is no longer a matter within the house, but one that involves the interests of minority shareholders and other stakeholders of all listed companies within the Tata stable. In that sense, the conduct of affairs on the Tata Sons board has a considerable impact on the governance of all of those listed companies.
Taking this into consideration, the sequence of events that transpired over the last few days leaves much to be desired. Even if the board of Tata Sons did legally possess the right to replace the chairman, the manner in which that was accomplished does not comport with basic principles of corporate governance. For instance, press reports indicate that sufficient advance notice may not have been given to Mr. Mistry and that the item regarding his replacement was included in the agenda as part of “other items”, thereby springing a surprise on him (although reports suggest that he was informed by one of the directors the day before the meeting). While this may be legal due to the nature of Tata Sons as an unlisted company, the impact of Mr. Mistry’s exit has been felt across all the listed companies in the group, which have witnessed declines in the market value of their shares.
What lessons from this episode may be relevant for the broader corporate governance framework in India? At the outset, this continues to raise significant issues for promoter-driven companies. Matters that affect promoters, including disputes among groups of promoters, will directly impact the listed companies and their minority shareholders and other stakeholders. Hence, the governance framework is important not only at the listed company-level, but also at the promoter-level. It is paradoxical that despite the establishment of a detailed governance framework (albeit through the articles of association) in Tata Sons, such a negative outcome was unavoidable.
Second, one cannot escape from the fact that in promoter-driven companies, there could be multiple centres of power. For instance, promoters themselves may have a governance framework (as Tata Sons did), and decisions taken through such a framework would have implications for all listed companies under it. However, there is a perceptible governance gap here. Decisions taken by promoters (being either individuals or unlisted companies) are not subject to the same level of transparency and governance norms as listed companies are. For instance, even though Tata Sons had a professional board with immensely competent individuals, the balance of power stipulated in the articles of association swayed heavily in favour of the Tata Trusts, thereby arguably impinging upon the exercise of powers of the board as a whole, and the chairman in particular. Hence, decision-making at the promoter level was not accompanied by any accountability to stakeholders of listed companies, although they are considerably impacted by such decisions. Moreover, in the Tata Sons episode, there was no advance warning to the markets about the impending precipitous action that was taken by the board on 24 October 2016. What began as a terse announcement of the chairman’s replacement then led to speculation regarding the reasons behind such action. The lack of any legal requirements on the part of Tata Sons to provide advance notice or sufficient details following the action may have led to this situation.
Third, the absence of disclosure and transparency requirements pertaining to the promoter (being an unlisted company) has left the shareholders of the listed companies in the lurch and kept them guessing about the reasons for the chairman’s replacement. This has led to a lot of speculation both among investors and commentators. Added to this are the allegations now made by Mr. Mistry in his letter to the Tata Sons board, which is now available in the public domain.
Fourth, and more importantly, what is the role of the boards of various listed companies within the group? At one level, the board’s attention may not be called for as the various events have occurred at the promoter level. The listed company boards have neither considered nor taken any decision. But, that would be too simplistic and naïve an approach. Given that the recent string of events have a direct impact on the shareholders and stakeholders of these listed companies, the boards must state their position and clarify the issues and assuage the concerns of investors. An additional complication is that Mr. Mistry continues to be the chairman and non-executive director of various listed companies within the Tata Group. Will this affect the functioning of the boards of the Tata Group when there is a battle for control and management of the promoter company? These are important questions that the boards will have to consider and answer. To that extent, the move by the stock exchanges in writing to the Tata Group companies to explain and clarify the events and their impact on each company is a welcome one.
The Way Forward
In all probability, the issues surrounding Tata Sons will be resolved one way or another, and the companies within the Tata Group will move on with their businesses. But, the lessons learned so far (there may be much more after a deeper analysis) cannot be ignored. From a governance perspective, this calls for a more focused approach towards promoter-driven companies, especially those run by business families. In such cases, governance oversight must extend beyond listed companies and into the domain of promoters. Issues affecting promoters cannot be isolated from their impact on listed companies. Hence, this raises a question whether some types of governance norms must be imposed on promoters themselves, in addition to the listed companies. Even if there is no need for a slew of corporate governance norms extending their reach towards promoters, decision-making by promoters ought to be made more transparent. More importantly, listed companies and their boards must be in a state of preparedness to deal with issues that occur at the promoter level, whether it be succession or any other disputes.