Issuance of Equity and Preference Shares with Differential Rights and Variation of Rights

Background The term differential rights with respect to shares can be interpreted to mean the existence of rights different in nature than the rights that are inherently associated with ordinary shares. The holder of these shares has rights which are different from the holder of ordinary shares. Differential Rights in association with shares are in relation to voting rights, dividend or otherwise. Issuance of shares with differential rights may be used as a tool for strategizing control and dilution of voting rights in a company. Shares with Differential Rights under the Companies Act, 2013 Section 43(a) of the Companies Act, 2013 provides for the issue of equity shares having differential rights in accordance with Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014. Rule 4(1) of the Companies (Share Capital and Debentures) Rules, 2014 stipulates that a company limited by shares can issue equity shares with differential rights as to dividend, voting or otherwise, only if such issue of shares meet the following conditions:

• The issue should be authorised by the articles of association;
• The issue should be authorised by the shareholders of the Company by way of an ordinary resolution; (issue of such shares of a listed company shall be approved by shareholders through postal ballot)
• The shares with differential rights shall not exceed twenty-six percent of the total post-issue paid up equity share capital including equity shares with differential rights issued at any point of time;
• The company should have a consistent track record of distributable profits for the last three years;
• The company has not defaulted in filing financial statements and annual returns for three financial years immediately preceding the financial year in which it is decided to issue such shares;
• the company has no subsisting default in the payment:

1. a declared dividend to its shareholders or
2. repayment of its matured deposits or
3. redemption of its preference shares or debentures that have become due for redemption or
4. Payment of interest on deposits or debentures

• The Company should not have defaulted on:

1. Repayment of loans from banks and public financial institutions or interest thereon
2. Payment of dividend on preference shares
3. Payment of statutory dues for employees
4. Depositing moneys into the Investor Education and Protection Fund.

However, a company may issue equity shares with differential rights upon expiry of five years from the end of the financial year in which such default was made good.

• The Company should not have been penalized by any Court or Tribunal during the last 3 years of any offence under RBI, SEBI, SCRA, FEMA or any other special Act, under which such companies being regulated by sectoral regulators.

Additionally, the notice of the general meeting for issuing equity shares with differential rights shall contain particulars in the explanatory statement as provided in Rule 4(2) of the Companies (Share Capital and Debentures) Rules, 2014. Private companies have been exempted from the applicability under Section 43 vide a Ministry of Corporate Affairs Notification G.S.R 464 (E) dated June 5, 2015. As Section 43 is read in accordance with Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014, the said rule shall also not be applicable to private companies. However, the question still remains whether private companies are at a full liberty to structure their share capital as they are not required to comply with Section 43 of the Companies Act, 2013. Differential Voting Rights Voting Rights of Holders of Compulsorily Convertible Preference Shares As per Section 47(2) of the Companies Act, 2013, a holder of compulsorily convertible preference shares shall vote only on those resolutions:

• That directly affects the rights attached to his preference shares
• For winding up of the Company.
• For repayment or reduction of its equity or preference share capital.

However, a holder of compulsorily convertible preference shares is eligible to vote on all resolutions placed before the Company in case the Company fails in paying the dividend in respect if those preference shares, for a period of two years or more. Private companies are exempted from complying with Section 47, where memorandum or articles of association of the private company so provides. If a Company has issued multiple classes of preference shares, the variation of rights (voting and dividend) of such classes of preference shareholders would be as prescribed by Section 48 which applies to both public and private companies. For the variation of rights for different classes of preference shareholders, a special resolution is required to be passed by the said class of shareholders for which the rights are to be varied. Therefore, a Company may have different classes of preference shareholders having voting rights different from the voting rights available to ordinary class of preference shareholders. Voting Rights of Holders of Equity Shares Under Section 47(1) of the Companies Act, 2013, in regard to voting rights, it has been stated that:

1. Every member of a company limited by shares and holding equity share capital therein, shall have a right to vote on every resolution placed before the company; and
2. His voting right on a poll shall be in proportion to his share in the paid-up equity share capital of the company.

As mentioned earlier, Section 43 provides for issuing equity shares with differential rights which includes but is not limited to differential rights as to voting. In case a Company has multiple classes of equity shareholders, the variation of rights (voting and dividend) of such classes of shareholders would be as prescribed by Section 48 which applies to both public and private companies. In a recent change, the Government of India has come up with a draft ecommerce policy wherein it suggests that there should be differential voting rights in order to give Indian founders with minority stakes more control over the Company. Conclusion Shares with differential rights may have rights that are secondary to those attached to ordinary equity shares. Thus, these enable promoters to have control of the company. An investor investing funds into a company may also want beneficial voting rights (along with preference shareholding), in order to ensure that the company utilises the supplied funds judiciously and honour all obligations undertaken in the transaction documents. This can be achieved by way of shares issued to them having differential rights. Hence, the transaction documents of such issuance and subscription of the shares with differential rights must include the available rights (e.g. reserved matters) to the investor and detail the manner of exercise of such rights. Authors: Mr Spandan Saxena Ms Alivia Das.