Issuing of Shares with Differential Rights, Companies Act 2013

Issuing shares with differential rights has become more prescriptive and restrictive  in Companies Act, 2013.New startups may  find it difficult to meet  the precondition of  consistent track record of distributable profits for last 3 years.

Voting Rights when there are Shares with Differential Voting Rights

There are a few subtle changes in the Companies Act, which bring about challenges in voting rights for different classes of shares and still be able to meet the requirement of balance of equity : preference in total voting rights.

Earlier to the Companies Act 2013 (Act), private companies could determine voting rights of equity(including differential rights) and preference shareholders as per their convenience, because of the Saving section 90 of old Companies Act, 1956.

The Act now has increased the boundaries for voting rights for preference shares, which now includes any resolutions which directly affect the rights attached to preference class and any resolution for the winding up of the company or for the repayment or reduction of its equity or preference share capital.

 In private equity deals (angels, VC) who opt for preference shares as the instrument, then having a list of matters (called as Reserved Matters) which requires the preference shareholder voting, then the Act enables it.  However, the proviso describes that the  “proportion of the voting rights of equity shareholders to the voting rights of the preference shareholders shall be in the same proportion as the paid-up capital in respect of the equity shares bears to the paid-up capital in respect of the preference shares”. It looks like additional language is required to be captured in the shareholders agreement at the time of investment, to protect the affirmative consent by the investors.

 This balance (pro-rata of equity: preference) gets murky when there is a class of shares with differential voting rights.

 Shares with differential voting rights:

Any company, whether private or public, will now have to comply with the below requirements.

  • The shares have to be ‘equity’ class.
  • The company cannot convert its existing share capital to a differential voting class but has to be fresh issuance of shares.
  • Issuance requires prior shareholders approval through ordinary resolution and the Articles of Association shall authorize issue of such shares. Also, there is a limit that such shares that it should not exceed 26% of the total post-issue paid up equity share capital. Further the Company should not have defaulted in filing financial statements and annual returns for 3 financial years. The Company should not have any subsisting default in the payment of

–  a declared dividend to its shareholders or

–  repayment of its matured deposits or

–  redemption of its preference shares or debentures that have become due for     redemption or

–  Payment of interest on deposits or debentures

  • Besides this, the Rules require that the Company should not have defaulted on

–  Repayment of loans from banks and public financial institutions or interest thereon

–  Payment of dividend on preference shares

–  Payment of statutory dues for employees

–  Depositing moneys into the Investor Education and Protection Fund.

(Our comment: Would an earlier default now made good still be considered as default under this clause, given there is a separate clause on “subsisting default”? )

  • The Company should also not have been penalized by 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.
  • Disclosure of relevant details in the shareholder notice, like, total number of such shares to be issued, details of the differential rights, percentage of shares with differential rights to the total post issue paid up equity share capital, reasons or justification for the issue; price at which such shares are proposed to be issued either at par or at premium; basis on which the price has been arrived at, change in control(if any) and other details in Explanatory Statement and Director’s Report is required by Companies (Share Capital and Debentures) Rules, 2014.

Disclaimer: There are many details that the Act prescribes, please speak with your attorney for advice. This is not a legal opinion and should not be construed as one.

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