Issue of Shares with Differential Voting Rights

Background:

• Shares: A share is the interest of a member in a company. Section 2(84) of the Companies Act, 2013 (hereinafter referred to as Act) “share” means a share in the share capital of a company and includes stock. It represents the interest of a shareholder in the company, measured for liability and dividend. It attaches various rights and liabilities.
• Voting Rights:  the right of a member of a company to vote in any meeting of the company or using postal ballot.
• Differential Voting Rights: The term differential rights concerning 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 that are different from the holder of ordinary shares. Differential Rights in association with shares are about voting rights, dividends or otherwise.
• Types of share capital:
  1. Equity Share Capital
  2. Preference Share Capital

Equity Share Capital: Equity shares are also known as ordinary shares. They are the form of fractional or part ownership in which the shareholder, as a fractional owner, takes the maximum business risk. The holders of Eq uity shares are members of the company and have voting rights. Equity shares are a vital source for raising long-term capital. Equity shares represent the ownership of a company and capital raised by the issue of such shares is known as ownership capital or owner’s funds. They are the foundation for the creation of a company. Equity shareholders are paid based on the earnings of the company and do not get a fixed dividend. They are referred to as ‘residual owners’. They receive what is left after all other claims on the company’s income and assets have been settled. Through their right to vote, these shareholders have a right to participate in the management of the company. It shall be of two kinds:

1. with voting rights; or
2. with differential rights as to dividend, voting or otherwise with such rules as may be prescribed;

Preference Share Capital:  Preference shares are the shares that promise the holder a fixed dividend, whose payment takes priority over that of ordinary share dividends. Capital raised by the issue of preference shares is called preference share capital. The preference shareholders are in a superior position over equity shareholders in two ways: first, receiving a fixed rate of dividend, out of the profits of the company, before any dividend is declared for equity shareholder and second, receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation. In short, the preference shareholders have a preferential claim over dividend and repayment of capital as compared to equity shareholders.

Purpose of Issue of Shares with Differential Voting Rights: Issuance of shares with differential rights may be used as a tool for strategizing control and dilution of voting rights in a company.

Procedure of Issue of Shares with Differential Voting Rights: Section 43(a) of the Companies Act, 2013 provides Company can issue equity shares with differential rights as to dividend, voting or otherwise, only if such issue of shares meets 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. Declared dividend to its shareholders
2. Repayment of its matured deposits
3. Redemption of its preference shares or debentures that have become due for redemption or
4. Payment of interest on deposits or debentures
5. Repayment of loans from banks and public financial institutions or interest thereon
6. Payment of dividend on preference shares
7. Payment of statutory dues for employees
8. Depositing money 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 are 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.

Note: Private companies have been exempted from the applicability under Section 43, the private companies are at  liberty to structure their share capital as they are not required to comply with Section 43 of the Companies Act, 2013.