Companies in India are primarily incorporated either as private companies or as public companies under the Companies Act, 2013 (the "Companies Act"). Private companies have a limit of 200 shareholders (other than current and past employees) and provide for share transfer restrictions in their articles of association. Public companies can be either unlisted or listed on one or more Indian stock exchanges. The Companies Act also provides for the formation of "one person companies" which, as the name suggests, cannot have any external investments.
Whilst there are no express qualification criteria for shareholders under the Companies Act, Indian and foreign residents are subject to separate requirements in connection with their investments in Indian companies. All Indian investors, and in certain cases even foreign investors, are required to have permanent account numbers (PAN) in India for tax reporting purposes. All foreign equity investments into India need to comply with the Indian foreign investment rules laid out by the central government and administered by the Reserve Bank of India (RBI). For instance, following a rule change introduced in 2020, investments from any entity which is itself, or whose beneficial owner is, based in a country which shares a land border with India (eg, China, Pakistan and Bangladesh), will require prior government approval.
Foreign investors need to be mindful of relevant sector-specific restrictions and other requirements under Indian foreign investment laws. Furthermore, whilst investments under the foreign direct investment (FDI) route do not require any prior registration in India, other types of investments (eg, foreign portfolio investments and foreign venture capital investments) are subject to separate eligibility and registration requirements.
All investments in listed companies are subject to the regulations of the Securities Exchange Board of India (SEBI). All listed companies and unlisted public companies are required to issue securities only in de-materialised form. Accordingly, investors seeking to invest in such companies are required to open accounts with Indian depository participants (commonly referred to as "demat accounts").
There are two main classes of shares issued by Indian companies, equity shares and preference shares. Equity shares can be further classified into equity shares with normal voting or dividend rights and equity shares with differential rights as to dividend, voting or as otherwise prescribed. Preference shares can be further classified based on their associated rights (ie, convertibility into equity shares, participation in surplus funds, assets and profits, and cumulative nature of dividend payable).
In general, private companies have greater flexibility compared to public companies in having shares of different classes as part of their share capital. In relation to listed companies, whilst there is a general prohibition on issuing shares with superior rights vis-à-vis rights associated with shares that are already listed, SEBI has approved a framework permitting "tech companies" with shares of differential voting rights to go in for an initial public offering.
Whilst equity shareholders are entitled to vote on all matters, unless otherwise provided, preference shareholders are entitled to vote only on matters which either directly affect their rights or relate to the winding up of the company. However, preference shareholders are entitled to a priority over equity shareholders with respect to payment of dividend and repayment of share capital.
Shareholders’ rights are primarily dealt with under the Companies Act (along with additional rules, circulars and notifications issued) and the articles of association of the concerned company. In addition to the Companies Act and the articles of association, in the case of listed companies, the relevant SEBI regulations also have a bearing on shareholders’ rights, mainly:
In addition, foreign shareholders need to be mindful of sector-specific requirements under Indian foreign investment laws and the relevant sector-related legislations (eg, in certain sectors such as aviation and insurance (except insurance intermediaries), effective ownership and control, including board composition, is required to be in Indian hands at all times).
In general, all equity shareholders of an Indian company are entitled to vote on shareholder matters at general meetings or in postal ballots and receive dividends as and when they are declared.
Subject to the company’s constitutional documents and the specific terms of the instrument, the rights attached to a class of shares may be varied with the written consent of the shareholders holding not less than three quarters of the issued shares of that class, or by means of a "special resolution" (ie, requiring affirmative approval of at least three quarters of the votes cast) passed at a separate meeting of the shareholders of the issued shares of that class. Any such variation of shareholders’ rights will need to be disclosed in a filing to be made with the Registrar of Companies, which is publicly accessible.
Since the constitutional documents and agreements entered into by a company are expressly subject to the provisions of the Companies Act, none of the statutory rights of shareholders can be derogated from by way of constitutional documents or agreements; in the event of any such inconsistency, the corresponding provisions under the relevant constitutional documents and/or agreements would be rendered void. For the sake of clarity, constitutional documents and/or agreements can impose a stricter set of requirements (ie, compared to those statutorily prescribed) on the shareholders as well as the company.
It is common for shareholders in Indian companies to enter into shareholders’/joint venture agreements to record their respective rights and obligations. In order to bolster the enforceability of such arrangements, it is common practice and recommended for the key provisions under such arrangements to be expressly incorporated in the articles of association of the underlying companies.
Where listed companies are concerned, consistent with the requirement under the LODR Regulations mandating all shareholders of the same class to be treated equally, as part of the listing process, companies are usually required to ensure that any shareholders’/joint venture agreements are terminated and that any special rights in favour of certain shareholders under the articles of association are deleted (or significantly pruned down) as a pre-condition to listing. Whilst there are instances of shareholders’/joint venture agreements and articles of association incorporating special rights in favour of certain shareholders in the context of listed companies, these arrangements are increasingly prone to regulatory scrutiny.
Whilst many shareholder-level matters in an Indian company can be approved by way of an "ordinary resolution" (ie, requiring affirmative approval of more than 50% of the votes cast), certain matters under the Companies Act and the LODR Regulations require the approval of a "special resolution" (see 1.4 Main Shareholders' Rights). Therefore, a shareholder holding more than 25% of the shares in a company can effectively block any special resolutions tabled for shareholder approval. Examples of special resolution matters include any alteration of the constitutional documents (other than with respect to authorised share capital), variation of shareholders’ rights, substantial borrowings and disposals in the context of a public company, reduction in share capital, buy-back of securities exceeding 10% of the paid-up capital and free reserves, issuance of debentures convertible into shares, removal of auditors and striking off/winding up of a company.
The specified thresholds for the exercise of certain other key minority protection rights are:
Shareholders are statutorily entitled to have access to and inspect certain records of the company, including the constitutional documents, audited financial statements, statutory registers and minutes books of shareholders’ meetings. In addition, in the case of unlisted companies, shareholders’/joint venture agreements can provide additional information and inspection rights to the shareholders.
As a general matter, the board of directors of a company (the "Board") is entitled to exercise all such powers and to do all such things that the company is authorised to do. However, the approval of the shareholders of the company is mandatorily required in respect of matters such as:
In the case of closely held companies, the approval of the shareholders will need to be obtained by way of ordinary or special resolutions, as relevant, passed at a duly convened general meeting of the shareholders. In the case of listed companies and public companies with more than 1,000 shareholders, in order to ensure wider participation, shareholders are required to be provided with remote electronic voting facility to vote on all shareholders’ resolutions. In addition, listed companies, as well as other public companies having more than 200 shareholders, are required to ensure that certain specified matters are approved by way of a postal ballot conducted amongst the shareholders, or alternatively, at a physical meeting subject to the shareholders being provided with electronic voting facility.
Shareholders with at least 10% of the total paid-up share capital in a company are entitled to requisition the Board to call an EGM of the shareholders. The requisition should set out the matters to be considered at this meeting and should be signed and sent to the registered office of the company by the requisitioners. Within 21 days of receiving a valid requisition, the Board should call a meeting, held no more than 45 days after receiving the requisition. In the event the Board does not call such meeting, the requisitioners can call and hold the meeting themselves within three months of making a valid requisition, in the same manner in which a meeting is called and held by the Board.
The company is required to give notice to the shareholders of any proposed resolutions which are intended to be passed at the requisitioned meeting and to circulate a statement, if any, with respect to the matters referred to in the proposed resolutions.
A company is required to provide the shareholders with 21 clear days' notice when calling a general meeting of the shareholders. A general meeting of the shareholders may be called at shorter notice (even on the same day of the notice), provided that in the case of an annual general meeting (AGM), the consent of at least 95% of the shareholders entitled to vote is obtained prior to such meeting, and, in case of any other general meeting, the consent of the majority of shareholders entitled to vote and representing at least 95% of the paid-up share capital is obtained prior to such meeting. The notice of the meeting should specify the place, date, day and hour of the meeting and contain a statement of the business to be transacted at such meeting. The notice and consents for shorter notice may be provided either in writing or in electronic form.
Whilst in the normal course of operations the minimum quorum is required to be present in person at the venue of the shareholders’ meeting, in light of the COVID-19 pandemic, annual general meetings to be held in the calendar year 2020, and extraordinary general meetings proposed to be held before 31 December 2020, have been permitted to be conducted virtually (ie, without requiring the personal presence of any of the members) using video conferencing or other audio-visual means.
Resolutions which are put to vote at a general meeting of the shareholders are decided on a show of hands, unless a poll is demanded or voting takes place through electronic means. Every listed company and every other company having not less than 1,000 shareholders is required to provide its shareholders with an electronic voting facility. In such cases, the company will need to make sure that the notice to the meeting indicates the process and manner of voting by electronic means, including details of the members’ login IDs, the manner of generating/receiving the passwords and the time schedule for casting of the votes.
Shareholders who are entitled to attend and vote at general meetings are also entitled to appoint another person as a proxy who will attend and vote at the general meeting on the shareholder’s behalf. In cases where the meeting is conducted using video conferencing or other audio-visual means, the shareholder will not be entitled to appoint a proxy.
As for the quorum requirements, two shareholders personally present shall constitute the quorum in the case of a private company. In the case of a public company:
If the quorum requirement is not met within 30 minutes of the time appointed for the general meeting, the meeting shall stand adjourned to the same day in the following week, at the same time and place (or such other time and place as the Board may decide). However, in the case of a meeting called by requisitioners, if the quorum is not met within 30 minutes of the time appointed for the requisitioned meeting, the requisitioned meeting would stand cancelled, without adjournment. If, at the adjourned meeting, the quorum requirement is not met within 30 minutes of the time appointed, the shareholders present will constitute the quorum.
As a general rule, no items of business other than those specified in the notice can be taken up at a shareholders’ meeting. Therefore, whilst shareholders can specify the matters to be considered at any meeting to be requisitioned by them, once a notice has been issued, no further amendments can be made unless a fresh notice of 21 clear days is issued.
It is common for shareholders in closely held companies to seek a right to participate in the management of the company (ie, by nominating the CEO, CFO and other key managerial personnel) and additionally have nominees on the company’s Board. These rights are invariably provided for in shareholders’/joint venture agreements, and are incorporated in the articles of association of the relevant company. In the case of a private company, subject to having facilitating provisions in the articles of association, the nomination of the relevant key managerial personnel or director nominees by the concerned shareholder could itself serve to complete the appointment.
In some cases, this nomination would need to be followed by resolutions to be passed by the Board and/or shareholders to complete the appointment. Regarding Board appointments, the Board could initially appoint the person as an additional director, whose term would extend until the next AGM of the shareholders at which meeting the shareholders could approve his or her appointment.
As for nomination of key managerial personnel and directors in listed companies, if at all, such rights are provided only to controlling or significant shareholders as part of shareholders’/joint venture agreements and the articles of association of the concerned company. Technically, the Companies Act provides for listed companies to have one director elected by "small shareholders" (ie, shareholders holding shares having a nominal value of no more than INR20,000 each), subject to receiving a notice to that effect from 1,000 small shareholders or 10% of the total number of small shareholders, whichever is lower.
In practice, however, instances of these appointments are limited, and any such efforts are likely to be resisted by the company. For example, in July 2017, Unifi Capital Private Limited, a minority institutional investor, along with other small shareholders, sought the appointment of a small shareholders’ director on the board of Alembic Limited. This request was rejected by Alembic Limited on the ground that many of the small shareholders were connected to certain large shareholders and that therefore the proposal defeated the intent of electing a small shareholders’ director.
Directors are usually appointed to the Board only with the approval of the shareholders at a general meeting; however, additional and alternate directors may be appointed by the Board for a limited term, if so authorised by the articles of association of the company. Similarly, a director may be removed from the Board before the expiry of their term, after being provided with a reasonable opportunity of being heard, by way of a resolution passed at a general meeting of the shareholders.
If the shareholders of a company decide to remove a director, a special notice (ie, a notice signed by shareholders having at least 1% of the total voting power, or having shares on which an aggregate amount of at least INR500,000 has been paid up) will need to be issued to the company regarding the proposed removal of a director. Immediately following receipt of the special notice, the company is required to provide all shareholders with notice of the resolution prior to holding the general meeting where the resolution is to be given effect.
Shareholders constituting the specified threshold can challenge a decision or action taken by the Board as part of oppression and mismanagement proceedings or class action proceedings (see 3.2 Legal Remedies Against the Company). However, in these proceedings, the shareholders seeking to challenge the Board’s decision or action will have a relatively high bar to clear.
In oppression and mismanagement proceedings, the shareholders will need to satisfy the NCLT that the company’s affairs have been conducted in a manner which is either prejudicial or oppressive to the members or prejudicial to public interest or the interests of the company, but that to wind up the company would unfairly prejudice such members. In the case of class action proceedings, the shareholders will need to establish the Board’s decision or action is either contrary to its constitutional documents, any applicable law or any resolution passed by the members, or based on the suppression of material facts or on any misstatements made.
The shareholders of a company have the right to approve the appointment of an auditor at an AGM for a term of five consecutive years at a time. An auditor may be removed before the expiry of their term, after being provided with a reasonable opportunity of being heard, with the prior approval of the central government. A resolution approving such removal will need to be passed at a general meeting of the shareholders within 60 days of the receipt of the approval of the central government.
Whilst there is no obligation for shareholders of unlisted companies to disclose their interests in the company, under the Companies Act, every company is required to file an annual return with the Registrar of Companies within 60 days from the date of the AGM, including, amongst other matters, details of the shareholders of the company and any changes since the close of the previous financial year.
In cases where a shareholder holds shares in a company for the beneficial interest of another person, both the registered shareholder and the beneficial interest holder are required to make separate declarations in respect of the creation of beneficial interest (and any changes thereto) to the company. In addition, the Companies Act requires every significant beneficial owner in a company (ie, an individual holding ultimate beneficial interest of at least 10% or exercising significant influence or control in the company other than only through direct holdings) to make a declaration to that effect (and any changes thereto) to the company. In both cases, the company is then required to disclose such information in relation to the beneficial interest or significant beneficial ownership to the Registrar of Companies.
For shareholding in listed companies, there are disclosure requirements under separate regulations of SEBI:
SEBI Substantial Acquisition of Shares and Takeovers Regulations, 2011 (the Takeover Regulations)
An acquirer who, together with any persons acting in concert either acquires 5% or more of the shares or voting rights in a listed company, or, having acquired 5% or more, acquires or disposes more than 2% of the total shares or voting rights in a listed company, is required to make a public disclosure to the relevant Indian stock exchanges and the company itself. The Takeover Regulations also include annual disclosure obligations for "promoters" (persons who are considered to have "control" over the listed company’s affairs as per Indian law) as well as persons holding 25% or more of the voting rights in the listed company.
SEBI Prohibition of Insider Trading Regulations, 2015 (the Insider Trading Regulations)
Every promoter group member, key managerial person and director of a listed company is required to make an initial disclosure in relation to their respective shareholding in the company at the time of appointment, and further disclosures as and when they acquire or dispose of securities whose aggregate traded value is in excess of INR1 million during any calendar quarter. In each case, the disclosures under the Insider Trading Regulations need to be made by the concerned person to the listed company in the first instance, and then onwards by the company to the relevant Indian stock exchanges.
Every listed company is required to disclose its shareholding pattern, including shareholding details of the promoters and of every person who holds 1% or more in the company, on a quarterly basis to the relevant Indian stock exchanges.
Shareholders are entitled to grant security interest over their shares held in Indian companies. However, if the shareholder is a foreign resident, security interest can be granted only in limited circumstances, eg, either to secure the credit facilities extended by an Indian bank or a non-banking financial company to the Indian company in which the shares are held, or to secure the credit facilities extended by an overseas bank to an overseas group company.
If the shareholder providing the security is an Indian company, the security interest must be registered by filing with the Registrar of Companies. Furthermore, if the security interest is in relation to shares of a listed company, the encumbrance is treated as an acquisition (and any release of the encumbrance as a disposal), which would trigger the disclosure obligations under the Takeover Regulations outlined above, see 1.14 Disclosure of Shareholders' Interests in the Company.
The ability of a shareholder to dispose of shares in an Indian company is subject to the terms of any shareholders’/joint venture agreement and the articles of association of the relevant company. As per the Companies Act, the right to transfer shares in a private company is restricted by its articles of association. In relation to a public company, whilst the securities of a company are required to be freely transferable, the Companies Act expressly clarifies that share transfer arrangements (eg, pre-emption provisions, drag-along/tag-along requirements, etc) are contractually enforceable between shareholders. In order to bolster the enforceability of such share transfer restrictions under shareholders’/joint venture agreements, it is common practice, and also recommended, for such provisions to be expressly incorporated in the articles of association of the underlying companies.
For foreign investors investing under the FDI route, their ability to transfer shares to Indian residents is restricted by the foreign investment rules. Importantly, the consideration for any such transfer cannot exceed the fair value of the shares, which is to be determined as per any internationally accepted methodology in the case of unlisted shares, and based on the prevailing market price in case of listed shares. Any put option in the hands of the foreign investor can be exercised only after a minimum lock-in period of one year (or any higher sector-specific lock-in period) and cannot provide for an assured return to the foreign investor.
As per the Insolvency and Bankruptcy Code, 2016 (IBC), in case of a corporate default, only a financial creditor (ie, any person to whom a financial debt is owed by the company), an operational creditor (ie, any person to whom an operational debt is owed by the company) or the corporate debtor itself (ie, the company) are entitled to initiate a corporate insolvency resolution process against the company. Therefore, unless a shareholder qualifies as a financial creditor or an operational creditor, it will not be entitled to initiate a corporate insolvency resolution process. However, if the company itself is initiating a corporate insolvency resolution process (ie, against itself), the shareholders of the company will need to pass a special resolution approving the filing of an application to that effect at a general meeting.
In light of the COVID-19 pandemic, creditors and companies are currently restricted from filing applications to initiate corporate insolvency resolution process under the IBC for defaults that occur during the nine-month period (which may be extended to one year) following 25 March 2020.
Separately, under the Companies Act, a petition for the winding up of a company may be presented to the NCLT by any shareholder holding fully paid-up shares in the company. Any such petition will need to be supported by a special resolution passed by the shareholders of the company, or alternatively, the NCLT will need to be satisfied that it is just and equitable for the company to be wound up.
In addition to the minority protection rights and corresponding shareholding thresholds outlined in 1.6 Rights Dependent Upon Percentage of Shares are certain additional legal and regulatory provisions which have a bearing on shareholder activism in India:
Whilst shareholder activism is still a developing concept in India, in recent years, there is a clear trend of enhanced participation of public shareholders in corporate decision making as well as increased scrutiny of corporate proposals of listed companies.
One of the key reasons behind this changing trend is the slew of legal and regulatory measures introduced under the Companies Act and various SEBI-administered regulations. The mandatory electronic/postal ballot voting requirements and the more recent live AGM webcast requirement (for large companies) have facilitated increased shareholder participation and engagement in members’ proceedings. Also, institutional investors like mutual funds, alternative investment funds, insurance companies and pension funds have been expressly tasked by the respective regulators to adopt a stewardship role and play a more active role in the form of monitoring their investments and engaging with investee companies on governance related matters. Further, greater internet penetration has ensured an increase in the participation of retail shareholders as well. The quality and extent of information received by the shareholders has also significantly improved in recent years, aided by the various measures introduced under the Companies Act and the LODR Regulations.
Whilst many of the legal and regulatory changes have contributed to increased shareholder participation and engagement, the introduction of a separate regulatory regime in relation to related party transactions (RPTs) has enabled public shareholders to more directly influence the outcome of shareholder votes. Specifically, the LODR Regulations prohibit all related parties (ie, regardless of their interest in the specific transaction) from voting on any “material” RPTs. The materiality threshold for RPTs is set at 5% of the listed company’s annual consolidated turnover for RPTs involving brand usage and royalty and at 10% of the listed company’s annual consolidated turnover for all other RPTs. The "majority of minority" approval requirement has meant that promoters and management are reliant on public shareholders to approve such material RPTs.
Proxy Advisory Firms
Another key factor contributing to shareholder activism in India in recent years is the role of governance intermediaries, specifically proxy advisory firms. Proxy advisory firms analyse corporate proposals and provide their clients, usually institutional investors, with recommendations on how to vote at shareholder meetings. Small investors are also provided with access to the voting recommendations of the proxy advisory firms, invariably free of charge.
Whilst the proxy advisory industry in India has developed only in the last decade, proxy advisory firms have had a significant influence not only in ensuring more effective shareholder participation, but also in persuading companies to improve the quality of their disclosures. Given their considerable influence, proxy advisory firms are separately regulated by SEBI, which has recently in August 2020 enhanced the compliance requirements to now require proxy advisory firms to, amongst other things, formulate and annually update voting recommendation policies, disclose the methodologies underlying their recommendations, disclose and address any conflicts of interest, share their reports with the clients and the respective companies at the same time and also make sure to publish any comments from the companies as addendums, all with a view to maintain the credibility and independence of such firms. SEBI has clarified that proxy advisory firms must comply with the new requirements with effect from 1 January 2021.
In the recent past, there have been a few notable instances where large companies in India have faced shareholder dissent on a variety of issues, including RPTs, management appointment and remuneration, share issuances and buy-backs, including:
Shareholding in Indian listed companies is usually concentrated in the hands of one or more groups of controlling shareholders who are statutorily referred to as "promoters", with the public shareholding in many companies being restricted to the statutory minimum of 25%. The concentrated nature of the shareholding enables promoters to control the outcome of most matters requiring shareholder approval, including the appointment of the company’s independent directors and management. Until the introduction of the RPT regime, activist shareholders were mostly restricted to exercising the handful of statutory minority protection rights available to them. The various mechanisms or grievance redress provided an avenue for addressing complaints of small shareholders, but again did not facilitate public shareholders taking on a more proactive or combative stance.
The RPT rules have enabled public shareholders to have a decisive say on the outcome of material transactions involving interested parties. Whilst the recommendations of proxy advisory firms on such matters have a significant influence on the voting pattern, such resolutions also provide an avenue for shareholders to collaborate with each other and to persuade management to provide meaningful disclosures explaining the rationale and proposed benefits for the company.
The prevalence of concentrated shareholding in Indian listed companies, allied with the ongoing shareholding disclosure requirements, makes it difficult for third parties to build their stake in a listed company without the concurrence of the promoters. Other factors, such as the mandatory takeover offer rules, which require an open offer to be made when a shareholder crosses 25% or otherwise acquires "control", and the annual "creeping acquisition" facility of up to 5% (10% for the financial year 2020-21 in cases involving a preferential issue by the listed company) available to incumbent controlling shareholders, make hostile takeovers even more difficult.
The instance of Larsen & Toubro Limited (L&T) acquiring a controlling stake in Mindtree Limited (Mindtree) in 2019 without the concurrence of the promoters and the management is a rare occurrence, and one made possible because of the specific circumstances involved, including the diffused nature of the shareholding, the single largest shareholder not being a promoter and the acquirer being an Indian company.
Stake building in a listed company is even more difficult for foreign investors, as Indian foreign investment laws do not allow a foreign party to acquire shares on the floor of an Indian stock exchange unless the party already has a controlling stake in the listed company. Share sales outside the stock exchange mechanism are tax inefficient from the seller’s perspective, and therefore not usually preferred.
The COVID-19 pandemic does not appear to have resulted in any noticeable changes in the strategies or agendas of activist investors thus far. If anything, in cases where the stock prices have fallen significantly, it is the promoters and company-controlled ESOP trusts which seem to have taken advantage of the situation and shored up their holdings.
Whilst there is no specific trend in India in terms of activist shareholders targeting particular industries, sectors or companies with a specific threshold of market capitalisation, as evidenced by the L&T acquisition of Mindtree in 2019, companies with a dispersed shareholding are likely to be more susceptible to hostile takeovers.
As compared to retail shareholders, institutional shareholders, are likely to be more active as shareholder groups in listed companies. Amongst institutional shareholders, whilst foreign portfolio investors, and to a lesser extent domestic mutual funds, are more likely to take an independent view on shareholder matters, institutions owned or controlled by the Government (eg, Life Insurance Corporation of India, General Insurance Corporation of India, etc) have traditionally sided with management on such matters. It is worth noting that domestic mutual funds, which have been expressly tasked with the responsibility of playing an active role in ensuring better governance of listed companies, have come under SEBI’s scanner in the context of "standstill arrangements" entered into by a handful of mutual funds with the promoters of certain cash-strapped companies.
There are also instances of fellow promoters turning against each other, as well as against the company’s management. Recent examples include Mr Cyrus Mistry’s firms initiating oppression and mismanagement proceedings following his dismissal as the Chairman of Tata Sons Limited in October 2016, the change of CEO and the Board of Infosys Limited in August 2017 following disagreements with certain founder promoters, and the ongoing public disagreement between the two promoter groups of Interglobe Aviation Limited, which operates IndiGo Airlines.
There is no reliable publicly available information on the proportion of activist demands which have been met in full/part.
If an open offer is triggered under the Takeover Regulations, the ability of the Board or the management to frustrate the acquisition is limited. The Board is expressly required to ensure that the company’s business is "conducted in the ordinary course consistent with past practice" during the offer period, and also to secure approval by way of a special resolution of the shareholders by postal ballot in connection with matters including material disposals and borrowings, share issuances and buy-backs, and execution, amendment and termination of material contracts. In the recent L&T acquisition of Mindtree, the Board declared an unusually high dividend pay-out to shareholders after the open offer had been triggered, though it did not prevent L&T from successfully completing the acquisition.
For other instances of shareholder activism, companies are increasingly resorting to proactive and constructive engagement with the activist shareholders to address their concerns to the extent possible. For instance, in August 2014, a majority of the shareholders of Siemens Limited voted against the proposal to sell its metals technologies business to a wholly owned subsidiary of its parent company on the basis of the valuation being significantly low. Siemens Limited subsequently provided further disclosures and revised the terms of the transaction to be more favourable to the listed company, following which, in November 2014, the shareholders voted in favour of the revised proposal.
Another instance, in May 2014, saw the shareholders of Tata Motors Limited initially vote against the payment of excessive remuneration to three executive directors during a year in which the company had reported standalone losses. Following additional disclosures and explanations by the company, the resolution was eventually approved when it was tabled before the shareholders again in January 2015.
More recently, in September 2018, the minority shareholders of Apollo Tyres Limited voted down the re-appointment of the company’s promoter as the managing director of the company, on the basis of the remuneration being excessive. Again, following the company’s engagement with the institutional investors and a significant reduction in the promoter’s remuneration, the re-appointment was eventually approved by the shareholders.
It is a well settled principle under Indian company law that a company is a separate legal personality, distinct from its shareholders.
Set out below are a few legal remedies available to the shareholders against the company under the Companies Act.
Oppression and mismanagement proceedings can be initiated before the NCLT by:
The NCLT is vested with wide powers to issue such orders as it considers appropriate in such proceedings, including in relation to regulation of the company’s affairs, purchase of the company’s shares, restrictions on share allotments and transfers, removal of or termination of agreements with the company’s management or other persons, and setting aside third-party contracts.
Class action proceedings can be initiated before the NCLT by:
The remedies available to the shareholders by way of a class action suit initiated before the NCLT include restraining the company from acting in a manner that is contrary to its constitutional documents, any applicable law or any resolution passed by the members, and claiming damages or compensation from the company, directors, auditors and/or third parties for any wrongful acts or any incorrect and misleading statements.
The shareholders of a company can pass a special resolution to approach the NCLT to initiate the process of winding up the company.
In addition to seeking statutory remedies against a company’s directors as part of any class action proceedings (see 3.2 Legal Remedies Against the Company), shareholders holding 10% of the paid-up share capital of the company can also convene an EGM to seek the removal of any director. The director concerned can be removed by passing an ordinary resolution (or special resolution in the case of an independent director appointed for a second term) after being provided with a reasonable opportunity of being heard.
As part of any oppression and mismanagement proceedings (see 3.2 Legal Remedies Against the Company), the shareholders can seek remedies against other shareholders, including in relation to transfer of the shares held by such other shareholders in the company.
In addition to seeking statutory remedies against a company’s auditors as part of any class action proceedings (see 3.2 Legal Remedies Against the Company), shareholders holding 10% of the paid-up share capital of the company can convene an EGM to seek the removal of the company’s auditor. The auditor can be removed by passing a special resolution after being provided with a reasonable opportunity of being heard, and subject to obtaining the approval of the central government.
As part of any class action proceedings (see 3.2 Legal Remedies Against the Company), shareholders can bring derivative actions against third parties for any wrongful acts or any incorrect and misleading statements.
In addition to class action proceedings under the Companies Act, a shareholder’s right to initiate other derivative actions on behalf of a company has been recognised under case law. In any derivative action, the concerned shareholders are required to ensure they act with bona fide intent on behalf of the company, not as a personal cause of action, and establish there is no other remedy available.
In practice, shareholders in India have very rarely invoked derivative actions on behalf of companies. Apart from litigation in India being a very time-consuming process, unlike in other jurisdictions where such derivative actions are commonplace, lawyers in India are prohibited from charging contingency fees, resulting in the absence of an active plaintiff bar which can initiate such actions on behalf of shareholders. There are other procedural hurdles, including court fees and stamp duty liability, which make it even more difficult and inefficient for shareholders to initiate derivative actions.
Whilst class action proceedings and other derivative actions have rarely been used in India, oppression and mismanagement proceedings are more common, not least owing to the remedy being long established in the statute book. However, the relatively high statutory threshold required to initiate a claim, as well as the substantive requirements to justify its invocation, makes it more suited to closely-held companies and less relevant to large listed companies with small shareholders.
In cases where the investment is accompanied by a share purchase or subscription agreement and/or a shareholders’/joint venture agreement, investors routinely choose to enforce their rights by way of arbitration, preferably in an offshore venue in order to avoid interference by Indian courts. Daiichi Sankyo's proceedings against the former promoters of Ranbaxy Laboratories Limited is a good example of an international investor successfully pursuing its rights in arbitration.
There are instances of foreign shareholders in Indian companies resorting to other remedies to address their claims. Indian companies listed overseas have faced class actions suits in other jurisdictions from the holders of the underlying depository receipts. Foreign shareholders in listed Indian companies controlled by the Indian Government have the option of pursuing their remedies under the provisions of the bilateral investment treaties entered into by India, a prominent example being the proceedings initiated by the UK-based hedge fund, The Children’s Investment Fund Management, with respect to its stake in Coal India Limited.
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Delisting and Takeover Offers in a Falling Market
As with most major stock markets across the world, the outbreak of the COVID-19 pandemic led to a market crash in India resulting in the stocks of several listed companies touching multi-year lows. Whilst the benchmark BSE Sensex and NIFTY 50 indices have since recovered from their record lows, certain sectors – especially those directly impacted by the lockdowns and consequent fall in consumer spending – have yet to see any meaningful recovery. The volatility in the stock prices has seen renewed buying interest, particularly from well capitalised controlling shareholders and financial investors.
This article explores the various challenges in undertaking delisting and hostile takeover offers in India. As we explain below, whilst a falling market incentivises incremental shareholding increases by incumbent controlling shareholders and negotiated acquisitions/control changes in listed companies, the various ground realities and statutory limitations make it difficult either for an incumbent controlling shareholder to voluntarily delist the company or for a third-party acquirer to complete a hostile takeover offer.
Shareholding and voting rights in Indian listed companies – a brief primer
The statutory rights and obligations of shareholders in listed Indian companies broadly correspond to four shareholding levels – 25%, 50%, 75% and 90%:
An acquirer who comes to acquire more than 25% of the shareholding in a listed company is assured of the ability to block all shareholder matters which require the approval of a “special resolution” (ie, not less than three quarters' majority of the votes cast). Further, once an acquirer acquires, or agrees to acquire, 25% or more of the shares or voting rights (or “control”, whether directly or indirectly, by any other means) in a listed company, the acquirer is required to mandatorily make an open offer for a further 26% shareholding in the company and also comes to be categorised as a “promoter”.
Once a shareholder comes to hold more than 50% of the shareholding in a listed company, with the exception of related party transactions, it would be able to pass all other “ordinary resolution” matters (ie, which need only a simple majority of the votes cast) on its own, without requiring the support of any of the public shareholders of the company. Since the list of “ordinary resolution” matters also includes appointment and removal of directors, a shareholder having a simple majority is also assured of the ability to effectively control the board composition of the listed entity.
Since listed companies are required to have a minimum public float of 25%, controlling shareholders/promoters are capped at 75% in terms of their shareholding. With a 75% shareholding (or even at lower shareholding levels, given that the approval requirements are based on the votes cast and not the total outstanding shares), a controlling shareholder/promoter can approve virtually all shareholder-level matters (ie, whether requiring ordinary or special resolutions) other than related party transactions.
If an incumbent promoter or third party acquirer intends to delist a company, it would need to acquire adequate shares to end up with a minimum of 90% of the entity. The threshold is also significant given the handful of protective measures which are available to minority shareholders holding 10% or more of the issued capital of a company (eg, requisition shareholder meetings, seek investigation into the company’s affairs, object to schemes of compromise/arrangement and initiate oppression and mismanagement proceedings).
Voluntary delisting offers – some recent interest but significant hurdles remain
The fall in stock prices over the past few months, particularly in the case of companies whose intrinsic value and long-term outlook remain strong, has prompted promoters of listed entities to review the possibility of taking the scrips off the market by launching voluntary delisting offers under the regulations issued by the Securities and Exchange Board of India (SEBI) in this regard. Vedanta Limited, Hexaware Technologies Limited and Adani Power Limited are a few prominent examples of companies whose promoters have launched delisting offers in recent months. However, as explained below, voluntary delisting in India is far from being a straight forward affair.
Board and shareholder approvals
Any delisting proposal, which can be initiated by either an incumbent promoter or a third-party acquirer, requires the approvals of the board of directors as well as the shareholders of the listed entity. As for the board of directors, the SEBI regulations impose an express obligation on the board to certify that the “delisting is in the interest of the shareholders”. Therefore, whilst a promoter or third-party acquirer may initiate the delisting process at a time when the stock prices are more favourable, the board is obligated to analyse and opine as to whether it is indeed in the interest of the public shareholders. Having said that, it is worth noting that the level of responsibility on the board in the context of a delisting offer is lower as compared to a takeover context, where a committee of independent directors is required to provide “reasoned recommendations” on the open offer.
Once the board approval comes through, the shareholders are required to approve the delisting proposal by way a special resolution (by three-fourths majority), subject to at least two-thirds of the total number of votes cast by public shareholders being in favour of the resolution. Given the “majority of minority” approval requirement, the promoter/acquirer has very little say in determining the outcome of this process, and a few large non-promoter shareholders could potentially defeat the shareholders’ resolution. In the past, SEBI has pulled up promoters who have attempted to engage with “friendly shareholders” in an effort to influence the delisting process. Two such recent examples in 2020 include SEBI censuring the promoters of AstraZeneca Pharma India Limited and in a separate instance, the promoters of ECE Industries Limited being required to settle the matter with SEBI, both cases involving collusion with shareholder groups in order to influence the exit price during their respective delisting processes.
A promoter/third-party acquirer proposing to launch a delisting offer has no basis to estimate the exit price prior to launching the offer. The SEBI regulations prescribe only a floor price, but provide for the exit price to be “discovered” through a reverse book-building (RBB) process, a concept which is unique to India. Under the RBB process, whilst the promoter/acquirer can provide an indicative offer price, the actual bidding price is left to the wisdom of the individual shareholders. In the absence of any price band or cap, the RBB process often runs the risk of being influenced by arbitrageurs and shareholders groups who may place bids at unreasonably high levels, thus effectively thwarting the price discovery process.
The promoter/acquirer concerned would only have the option of either accepting or rejecting the exit price. If the promoter/acquirer chooses to accept the exit price, it would be required to purchase at the exit price (or higher, if it deems fit) all the shares of the company which have been tendered at or below the exit price, subject to the shareholding of the promoter/acquirer increasing to 90% of the total issued shares. Following an amendment in 2018, the promoter/acquirer is also entitled make a counter offer to the public shareholders in case it is not happy with the price discovered through the RBB process, subject to the counter offer price not being less than the book value of the company’s shares. This change effectively provides the promoter/acquirer with one more chance to try and make the delisting offer successful.
However, even if the counter offer price offered by the promoter/acquirer is attractive to some of the public shareholders, given the “all or nothing” nature of the delisting process, the promoter/acquirer would necessarily need to have acquired a minimum 90% of the total issued shares for the offer to be successful. Rather tellingly, there have been no instances where this counter offer option has been used to date. By way of practical guidance, in the recent example of the delisting proposal in INEOS Styrolution India Limited in July 2020, the promoters simply rejected the exit price discovered through the RBB process and also chose not to make a counter offer.
Challenges in “squeezing out” remaining minority shareholders
Another consideration that weighs heavily in the context of a delisting exercise is the absence of a reliable “squeeze-out” mechanism to purchase any remaining shares held by the public shareholders following a delisting. Whilst the public shareholders are entitled (at their option) to tender their securities at the exit price for a further period of at least one year from the date of delisting, there is no corresponding facility for the promoters/third-party acquirers. The Indian Companies Act, 2013, does have a provision for purchase of the minority shareholding by a shareholder who holds 90% or more of the issued equity share capital, but that provision only facilitates a squeeze-out and does not mandatorily require the minority shareholders to sell their shares to the promoter/acquirer.
Indeed, in order to effect any such squeeze-out, the company and the promoters/acquirers concerned will need to pursue one of two options, both of which require applications to the National Company Law Tribunal (the NCLT): either (i) the company buying out shares of the public shareholders through a selective capital reduction exercise, or (ii) the promoters/acquirers acquiring the remaining shares held by the minority shareholders as part of a scheme of compromise or arrangement.
Whilst the second route, which was recently introduced in February 2020, provides a basis for the majority shareholder to directly make an offer to acquire the minority shareholders (ie, as opposed to a selective capital reduction exercise, in which the majority shareholder is necessarily reliant on the target company having sufficient funds), the success of the exercise is still subject to the NCLT being convinced that the offer is reasonable as well as the risk of objections and appeals from the minority shareholders.
Takeover offers – a regime not really conducive to opportunistic hostile takeovers
The downturn in the stock market in March and April of 2020 also prompted fears of “opportunistic takeovers/acquisitions” of Indian companies by foreign acquirers, specifically from China, a country with which India has ongoing border and trade hostilities. Accordingly, a few months back, the Government of India introduced an amendment to the foreign direct investment (FDI) regime, requiring investors who are themselves, or whose beneficial owners are, based in a country which shares a land border with India (eg, China, Pakistan and Bangladesh) to seek the government’s approval prior to making any investments in India. The approval requirement is framed in broad terms and extends to both primary infusions as well as secondary share transfers in listed and unlisted companies alike, and regardless of whether or not investors from these jurisdictions have existing holdings in India.
There is ambiguity on a number of aspects relating to the amendment, including as to how the term “beneficial owner” is to be construed and whether there is any shareholding threshold (eg, 10% or 25%) to be used to determine such beneficial ownership. The Government of India is expected to issue clarifications on some of these aspects but, as of October 2020, it has not yet done so.
In any event, in the context of listed companies, the risk of opportunistic hostile takeovers, whilst existing on paper, seems somewhat exaggerated in light of the various associated practical and statutory constraints, as explained below. Not surprisingly, none of the open offers announced since the market downturn in March 2020 has involved a hostile takeover.
Concentration of shareholding with promoters
Unlike in developed markets such as the USA and the UK, the shareholding in most Indian listed companies tend to be significantly concentrated in the hands of the promoters. In several cases, the promoters hold the entire 75% non-public shareholding or a significant portion thereof. Whilst there was a government proposal in 2019 to increase the minimum public float from 25% to 35%, there has been no progress on that count to date.
The instance of Larsen & Toubro Limited acquiring a controlling stake in Mindtree Limited in 2019 without the concurrence of the promoters and the management was indeed a rare occurrence, and one made possible because of the specific circumstances involved, including the diffused nature of the shareholding, the single largest shareholder not being a promoter and the acquirer being an Indian company.
Shareholders who hold in excess of 25% are also entitled to further fortify their position by making “creeping acquisitions” of up to 5% in any financial year, without triggering a further open offer. In view of the overall capital shortage following the outbreak of the pandemic, this limit has been increased to 10% for the current financial year in respect of any primary issuance made by a listed company.
Challenges associated with stake building by third parties
SEBI’s takeover regulations mandate public disclosures to be made by any shareholder who comes to acquire 5% or more in a listed company, and subsequently whenever there is a change of more than 2% in its shareholding. Further, the shareholding details of all shareholders who hold 1% or more at the end of a quarter are publicly disclosed by the listed entity as part of its shareholding pattern. Accordingly, it is difficult for a third-party acquirer to discreetly build its stake in a listed entity without either alerting the promoters or having an effect on the stock price.
Foreign investors are faced with a further hurdle in the form of the foreign investment rules, which do not permit on-market acquisitions under the foreign direct investment (FDI) route unless the acquirer is already in control of the listed entity. As a result, foreign investors investing under the FDI route are initially constrained to acquire shares by way of private arrangements outside the stock exchange mechanism, but since such off-market sales are tax inefficient from the seller’s perspective, they are usually not preferred. The other alternative available to foreign investors, subject to fulfilling the relevant eligibility criteria, is to secure a registration with SEBI as a foreign portfolio investor (FPI).
Whilst an FPI registration would enable the investor to buy and sell securities on the floor of the stock exchanges, it would require the investor to ensure that its shareholding in any company remains below 10% at all times, failing which it would be categorised as an FDI investor, together with all the attendant purchase and pricing restrictions.
Mandatory open offer requirements
As mentioned above, any acquisition, or agreement to acquire, a stake in 25% or more of the shares or voting rights (or “control”, whether directly or indirectly, by any other means) in a listed Indian entity would trigger a requirement to make a “mandatory open offer” to acquire a minimum of a further 26% stake in the listed entity. Also, unless 100% of the open offer consideration (assuming full acceptance of the open offer) is deposited in escrow, the acquirer will be required to first complete the acquisition under the open offer, before it can acquire shares under the agreement which triggers the open offer. Further, there are very limited grounds (eg, refusal of statutory approvals) on which an open offer can be withdrawn after it is announced.
Whilst as a technical matter, SEBI’s takeover regulations permit the withdrawal of an open offer on other grounds (ie, subject to such conditions being mentioned in the triggering share purchase agreement and being outside the acquirer’s reasonable control), in practice, SEBI does not usually allow withdrawal of an open offer other than due to refusal of statutory approvals.
Therefore, in the normal course, an acquirer intending to make an open offer will need to be prepared to acquire at least a majority stake in the listed entity (ie, 25% under the triggering acquisition and up to 26% under the resulting open offer). Accordingly, if an incumbent promoter holds a significant stake in the listed entity, unless such promoter is prepared to cede or share control, an incoming acquirer is unlikely to be left with sufficient shares to acquire. In the case of a hostile takeover offer, whilst the board of directors and management will need to adopt a neutral stance, the promoter could also potentially make a counter offer, either by itself or by combing forces with other third parties.
It is also worth noting that if, as a result of the triggering acquisition and open offer, the total public float were to reduce below 25%, the acquirer would need to ensure that the total non-public shareholding is reduced to 75% or below within 12 months. Given the time bound nature of this obligation as also the limitations imposed by SEBI on the methods which can be adopted to reinstate the minimum public float, acquirers are often constrained to sell their shares at a discount to the original purchase price.
Due diligence access
In a hostile takeover offer, the acquirer is unlikely to have due diligence access from the company. Whilst the acquirer can access all the publicly available information and the quality and reliability of such information has indeed improved over the years, this would still not serve as a substitute for inside information which can be accessed by undertaking a focussed diligence exercise.
As it happens, SEBI’s insider trading regulations expressly contemplate the company facilitating such a diligence exercise and sharing unpublished price sensitive information in the context of a transaction triggering an open offer, subject to the board of directors being convinced that the sharing of information with the potential acquirer is in the best interests of the company.
As explained above, delisting offers in India are associated with various risks and uncertainties, particularly in relation to process, pricing and the lack of a reliable squeeze-out mechanism. Whilst unlike in the case of a takeover offer, a promoter could “test the waters” by initiating a delisting offer (ie, on the basis that it could walk away from the offer if the board/shareholders’ approval does not come through or the discovered exit price is too high), a speculative offer could potentially send mixed messages to the market as also serve as a distraction for the company and its management. In deciding on an indicative offer price in a delisting proposal, promoters would do well to take into account not only the prevailing stock prices but also the stock prices over a historical period.
In the case of promoters who hold less than the maximum permissible 75% non-public interest, a falling market presents an opportunity to shore up their shareholding using the creeping acquisition route by either making opportunistic market purchases (subject, of course, to compliance with SEBI’s insider trading regulations) or, if necessary, infusing funds into the company and subscribing to a primary issuance. By making such incremental acquisitions, the promoter would also ensure that it is left with fewer shares to acquire in any future delisting offer (ie, if the promoter already owns 75%, it would need to acquire only 15% more in order to successfully delist the company).
SEBI’s legal regime, which makes it difficult for promoters to delist a company, comes to the incumbents’ rescue in the face of potential hostile takeover bids. Allied with the general trend of concentration of shareholding in the hands of promoters, SEBI’s ongoing disclosure thresholds, mandatory takeover offer regulations and insider trading regulations make it far more efficient for third parties to pursue negotiated acquisition/control deals with incumbent promoters (ie, as opposed to exploring hostile takeover bids). Indeed, as part of a negotiated acquisition from the promoters, a third-party acquirer could explore a consolidated delisting and takeover offer, with the only caveat being that even if the delisting offer fails, the acquirer would still need to complete the takeover offer.
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