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Non-Inclusion of Differential Voting Rights in the Companies Bill, 2009 Model Synopsis of the Project Work (Content wise) 1. Objectives of the Project Work 2. Introduction 3. Development of the Concept of DVRs and their current position World over: 3.1 3.2 3.3 3.4 3.5 3.6 Unites States Canada France Germany New Zealand United Kingdom

4. Issuing of shares with Differential Voting Rights in India 5. CLB Ruling on Superior Voting Rights Issue 6. Change in SEBIs Stand 7. Advantages and Disadvantages of issue of DVRs: 7.1 7.2 8. Conclusion Bibliography Advantages Disadvantages

MODEL PROJECT WORK (TO BE FOLLOWED BY EVERY STUDENT)

DECLARATION I hereby declare that the research project entitled Non-inclusion of Differential Rights in the Companies Bill, 2009 is a record of the individual research carried out by me under the supervision of (Faculty name). This has not been submitted by me for the award of any Diploma, Degree or other similar title to this or any other University.

Date: Place:

Signature of the student

List of Cases referred in the work (based on the cases referred alphabetically to be arranged)

1. Objectives of the Project Work: (1). To examine the backgrounder under which the Bill has been

proposed. (2). 2. To examine the scope of the Bill and provide a critical evaluation. INTRODUCTION:

Shareholding pattern has assumed great significance in the modern era with a number of instrumental changes happening in the way issuing of shares is being done. Company being a separate legal entity is characterized by separation of management from the ownership.1 The line of strict distinction between ownership and control has blurred over the years and the shareholder has been gradually reduced from an owner in the company to someone who is merely entitled to profits, i.e., dividends and other consequential benefits. The right to vote is an inherent right of the shareholders which signifies their overall supervisory powers and ultimately, control over the actions of the company. It helps them steer the management to act in the interest of the company. In India, the Companies Act, 1956 classifies shares into two kinds: equity and preference shares. Every member of a company limited by shares and holding any equity share capital shall have a right to vote.2 This is proportionate to the number of shares held. But the concept of Oneshare, one-vote slowly began to undergo dilution with the management wanting more control to ward off hostile takeovers, which were becoming recurrent. The era of globalisation and privatisation led us into an era of sweeping changes like never before. The urge to retain control demanded innovative ways of handling issue of shares. Keeping this objective in mind, an Expert study on establishment of New Stock Exchange was set up in 1991 under the chairmanship of Mr. M.J.
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Solomon v. Solomon & Co Ltd, [1895-99] All ER 33 (HL) Section 87, Companies Act, 1956

Phewani. The Committee proposed that the dividend-paying companies having a track-record of dividend payments in the preceding two years and/or in four out of five years or five out of seven years can issue nonvoting shares (hereinafter referred to as NVS) i.e., certain shares without the incidental right to vote.3 The provision for NVS found its place in the Companies Bill 1993 and 19974 with the condition that such shares shall not exceed 25% of the issued share capital with voting rights.5 This was also made subject to terms and conditions prescribed by the Central Government from time to time. But these bills could not see the light of the day. Unsuccessful attempts at enacting a new Companies Act forced the government to amend the existing Companies Act, 1956 to incorporate the concept of Differential Voting rights (hereinafter referred to as DVRs). S. 2(46) A provides that shares may be issued with DVRs in accordance with the provisions of s.86. The Companies Act Amendment of 2000 altered the s. 86 to now add a new class of equity shares which may be issued with differential rights as to dividend, voting or otherwise in accordance with such rules and subject to such conditions as may be prescribed. The inclusion of the aforementioned shares with DVRs meant that s. 88 which prohibited the issue of shares with disproportionate rights had to be repealed.6 To give effect to the new provision of 86(a) (ii), the Department of Company Affairs came up with the Companies (Issue of Share Capital with DVRs) Rules, 20017. These rules govern the issue of

Roy, Souvik & Kumar, Akarshan, Differential Voting Rights:A Necessity or A Burden, <http://www.taxmann.com/datafolder/Flash/flashart6-8-09_5.pdf> 4 Mukherjee, Arindam, No act of Corporate Democracy, Outlook India Online, September 1, 1997, < http://www.outlookindia.com/article.aspx?204143>, (Last visited on September 14, 2009) 5 Shares minus voting, The Hindu Financial Daily, January 11, 2001, <http://www.hindu.com/businessline/2001/01/11/stories/041118mo.htm>, (Last visited on 14 th September, 2009) 6 Vide the Companies (Amendment ) Act, 2000 (53 of 2000) 7 Notification SO 167(E) dated 09-03-2001

shares with DVRs and Rule 3 lays down the pre-conditions as well as the duties of a company seeking to issue such shares. percent of the issued share capital. 3. Development of the Concept of DVRs and their Current The rule lays down that the total number of shares with DVRS cannot be more than 25

Position World over: It is very interesting to find that the one share, one vote rule considered as a norm now-days has not always been believed to be so in business history. Reverting back in the sands of time to the days when the East India Company came to India we find that voting rights to the shareholders did not matter much. The Charters outlined the purpose of the corporation. The shareholder was considered just a member of the company rather than an owner, though individuality of shareholders was protected by Anglo-American Common law. The historical moment for One share, One vote rule came in the year 1781 when the Bank of North Americas congressional charter incorporated proportional voting and thus generated a huge controversy.8 But then, it was there to stay. The development of the concept of DVRs began soon as companies entered into the One share, One vote era. This can be traced back to Alexander Hamilton, who in 1791, as the Secretary of the U.S. Treasury thought that the proportionate voting was being misused by the majority shareholders to connive and establish their control at the expense of the interests of the small shareholders. 9To counter the same, he proposed graduated voting rights which were to impose certain checks and balances on unfettered power of landlords, family dynasties and governments, who generally had the major shares. They soon became popular in the U.S. At the same time, proportionate voting continued to make large strides and
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Joshi V., Voting Rights and Corporate Governance, Chartered Secretary, January 2001, . 26-29 Ibid

became very popular.10 By the turn of the nineteenth century, One share, One vote had become a rule world-over. 3.1 United States:

Differential voting rights came to be recognised and known as Dual-Class shares with the passage of time in the U.S, though New York remained an exception to this.11 American Stock Exchange (AMEX) and National Association of Securities Dealers Automated Quotations (NASDAQ) have been more forth-coming with respect to dual-class shares than New York Stock Exchange (NYSE). For more than fifty years, starting from 1926 till 1980s the NYSE refused to list the companies which issued such shares. It was only in 1989 that NYSE in fact changed its stand. Although AMEX had a limitation cap of 1:10 in the favour of the class with superior shares with respect to all matters except election of directors for which the limited voting class of shared was given the ability to elect a minimum of 25% of the Board of Directors.12 AMEX also made sure that no further shares could be issued which may have the effect of further reducing the voting power of the existing shareholders with limited voting rights. The NASDAQ Exchange is considered the most liberal of the three and chooses not to discriminate between the different classes. The prevalence of different regimes within the U.S. has led to a general consensus among the experts about plutocratic nature of the American companies. A dual-class company is generally characterised by the management and other insiders holding the superior voting shares in higher proportion.13 This is also achieved in other ways, for e.g., by issue of one class of
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Ratner, The Government of Business Corporations: Critical Reflections on the Rule of One Share, One Vote, 56 Cornell L.Rev. 1 (1970). 11 Gompers, et.al, Extreme Governance: An analysis of dual-class firms in the United States, The Harvard Business School Rev Finance. Stud., 2009,< http://www.hbs.edu/units/am/pdf/dual.pdf> (Last visited on 19th September, 2009) (hereinafter Gompers, Extreme Governance); La Porta,et.al, Legal determinants of external finance, 52 J. Fin. 1131 (1997) 12 Sinhala, V.R. & Singh, V., Differential Voting Rights Shares: Tracing the Genesis of Chaos, SEBI and Corporate Laws, April27- May 3, 2009, Vole 91, p.119a 13 Gompers et al, Incentives vs. Control: An analysis of U.S. Dual-class companies, December 2003, <www.nber.org/papers/w10240>,(Last visited on 19 th September, 2009)

shares with no dividend but having very high voting rights. On other hand, people holding the second type of shares are divested of their voting rights in lieu of higher dividends. The dual class companies are also said to be associated with agency costs that have an adverse effect on the financial health of the company. Under the agency cost theory, managers are 'agents' for the shareholders.14. The relationship between the shareholders and managers of a corporation perfectly fits the definition of a pure agency relationship.15 Because both parties are utility maximizers, the interests of each party do not always correspond. The deviations in the utility functions create agency costs, which have been defined as the sum of the monitoring expenditures by the principal,...the bonding expenditures by the agent, [and] ....the residual loss....16 transaction costs, Agency costs include contracting costs, costs, and information costs. moral-hazard

Traditionally, agency costs have been contained through external and internal monitoring mechanisms, such as the voting rights that attach to certain common shares. Therefore, unbundling the voting rights and profit claims has potentially significant consequences on the level of agency costs.17 3.2 Canada:

Canada started issuing shares with differential rights towards the last quarter of the 20th century.18 The issuing of shares with DVRs requires the approval from minority shareholders in the sense that the resolution for the same has to be passed by a simple majority of the shareholders who

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Daniel, R. Fischer, the Corporate Governance Movement, 35 Vend. L. Rev. 1259,1262-65 (1982) Michael Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305, 308 (1976). 16 Ibid 17 Douglas H. Blair et al., Unbundling the Voting Rights and Profit Claims of Common Shares, 97 J. Pol. Econ. 420, 422-23 (1989). 18 The Role of the Stock Market in Corporate Governance, The Fraser Institute, <http://oldfraser.lexi.net/publications/books/gamble/chapter2.html>, (Last visited on 19th September, 2009)

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have less than 20% of the voting rights and only then the Toronto Stock Exchange (TSE) lists the companys shares. Despite having the essential safeguards, there has been active resistance against the dual-share regime, led by the Canadian Coalition on Good Governance that consists of a number of leading institutional investors who have combined assets worth more than $400 billions.
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This impact

of this opposition is discernable from the fact that a number of companies have done away with differential shares citing commitment to better Corporate Governance practices that have come to guide the corporate sector. 3.3 France:

Historically, it can be seen that corporate charters provided an upper limit on the number of votes which can be vast by a shareholders and a lower limit on the number of shares that can be held. In the early 20 th century, shares with more votes became prominent and were used as a tool of defence against takeovers. As France was going through a bad phase economically and there was shortage of capital, protectionism in the form of insider control was used as an instrument to save the management being passed to foreign hands.20 The provision has its negative impacts too but it served the needs of the time. Multiple voting shares are common in France today21 and the companies generally grant two votes for every share, as long as they have been held for at least two consecutive years and this period can be extended to four years for

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Kai Li, et al, Do Voting Rights affect Institutional Investment Decisions: Evidence from Dual class firm, August 2007, available on <https://www.cicbv.ca/UserFiles/File/pdf/Do%20Voting%20Rights%20Affect%20Institutional%20Investment %20Decisions.pdf>,(Last visited 19th September, 2009) 20 Konczyk, Muriel, Big changes in ownership structures: Multiple votes in Interwar France, October 2006, <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=944808 > , (Last visited on 19th September, 2009) 21 Adams R., Ferreira R, One Share-One Vote: The Empirical Evidence, Review of Finance (2008) 12: 5191, < http://www.business.uq.edu.au/download/attachments/18415929/AdamsFerreira_RofF.pdf>, (Last visited on 18th September, 2009)

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publicly trading these shares.22 They have become such an integral part of the system in France that they are treated as ordinary shares and are not classified under a special category. 3.4 Germany:

Germany has the normal One share-One vote regime since 1884 when the Company Law underwent a complete overhaul in the country. 23 But this was not an absolute rule. An option was also given to companies to issue shares limiting voting rights in the desired ways. But the option was withdrawn when owing to long time demands and pressure for one voteone share rule, Germany abolished multiple voting shares in the 1998 Schroeders KontraG Law.24 The European Council (EC) has long aspired for a European harmonization of the field of takeovers, seeing it as a sine qua non for the attainment of its broader objective, i.e. the creation of an integrated capital market by 2010. It has faced a stumbling block in the form of German opposition for issuing a common Takeover Directive to members of the EC. Germany wants a one share one vote system to create equal conditions across the EU.25 Germany has argued that the level playing field would be unfair as other members like France have shares with multiple votes.26

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R. A. I. Van Frederikslust et al., Corporate governance and Corporate Finance: A European Perspective, <http://books.google.co.in/books?id=XoD9J7QQ9dAC&pg=PA177&lpg=PA177&dq=france+%2B+dual+class +shares&source=bl&ots=lJ52jndyKF&sig=onk6t3M1Ph0EMFTZ_A68s7KvM-s&hl=en&ei=JanSq7AKZTG6QOek5ShBg&sa=X&oi=book_result&ct=result&resnum=3#v=onepage&q=france%20%2B%20 dual%20class%20shares&f=false>,(Last visited on 18th September, 2009) 23 Sinha V.R. and Singh V., Differential Voting Rights Shares: Tracing the Genesis of Chaos, SEBI and Corporate Laws, April27- May 3, 2009, Vol 91, p.119 24 Ehrhard O. et al., Unifications of Dual-Class Shares in Germany - First Empirical Evidence on Liquidity Effects of Share Class Unifications. Swiss Finance Institute Research Paper No. 06-12; 21st Australasian Finance and Banking Conference 2008 Paper. Available at SSRN: <http://ssrn.com/abstract=677000>, (Last visited on 19th September, 2009) 25 New EU takeover Directive needs to address concerns before adoption, The Finance Magazine, September 2009, < http://www.finance-magazine.com/display_article.php?i=2389&pi=104> , (Last visited on 18th September, 2009) 26 Cioffi, J. , Restructuring Germany Including.: The Politics of Company and Takeover Law Reform in Germany and the European Union, Law & Policy , Vol. 24, No. 4, pp. 355-402 (2002),

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Germany wants to prevent hostile takeover of its giant corporations, and feels particularly vulnerable having abolished multiple voting shares.27 3.5 New Zealand:

The law in New Zealand as regards to the differential voting shares is quite similar to Germany. S. 37 of the New Zealand Companies Act, 1993 allows companies to issue different kinds of shares carrying special limited or conditional voting rights subject to the constitution of the company. 3.6 United Kingdom:

The London Stock Exchange permits the issue of shares with differential voting rights like that of other European nations like France, Italy, etc. The options available to the entrepreneur explain for a number of companies with varying capital and voting structures.28 The shareholder voting rights are undergoing a rethink wherein the U.K. minister responsible for London's financial centre, Paul Myners, has suggested that shareholders should be able to buy and sell their voting rights which according to him, would elevate them to the owners of the company and not just traders. The proposal has been criticised vehemently by asset managers as opposed to democracy and the principles of corporate governance.29 4. Issuing of shares with Differential Voting Rights in India

After the amendment of s.86 of the Companies Act in 2000 to include the provision for DVRs, they were issued in India, by TATA Motors in

Clift, Ben, The Political Economy of the Market for Corporate control in France and the Hamstrung Harmonisation of European (and French) Corporate Governance, GARNET Working Paper: No 3008 ,January 2008, < http://www.garnet-eu.org/fileadmin/documents/working_papers/3008.pdf> , (Last visited on 18 th September, 2009) 28 Brecht, M. & Mayer, C., Corporate Governance in Europe: Competition versus Harmonization, <http://www.sbs.ox.ac.uk/NR/rdonlyres/0B017B7F-BAE4-4242-BA9E941954BEEF29/2961/CorporateGovernanceinEurope4.pdf> , (Last visited on 17th September, 2009) 29 Shareholder Voting Gets Rethink in U.K, The Wall Street Journal, August 10, 2009,< http://online.wsj.com/article/SB124984880909817763.html> , (Last visited on 17th September, 2009)

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November, 2008 for the first time ever by a listed company. TATA had issued 6.4 crore such shares as per a part of the repayment of its loan for Jaguar-Land Rover acquisition.30 The DVR shares were priced at Rs. 305 per share as against Rs. 340 for an ordinary share. Moreover, the dividend paid on the DVR shares was to be 6% which was much more the 1% payable on the ordinary shares.31 Pantaloons Retail also issued DVR shares with their bonus issue in February, 2009 but they made a very innovative use of a provision for the shares with differential shares by not issuing these shares differently but by offering one bonus share for every ten ordinary equity shares.32 It can be seen that the DVR shares were used here to attract more capital from the public by using such shares as sops rather than an instrument of consolidating power by the insiders. Even a cursory glance at the stock market trading of such shares shows that the investor community lacks the knowledge about DVRs at present. They do not seem to have the sufficient maturity or vision to appreciate them. The fact that only 5427 shares with DVRs issued by TATA Motors were traded on BSE of the huge numbers issued33 is an indicator of that they were not be popularised so that they could have been used more often by the investor community for their good. On the other hand, Pantaloons saw hectic trading of its shares with DVRs which stood to the tune of 23.05 lakhs in 2009.34 But as mentioned above, this is due to the fact that they were not traded separately from the ordinary shares. They
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Tania Kishore Jaleel, IFCI offloads 4% Tata Motors DVR shares, The Hindu Business Line, Mumbai, September 1, 2009, < http://www.thehindubusinessline.com/2009/09/01/stories/2009090151701000.htm> , (Last visited on 14th September, 2009) 31 S. Hamsini Amritha, Differential Voting Rights, The Hindu Business Line, October 5, 2008, < http://www.thehindubusinessline.com/iw/2008/10/05/stories/2008100550501300.htm>, (Last visited on 14 th September, 2009) 32 Pantaloon Offers bonus DVR shares, The Indian Express, Bombay, July 25, 2008, available on http://www.indianexpress.com/news/pantaloon-offers-dvr-bonus-shares/340185/ 33 Tania Kishore Jaleel, Differential Voting Rights trading remains dull, The Hindu Business Line, Mumbai, July 2, 2009, <http://www.thehindubusinessline.com/2009/07/02/stories/2009070251771200.htm >, (Last visited on 14th September, 2009) 34 Ibid

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were offered as a bonus instead and hence this does not reflect the voluntary trading based on sufficient knowledge/information/willingness/foresight of the buyer and cannot be used to base any conclusion about the impact of shares with DVRs on the Indian market. This can also be partially attributed to disinterest of the institutional shareholders in such shares who institutional investors care more about the capital gains. Even otherwise, they have not been able to buy such shares even otherwise, because of restriction clause on trading such shares in their charters. Until that clause is removed, they cant buy such shares.35 Also, the companies with sound business ethics and a pre-existing control over the management generally confident of taking decisions on its own and without any threat of takeover will be very reluctant to use such instruments that may be detrimental to the hard-earned goodwill in the economy and drive away institutional investors.36 5. CLB Ruling on Superior Voting Rights Issue:

The use of shares with DVRS to exercise control has already begun in India. In Anand Pershad Jaiswal and Ors v. Jagatjit Industries Ltd. and Ors37 the first case of its kind, before Company Law Board, the The promoters were issued shares with 20 voting rights per share which enabled them to exercise complete control over the company. preferential allotment of new shares with superior voting rights had increased their voting rights to around 64% though the economic stake increased merely by a little more than 8 percent from 23.59% to around 32% . This was initially challenged before SEBI by the rival groups
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Will Differential Voting Rights Work in India, Economic Times, May 30, 2008,< http://economictimes.indiatimes.com/Markets/Stocks/ViewsRecommendations/Will_differential_voting_rights_ work_in_India/articleshow/3084229.cms > 36 Carleton Willard T et al., The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAA-CREF, Journal of Finance 53, 1998, 1335-1362. 37 MANU/CL/0002/2009; Order No. WTM/TCN/01 /CFD/ APRIL /08, April 8, 2008, also available on <www.sebi.gov.in/cmorder/jagatjitorder.pdf >, (Last visited on 17th September, 2009)

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contending foul play in pricing of shares and the fact that approval for the same was not acquired from the stock exchanges. SEBI found itself incompetent to decide the matter citing the fact that Section 86 of the Companies Act does not come under Section 55A which enumerates the powers exercisable by SEBI on companies. The petitioners then moved the Company Law Board praying for declaration of the resolution approving such differential voting rights as bad in law and hence null and void. The contention was negated by the CLB. The issue of shares with DVRs was upheld as valid as being in accordance with the Articles of Association of the Company and provisions of the Companies Act. The Company was directed to buyback the entire shareholding of the two petitioner groups for a total consideration of Rs. 36, 50, 00,000/- to be paid to each Group. The said shares were ordered to be converted into physical form and tendered to the Company for buy back as a consequence thereof the share capital of the company stood reduced and the Company was exempted from compliance under Section 100 of the Companies Act, 1956. The CLB also observed that since the shares were being bought back by the Company from the existing promoters as part of a settlement between them, in the circumstances, the parties were exempted from complying with the provisions of Section 77A, the provisions of SEBI (Buyback of Securities) Regulations, 1988, SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 1997 and any other applicable Regulations and provisions of the Companies Act. 6. Change in SEBIs Stand:

As a counter measure to disable companies to imitate the above model by changing share structure, SEBI prohibited public listed companies from issuing shares with superior voting rights or dividends by letter dated July 21, 2009 addressed to all stock exchanges. The letter entails the amendment of the Listing Agreement ensuring compliance with the

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directions of SEBI. This has created more uncertainty as a deadline for bringing the shares with DVRs on par with other shares has not been provided. The companies which have already issued such shares may in fact also contend only prospective operation of the direction since it does not address this point. The SEBI should clarify its position. With its latest move, SEBI has come a full circle on this matter. Earlier this year in February, SEBI had inserted clause 8.3.5.238 in SEBI (Disclosure and Investor) Protection Guidelines, 2000 popularly known as DIP Guidelines which allowed listing of equity shares with differential rights without making an initial public offer for the same. This did not last long. Then came the CLB ruling in March. The SEBIs move to ban issue of votes with superior rights has been seen as a response to the CLB ruling in Anand Pershad Jaiswal case. The said letter dated 21st July was written in pursuance of SEBI Board Meeting on Primary Market reforms chaired by Mr. M.S. Verma on June 18, 2009 which had decided to do away with different class of equity shares in light of the increased focus on corporate governance of late. SEBI has also issued the new SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 replacing DIP Guidelines, 2000 this September. The new regulations do not have an analogous provision to Clause 8.3.5.2 that had allowed a company to list equity shares with DVRs. This has followed SEBI (Delisting of Equity Shares) Regulations 2009 that replaced Delisting Guidelines in June.
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8.3.5.2 Application by a listed company for listing of equity shares with differential rights as to dividend, voting or otherwise. 8.3.5.2.1 A listed company may make an application to the Board for relaxation from applicability of clause (b) to sub-rule (2) of Rule 19 of the Securities Contracts (Regulation) Rules, 1957 for listing of its equity shares with differential rights as to dividend, voting or otherwise, without making an initial public offer of such equity shares, if it satisfies the following conditions: i. issue of such equity shares are made to all the existing shareholders as on record date by way of rights or bonus; ii. the issuer is in compliance with the conditions of minimum public shareholding requirement with reference to the equity shares already listed and the equity shares with differential rights proposed to be listed; iii. the issuer undertakes to disclose the shareholding pattern of the equity shares with differential rights separately under clause 35 of the Equity Listing Agreement.

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Barring the decision to insert clause 8.3.5.2 in DIP Guidelines, 2000 the other moves seem to be compatible with the Companies Bill, 2000 introduced in Lok Sabha on 3rd August, 2009. The current bill i.e. Companies Bill, 2009 akin to the Companies Bill, 2008 that lapsed after dissolution of Lok Sabha before General Elections, 2009 does not contemplate different class of shares with varying votes or dividends. 7. Advantages and Disadvantages of issue of DVRs:
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7.1. Advantages: Experts have not come to a consensus on a single motivating factor world-wide40, which prompted the move to come up with this concept, though the control factor is generally believed to be the driving force.41 The fact that attempts of hostile takeover can be checked through the shares with disproportionate votes us one of the prime reasons42 for enacting such a provision as acquisition, merger and takeover activities began to dominate the corporate sector post 1991. When a company issues shares without voting rights, it tries to balance the negation of suffrage by offering them shares at a discounted price with higher dividends.43 This has a positive impact on the minority shareholders. As an implication, voting rights also get accumulated with fewer shareholders thereby making the supervision of voting simpler and easier to monitor. The responsibility of the managements actions can be

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Clause 37 of The Companies Bill, 2009 laying down the different kinds of share capital does not make a provision for issuing of shares with Differential Rights unlike S.86 of the Companies Act, 1956. 40 Mandelbaum A., Departure from One Share- One Vote Rule: An Overview and Some Lessons from New Zealand, (1995) 10 (2) Journal of Intl Banking Law 56-61 [hereinafter Mandelbaum, Departure from One Share-One Vote Rule] 41 Bennedsen, M. and Nielsen, K. The principle of proportional ownership, investor protection and firm value in Western Europe, ECGI Finance Working Paper No. 134/2006. ((2007) 42 H. De Angelo and L.De Angelo, Managerial Ownership of Voting Rights: A Study of Public Corporations with Dual Classes of Common Stock, Journal of Financial Economics 33-69 (1985) [ hereinafter H. De Angelo, Managerial Ownership of Voting Rights]
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Pandya Arnav, Change in Voting Rights, Business Standard, July 9, 2009, <http://www.businessstandard.com/india/storypage.php?autono=326742 >

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fixed on this group of shareholders as they have added accountability which flows from their right to vote.44 It allows the management to leverage the capital structure in a better way as the obligation to pay back the investors is not immediate as compared to the debt instruments.45 It also attracts people to invest in a company as the shares with DVRs have more liquidity in the market than normal shares.46 The structure of the company, at present, generally comprises of widely dispersed shares wherein the minority shareholders do not have a voice. To add to this, there is a general sense of apathy and disinterest prevalent amidst them towards the affairs of the company or management.47 Since the return is low on the meagre investment by them, the desire to probe into the actions of the management is generally missing. The average shareholder also does not have the requisite knowledge and understanding of the issues to take an informed decision so as to really contribute towards a healthy development of the company.48 This may be due to various factors like disinterest and disinclination, as mentioned above, and also because of paucity of time, other engagements, etc. The costs and the cumbersome process involved in attending the Annual General Meetings outweigh the benefits and thus, such an exercise is not worth the effort for a small shareholder. Though proxy voting and postal ballots are options available in the alternative, the lack of knowledge about the same as well as a general reluctance to use them coupled with associated expenses ensure that such shareholders maintain a general attitude of indifference. In this light, the issue of shares with differential rights is aimed to entice small prospective investors to buy such shares.
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Mandelbaum, Departure from One Share-One Vote Rule, supra note 42 Chandra Shekhar Y., Differential Shares: More Room for maneuver, Corporate Finance, Vol IV, ICFAI University Press, , p.11 46 Forester S.R. & Porter D.C., Dual Class shares: Are there return Differences, 20(6) Journal of Business Finance and Accounting 893-903 (1993) 47 Supra note 20 48 Srinivas, Srikanth, Changing Voting Rights, Business World, (June 13, 2008), available on <http://www.businessworld.in/index.php/Columns/Changing-Voting-Rites.html >

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7.2

Disadvantages:

The creation of a group of shareholders with no powers to interfere in the working of the management renders the promoters and directors more likely to misuse the powers conferred on them to further their vested interests. This has been the major reason for opposition for the disproportionate shares.49Critics have labelled such a provision validating disproportionate powers to different shareholders as a major hindrance to Corporate Governance,50 which has come to dominate the subject today catapulted by a string of scams like Enron, Worldcom ,Satyam etc. that has dented the confidence of shareholders like never before. The existing shareholders are placed at a disadvantage in terms of dividends. Moreover, since the shareholders cannot be assumed to be rational, this also brings confusion and uncertainty in the market which may disturb the equity shareholding. The existing shareholders are forced to undertake exercises to keep themselves informed about the different capital structures the company may adopt. The institutional investors are also subjected to prudence standards unlike individual investors51 and are generally not able to buy such shares owing to prohibition on restrictions on such shares in their charters. The Agency costs in the case of companies which go for differential shares have been found to be in great excess to those companies which do not. The studies conducted based on U.S. Companies as discussed above elucidate such hypothesis and provides a rational for the same.
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Mandelbaum, Departure from One Share-One Vote Rule, supra note 42 La Porta, R.,et al.. Investor protection and Corporate Valuation, Journal of Finance, 57, 11471170 (2002); Morck, R.,Wolfenzon, D. & Yeung, B, Corporate governance, economic entrenchment, and growth, Journal of Economic Literature 43, 657722. (2005); Davies Arnold Cooper LLP, To vote or not to vote - Lord Myners' latest suggestion to break out of the current approach to shareholder engagement, Digest, 28 August 2009, <http://www.dac.co.uk/documents/resources/newsletters/To_vote_or_not_to_vote__Lord_Myners%27_latest_suggestion_to_break_out_of_the_current_approach_to_shareholder_engagement__Digest> 51 Del Guercio, Diane, The distorting effect of the prudent-man laws on institutional equity investments, Journal of Financial Economics 40, 31-62. (1996)

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Hostile Takeovers, though considered parasitic and negative to the shareholders of the target company, may sometime prove to be a blessing in disguise. The increase in power and autonomy of the management may cause the company in becoming complacent or inefficient which might in turn lead to poor utilisation of resources of the existing management and hence the company can use the threat of hostile takeover as a garb to hide its own inefficiency, corruption, collusion and other vested interests, detrimental to the interests of the general well-being of the company. In such instances, hostile takeover will serve as a welcome change that can turn the fortunes of the company for the better, freeing-up the locked assets in the target company through efficient management of resources ultimately benefitting the shareholders.52 There seems to be a prolonged holding of shares of the superior class by the group that acquires them initially. Empirical evidence shows that dual class shares especially those with superior voting rights are less traded, .Gompers et al. find that about 85% of firms in their dual-class sample have at least one class of shares that is not traded. 53 This is because of the fact that once the people buy such shares, generally the management and promoters, they tend to sit with them. 8. Conclusion: The move towards abolishment of the system of differential voting lines in the Companies Bill, 2009 is conspicuous from its absence in clauses 37and 41(1)(b) that provide for the kinds of share capital and voting power respectively. The interest of the minority and outside shareholders is one of the biggest concerns driving the move for the removal of shares with differential rights. But the DVRs do not go against the minority shareholders in all cases. As explained above in detail, the concept of

52 53

H. De Angelo, Managerial Ownership of Voting Rights, supra note 44 Gompers, Extreme Governance, supra note 13

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differential voting rights has been used in a positive manner to better Corporate Governance in countries like Germany and France. Shares with DVRs has not been frequently issued by listed companies ever since the provision was inducted through an amendment to Section 86 of the Companies Act in 2000. The two listed companies, namely Tata Motors and Pantaloons, have not resorted to issuing shares with superior voting rights that may due to the apprehension that shares with superior voting rights may adversely impact on its corporate governance ratings and as a mark of commitment to business ethics. The companies may also feel that such a move might create confusion in the market and drive away prospective investors and hence discourage investment from general public, institutional investors, creditors alike. The reasons for the listed companies for not issuing DVRs is general may vary from lack of knowledge about such innovative use, less expectations for investment from public as exemplified by the meagre trading of such shares of Tata Motors that has been attributed to the immaturity of the market, widespread ignorance and disinterest in complex instruments amidst the common investor; and reluctance to change the present capital structure. Post-Satyam there is an increased debate on corporate democracy with renewed focus on accountability and transparency in the affairs of the Companies. But to impose a blanket ban on DVRS will send a message that the Indian economy is inflexible and does not adapt itself with changing times and needs. The shares with superior voting right of course present a great challenge to the corporate governance ideals and have been rightly prohibited. It is imperative that the Companies Bill, 2009 should not in entirety ban the issue of shares with differential votes but improvise upon the same. Different measure have been adopted as checks and balances in countries like Canada and the U.S. to make sure that these do not become an instrument for abuse and circumvention of

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the provisions safeguarding the interests of the mass investor community. On the lines of Canada, the issuing of shares with DVRs may be made subject to approval from minority shareholders and in this way, the smaller shareholders will also have a say in the issue of such shares. Even the superior voting rights can be retained with a cap on the total number of votes per share and the number of shares that can be issued in proportion to the number of equity shares which may be five in both cases. The provision could also debar the persons who are already holding shares in excess of say, 20 per cent, of the existing share capital from subscribing to shares with superior votes. Such a provision will check the ulterior motive behind issuing such shares as it includes the Rawlsion concern for maximum advantage to the least privileged. The inclusion of shares with DVRs vide an amendment in 2000 was a step in the right direction. It indicates progress and maturity of the securities market and should not be undone by putting a total prohibition on shares with DVRs as is indicative from the Companies Bill, 2009. The lacunae can be rectified by making changes on the lines suggested above that shall serve the purpose of plugging the gaps that exist at present. Removal of a forward-looking concept itself in its entirety rather than facing the resultant consequences and challenges that stand in its way to success is reflective of the lack of will and hesitation on the part of the lawmakers. The position needs to be reappreciated with changes to the relevant clauses of the bill to include differential voting rights qualified in a way so as to extend maximum benefits and choice to the shareholders without leaving a scope for misuse/abuse.

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