Mumbai: A decision by India’s Company Law Board, or CLB, this month on differential voting rights, or DVRs, could arm promoters with a minority holding in their companies with a potent tool to fight hostile takeovers.
To use this, a firm will have to issue shares with more voting rights than other shares. This gives shareholders who own these shares with DVRs an ability to control the firm’s decisions that is far in excess of what their economic interest in it would entail. Sometimes called Class A, such shares are commonly issued in other parts of the world. However, grey areas in Indian laws have dissuaded promoters here from using DVRs.
CLB will rule this month on the legality of the use of DVRs by Karamjit Jaiswal of Jagatjit Industries—he used them to fend off a hostile takeover bid from his stepbrothers, Anand Jaiswal and Jagajit Jaiswal, in 2004.
Karamjit Jaiswal and his unlisted firm, LP Jaiswal and Sons Pvt. Ltd, together owned 23.59% (8.59% by Karamjit Jaiswal and 15% by his firm) in liquor firm Jagatjit Industries.
Following an approval by the board and shareholders of Jagatjit, LP Jaiswal and Sons subscribed to 2.5 million shares in Jagatjit Industries, increasing its stake to 19.1% from 15%. However, each of these 2.5 million shares carried 20 voting rights.
Karamjit Jaiswal later acquired around 2.19 million ordinary shares, increasing his stake to 13% from 8.59%. With this, he and LP Jaiswal together owned a combined 32.1% in Jagatjit Industries. However, because of the DVRs of the shares acquired by LP Jaiswal and Sons, this minority holding translated into voting rights of 62%, giving Karamjit Jaiswal complete control over the company as well as the means to fend off any attempt at a hostile takeover.
“Creating different classes of shares will make hostile takeovers more difficult, as acquirers would have to deal with any special rights given to different classes of shareholders,” says Akil Hirani, managing partner of Majumdar and Co., a law firm.
To gain effective control of a company, an acquirer would also have to buy shares with DVRs at a premium, he adds.
Hirani says there are other ways to prevent takeovers, but adds that shares with DVRs are “common internationally”.
However, Indian firms still shy away from issuing shares with DVRs because such shares cannot be listed. Firms prefer to use DVRs for emergencies, to protect against takeovers, or to simply raise money, says a banker who advised Alcan Inc. after Anil Agarwal’s Sterlite Industries Ltd attempted a takeover of Indian Aluminium Co. Ltd (Indal), the American firm’s Indian subsidiary. The banker did not wish to be identified.
In some parts of the world, the governments follow the golden share concept to retain their right while privatizing a public sector undertaking. A golden share is a nominal share that gives the government the right of decisive vote, thus, to veto all other shares in a shareholders’ meeting. The reverse of DVR is seen in Indian private banks where voting rights are capped at 10%, irrespective of one’s shareholding. This means no single entity can have more than 10% voting even if it holds the majority stake. The government has promised to lift the cap and offer voting rights to the stakeholders of private banks in accordance with their shareholding,?but?it hasn’t been done yet.
The issue of shares with DVRs in India can also be challenged.
Anand Jaiswal, who owns 5.84% in Jagatjit Industries, complained to capital markets regulator Securities and Exchange Board of India, or Sebi, and CLB, that Karamjit Jaiswal had violated rules by “hiding” information on the pricing of the shares with DVRs.
A person familiar with the matter, who did not wish to be identified, said Anand Jaiswal had told Sebi and CLB that the shares with DVRs had been acquired at a low cost by Karamjit Jaiswal and his company.
Karamjit Jaiswal, responding to a show cause notice from Sebi, argued the shares were issued in accordance with provisions in the Companies Act.
After its holding in Jagatjit crossed 15%, LP Jaiswal and Sons made an open offer for another 20% in the firm in keeping with Indian law, but Sebi stopped this until CLB determined the legality of shares with DVRs.
CLB is slated to hear the case on 15 May.
Some experts see the case as proof that India’s takeover laws need to be reformed.
The country’s takeover code needs a fundamental overhaul, says Nitin Podar, managing partner of J Sagar and Associates, a law firm that advises companies on mergers and acquisitions, among other issues.
The 1997 takeover code does protect the interests of minority shareholders, but the market regulator should also issue guidelines to protect promoters with low stakes, and DVRs can be used as a weapon by promoters to defend against hostile takeovers, Podar adds.
T.C. Nair, a full-time member of Sebi who investigated Anand Jaiswal’s complaint, says section 86 of the Companies Act permits a firm to issue equity shares with DVRs, subject to conditions prescribed under The Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001.
Under the Companies Act, a firm that has been profitable for three years and which has no default record in filing annual accounts and returns can issue shares with DVRs. The issue has to be approved by shareholders and should not exceed 25% of the total share capital issued. And family-owned businesses can issue shares with DVRs to members of their family.
However, chartered accountant Jayant Thakur of Jayant Thakur and Co., which specializes in securities law, says there are technical difficulties in issuing shares with DVRs with respect to pricing, minority shareholder interest and listing agreements.
Sebi should come out with regulations for issuing shares with DVRs, he adds. But Nair says Sebi does not have the authority to regulate issue of shares with DVRs.
The Jagatjit case, Hirani says, will, therefore, serve as a precedent.