Board Seat With 1 Share?
Mannapuram's investors are a lucky lot. Not all of them. Only a select few that enjoy special rights! A long list of very special rights accorded to 5 investors including private equity funds who hold between them approximately 22% of Mannapuram.
As long as AAIA and Hudson hold 1% of the company's share capital they each hold the right to appoint one Director on Board. Same applies to Barings & Sequoia. GHIOF is the luckiest. Even ownership of a single share gives it the right to appoint a Director on Board Mannapuram. This disproportionate Board representation amounts to Board control as together they constitute 5 of the not more than 12 Directors the Board can have, including a Chairman with no casting vote.
Except GHIOF, each investor will have representation in each Board committee- that means pretty much the entire committee will constitute of these investors' directors. And yes, both the AAIA and Hudson Directors must be present to constitute the quorom of 5 in board meetings and general shareholder meetings. By the way, the two Barings and Sequoia Directors do not carry any liability and the company has promised to protect them against any charges or proceedings.
Wait there's more! Hudson and AAIA enjoy a long list of affirmative rights covering 24 items. That means for everything, from marketing agreements to acquisitions, approval of annual business plan to capital structure changes, employment terms of key managerial personnel to related party transactions- Mannapuram needs written consent or an affirmative vote of these 2 investors.
The transfer of more than 3% shares by the promoters needs the prior written consent of AAIA and Hudson...they also have the right of first sale, of first offer and tag along rights. Barings and Sequoia have enforced a one year lock in on promoter shares, starting 14th march 2012.
There's lots more but I'll end by saying that if AAIA and Hudson choose to exit, the amended Articles make it the company's obligation to facilitate the exit via a secondary offering or private placement.
Why are some investors more special than other? Are such differential rights allowed in a listed company and do these special investors effectively control Mannapuram through their many affirmative rights? Siddharth Shah of Nishith Desai Associates and Vivek Gupta of BMR Advisors join me to talk about this.
Below is an edited transcript of the discussion.
Doshi: I will start with you first Siddharth. This matter came up when proxy advisory from IIAS raised it and recommended that shareholders of Mannapuram vote against this amended Article of Association because IIAS says, ‘In a listed entity, giving one set of shareholders certain preferential rights, is inimical to the interest of the other (public) investors.’ What do you make of the fact that is this within the letter of the law, but not within the spirit of the law or is it against the letter of the law and against the spirit of the law, how do you see it?
Shah: Traditionally it was not uncommon for the shareholders, even in case of a public company, to have exhaustive affirmative rights and what we call vetos or negative control rights. However, obviously as the law evolved, the regulatory mindset evolved. We have seen SEBI and especially the Exchanges growing more and more conservative and more I would say sensitive to the idea of special rights being created for certain set of shareholders and that is something, which we have been experiencing every time. You take a company public and clear direction coming in from the exchanges to dilute or do away with a lot of shareholders rights and that has been the position when it comes to a company which is going in for a listing.
Doshi: If you are cleaning up this stuff when you are about to list, then why shouldn’t the same standard apply during the course of the listed life of a company?
Shah: I agree with the philosophy there and I think that is probably where ultimately the law would evolve in my view.
Gupta: The first thing we have to recognise is at this point in time the law does not enforce an explicit bar on investors who hold these rights. Legalistically, the way I look at these rights is that I divide them into three types of rights.
One is the kinds of rights that relates to transferability of shares. So, these are your rights relating to tax, ROFRs etc. I think the legal argument there could be around Section 111A of the Companies Act to say whether in a public listed company these rights can exist or they can’t exist. If one were to look at the latest judgments on this, I think these rights are recognised by courts and courts say that two independent parties can always transact in a way and can always agree transferability restrictions inter se themselves. In fact an interesting nugget here is that the latest draft of the Companies Bill also seems to accord recognition to these inter shareholder transfer rights and as a specific proviso, which allows recognition of these rights- so these are the first kind of rights. The second kind of right is the affirmatives that you mentioned, which are the negative control rights. There I would legally argue that your Takeover Code already assumes a situation where a specific investor can have negative control rights. We have seen litigation in the form of Subhkam Ventures here. SEBI took a certain view.
The Tribunal took a certain view and then the matter went up to courts and so on. So, one would therefore legally argue that if the very fact that Takeover Code recognizes this itself means that these rights are per se allowed. Now whether it impacts control under the Takeover Code or not is a separate issue. The only kind of rights where I think I have a legal problem is with the third category of rights, which are information rights. So, I think in a public listed company the basic assumption is that every transacting party, every member of the public, every non-promoter shareholder is roughly subjected to the same level of information.
This is sought to be achieved through insider trading regulations and so on. So, information rights in the context of these regulations may get a little tricky, but the first two categories of rights I think are rights that the law itself recognizes could be available to specific shareholders.
So, if I were to look at your question purely legally I would actually argue that there maybe situations where these rights should exist. (interrupted…).
Doshi: In one place in this amended Article of Association, it says that one investor namely GHIOF- some Mauritius-based investor- has the right to appoint a Director on Board even if it holds on share. As long as it holds any shares, it has a right to appoint a Director on Board. I am curious if that right was handed out to all retail investors, we would all have Directors on Boards of companies. So, I think that these rights allow for disproportionate representation on Board, they allow for disproportionate representation in shareholder general meetings and essentially gives this set of investors an unfair amount of large control over the operations of this company as oppose to regular other investors. How can you say that these rights pass muster?
Gupta: I am not making the case that these rights pass muster per se. In every situation one has to see what kind of rights exist and whether they are fair in that situation or not, but who has to make that assessment of whether it is fair or not? I think in a company this judgement has to be made by the company’s shareholders including the promoter shareholders. Now if I am a promoter of a company and I believe and I can convince my minority shareholders that having someone on Board is useful for the company. (interrupted…)
Doshi: The reason why I will interrupt you there is because I know several private equity people have made this argument before that at the end of the day if you have some sort of minority interest being taken care of at the Board level itself that is beneficial to all minority investors, but that is based on the assumption that the interest of a fund or a private equity fund or some Mauritius-based investor is equal to the interest of all minority investors. I am not sure there was always be commonality in all of that, but I will leave that aside. I want to come to the control.
Doshi: Siddharth, what do you make of the fact that there is, I think, almost an every instance whether this company sneezes, coughs, or brushes its teeth it needs the explicit permission of some investor or the other from within this group of five investors and would that amount to control, this is very akin to the Subhkam case, isn’t it?
Shah: That is true and I think as I mentioned unfortunately the position of law never got settled with Subhkam.
Doshi: Yes because the case got withdrawn at the Supreme Court later?
Shah: That is right. Okay, if you purely ask me for the interpretation based on the definition of control and how SAT has interpreted, it clearly demonstrates that for an open offer to be triggered, it has to be something which is a positive control.
Doshi: So, this would not amount to control based on what SAT has said in the Subhkam judgment.
Doshi: Vivek, would you recommend your clients include such a long exhaustive laundry list of rights in such shareholder agreements based on how you have control and whether the SAT judgment prevails or you are saying SEBI could take this matter further?
Gupta: SEBI should take a holistic view based on the fact and circumstances of each case. In this case actually the fact of the matter is that these rights have existed since 2008. At this point in time all that has sought to be done is to extend part of these rights to the two new additional investors who have come in. So, I would imagine that the SEBI or the stock exchanges would have applied their minds already in terms of seeing whether these rights constitute control or not. In so far as the law of the land today is concerned, given that the maximum authority that we have today is the SAT judgment in Subhkam Ventures, it does seem that negative control of this kind does not constitute control and that is what the law of the land today says.
I go further to say that each case should be evaluated by SEBI to see whether in fact there are elements of control or not. I am not in the camp, which says necessarily PEs having additional rights is good or necessarily PEs should not have these special rights. All I say is that it should be left to parties- maybe the promoters take a call and then the minority shareholders vote in a separate resolution to allow or disallow this amendment in the Articles.
Shah: I just wanted to also add one point out here. If you really look at the previous version of the Takeover Code and where the trigger of an open offer was pursuant to a change in control, there was a carve out that if there was a change in control, but if that was approved by the shareholders through a special resolution passed in a postal ballot in those situations it would not tantamount to a change in control.
Doshi: That was a whitewash and that whitewash has been taken away in the new takeover code.
Shah: At some level, I know the new Code does not provide for this provision and in a sense maybe that could change a perspective out here, but if you look at the philosophy there, the same principle that if a shareholder is approving certain change in control or certain rights being given to a shareholder, then to that extent a shareholder is supreme under the corporate jurisprudence. In its all wisdom if they have approved certain rights then to that extent why a change in control should trigger an open offer if the shareholders have accepted that. As Vivek said if there is a mechanism where SEBI can direct that okay if these need to be approved – if it is approved by shareholders other than the interested shareholders, which are promoters in some sense I think then a perspective could be a lot different.
Doshi: Siddharth, what essentially both Vivek and you are saying is it is up to the shareholders. As a final question and in terms of control, but in terms of whether this is fair or not, differential rights to one group of investors. Do you think SEBI or the exchanges would intervene?
Shah: The way I look at it the process going forward can possibly open up an opportunity for an exchange essentially to look at it. SEBI of course, as a securities’ regulator, would always have a right to question, but in the process when the shareholders approve these amendments to the Article- to that extent those amended Articles would need to be filed with the exchanges and in the past we have seen exchanges at times can object to certain provisions of the Article. To what extent – because these provisions already existed since 2008 and nobody has raised an objection- is one way to look at it whether the exchange would just look at it as an extension of those rights.
Doshi: And to be fair, the most offensive ones have existed since 2008, the ones that have been introduced now by virtue of those two new investors are fairly standard ones- all they say in these important matters, the matters will be approved by the Board first before the company makes any decision, which in itself is not a bad thing; it doesn’t accord special rights. So, the new rights that are being tagged on are not as offensive as the existing rights and nobody raised any objection to the existing rights.
Shah: That maybe one way in which an exchange could look at it. The only other way possible and we need to see how it really unfolds is because since 2009, they did not - directly in respect of dealing with these issues, but shares with differential rights or any manner in which share issued, which create superior rights in favour of any person- if they extend the same philosophy and try to look at it whether it is in the compliance with the spirit of a listing agreement, that maybe one opportunity for the Exchange to really examine these rights from the perspective of whether it creates differential rights in favour of different set of shareholders.