SEBI has recently notified certain amendments to the SEBI (Listing Obligations and Disclosure Requirements) Regulations (Listing Regulations) which expressly recognise the grant of special rights in listed companies to certain shareholders, while also mandating certain guardrails in the form of disclosure and approval requirements. The safeguards introduced by SEBI serve to ensure equitable treatment of all shareholders, especially from the perspective of public shareholders. However, the amendments also bring to the fore a few discrepancies in the overall regime in relation to special rights in Indian listed companies.
Acknowledgement of special rights
It is common practice for promoters and even other shareholders to have certain special rights in listed companies. Such rights typically include board and management nomination rights as well as quorum and approval rights in relation to key decisions. From a promoter's perspective, these governance rights ensure closer integration and coordination with the listed company; for financial investors, these rights serve as an effective minority protection tool. For enforceability reasons, such rights are invariably enshrined in the articles of association of the underlying company following the approval of a special resolution (three-fourths majority) of the shareholders. However, the ability to have such rights in listed companies was never expressly recognised – previously, the Listing Regulations had only an oblique reference in the form of a negative covenant for outgoing promoters to not have any special rights in the listed company. Helpfully, the recent amendments as well as the consultation paper released by SEBI which preceded the recent amendments have expressly acknowledged the grant of such special rights.
While SEBI has recognised the prevailing market reality of special rights for certain shareholders, the regulatory position remains unchanged in relation to IPO-bound companies. As a default rule, to ensure parity between the pre-IPO shareholders and the public shareholders participating in the IPO, companies are expected to wipe the slate clean and terminate all special rights (including any existing shareholders' agreements) prior to listing. In several cases, companies have been allowed to include a narrow set of special rights for certain shareholders, albeit with the caveat that such rights can be exercised only after obtaining the approval of the shareholders following the IPO. While the condition requiring shareholders' approval is indeed necessary, the number and nature of special rights are best left to individual companies and should not be a matter of regulatory scrutiny.
Disclosure of shareholders' agreements
As part of the amendments, SEBI has introduced a new disclosure requirement for virtually all inter-se agreements between shareholders relating to the listed entity. While previously the Listing Regulations only specified that such agreements affecting management and control of the listed company are to be disclosed, it did not expressly require disclosure of shareholders' agreements to which the listed company itself was not a party. The new norms have expanded the ambit of disclosure and now mandate disclosure of all agreements, which either impact the management or control of the listed company or impose any restrictions or liabilities upon the listed company. Such agreements will need to be disclosed irrespective of whether the listed company is a party to the agreement (including where the shareholders undertake to influence the actions of the listed company). In cases where the listed company is not a party to the agreement, the contracting parties are now required to notify the listed company within two working days, in order to enable the listed company to make onward disclosures to the stock exchanges.
Given that shareholders' arrangements are usually incorporated in the articles of association of the underlying company, the amendment of the articles would in any case need the approval of the shareholders by way of a special resolution. In these cases, the additional disclosure would be a duplicative exercise. Interestingly, the consultation paper had also proposed mandatory board review and shareholders' approval (including the approval by a majority of the public shareholders) for all shareholders' agreements, but the amendments contemplate only a public disclosure.
In cases where the promoter has an inter-se / bilateral arrangement with a third party to exercise control over the listed company, as per SEBI's takeover norms, the third party would be considered as a person acting in concert with the promoter. Accordingly, the shareholding of any such third party would be aggregated with the shareholder of the promoter and therefore publicly disclosed in any event. In these cases, the additional disclosure would only serve to make public details of the arrangement with the third party.
The separate obligation imposed on shareholders and other contracting parties (i.e., to notify the listed company of any shareholders' agreement) is a departure from the overall framework of the Listing Regulations, which is meant to regulate only listed companies. While the Listing Regulations include other obligations on parties associated with a listed company (e.g., fiduciary obligations of board of directors, embargo on related parties from voting on related party transactions), such obligations have been historically enforced via the respective listed companies. Going forward, SEBI could seek to take independent enforcement action against contracting parties who are in breach of the new disclosure obligation.
Periodic shareholders' approval of grant of special rights
In addition to the disclosure requirement for shareholders' agreements, the amendments include a new provision dealing with special rights granted to the shareholders of a listed company, which now require the approval of the shareholders by way of a special resolution once in every five years. In the case of listed companies which have existing special rights for shareholders, such special rights will need to be approved by the shareholders within five years of the notification of the amendment.
It appears that the new disclosure and approval requirements are not meant to be mutually exclusive. For example, in cases where the listed company itself is a party to a shareholders' agreement and the terms of the agreement are also enshrined in the articles of association, the listed company will be expected to make a public disclosure of the agreement and also seek shareholders' approval for the grant of rights. While this practice was also required to be followed in such instances under the previous regime, the listed company is now also required to seek shareholder approval every five years to ensure continuation of such rights.
The five-year sunset period for grant of special rights is at variance with the Companies Act, under which any shareholders' approval (including for amendment of articles of association) is valid indefinitely until there are any changes to the terms of the original approval. Further, in the context of a change of control, an incoming promoter will now need to be mindful of the risk of not being able to inherit and continue with the entire rights package available to the outgoing promoter. While securing shareholders' approval is likely to be only an administrative hurdle for controlling shareholders whose stakes are close to 75% (i.e., the maximum permissible non-public shareholding), this could well prove to be a substantive risk for promoters with significantly less shareholding.
Periodic shareholders' approval of non-retiring directors
As in respect of grant of special rights, the amendments also require listed companies to ensure that all non-retiring directors are approved by the shareholders at least once in every five years. With respect to existing directors who have been in office for five years or more, the respective listed companies will be required to secure shareholders' approval in the first general meeting to be held after March 2024.
This change effectively puts an end to the practice of listed companies having directors who are permanently entrenched on the board. Under the Companies Act, listed companies are allowed to designate up to one-third of the non-independent directors as non-retiring directors. In practice, such non-retiring directors are usually managing directors / whole-time directors of the listed company; in certain cases, representatives of the promoter (or individual promoters themselves) are designated as non-retiring directors.
Going forward, while such directors will still not be required to retire by rotation, their continuing presence on the board beyond five years will need to be approved by the shareholders. Unlike in respect of grant of special rights (i.e., where the five-year period seems arbitrary and at odds with the Companies Act), the five-year rolling term for non-retiring directors is consistent with the corresponding regime under the Companies Act for managing directors and whole-time directors.
Conclusion
Going forward, parties to any voting or other contractual arrangement in relation to a listed company will need to be mindful of the enhanced disclosure and approval requirements introduced by SEBI. While in many cases the additional requirements are likely to be merely duplicative or administrative hurdles, these requirements could well prove to be more substantive and even onerous in certain cases. It remains to be seen if the benefits of the tightened measures from the perspective of the public shareholders would outweigh the potential uncertainty arising out of these measures for promoters and other investors who seek to have special rights in listed companies.
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