Different Level of Shareholding can get you Different Shareholder Rights

By Lalit Kumar, Partner, J Sagar Associates


Lalit Kumar, Partner, J Sagar Associates

An important issue in an M&A deal for acquisition of shares is the level of shareholding a shareholder must have and the related rights that come along with it. For this it is good to know the rights given under the Companies Act, 2013 (“the Act”) at different levels of shareholding.

Under the Act, a shareholder holding even a single share has a right to attend the shareholders’ meeting, right to be counted towards quorum, right to speak at the general meeting, right to vote, right to get dividend when declared by the company and all other shareholders’ right up to her entitlement of shareholding. For example, entitlement to bonus shares or rights shares issued by the company.

Having said that, the above stated may not be real rights an investor looks for. The real rights to a shareholder are not given until the shareholding touches10%. This is because with 10% or more shareholding, the shareholders either singly or in a group are eligible to file for oppression and mismanagement against the majority and the management of the company, should the shareholders feel the need to file such a case looking at company’s operations. They can also initiate class action as provided under Section 245 of the Act. Further, they can also object to the scheme of compromise or arrangement (like a merger, demerger or other kinds of re-organisation of share capital). However, it may be noted that these rights are more protective in nature when a company has already initiated an action and are not really rights to stop a company from taking that action.

The right to stop or block a resolution comes only a shareholder holds more than 25% shareholding (it could even be 25% plus one share). With such shareholding, the shareholder can block special resolutions. Special resolutions mean shareholders resolutions which under law require at least 75% vote. Therefore, if a shareholder holds more than 25%, it can very well block special resolutions. Some important resolutions that need to be approved as special resolutions are change of company’s line of business; change of company’s name; modifications company’s by-laws; buy-back of shares; inter-corporate loans and investments crossing the permissible threshold limits; selling or disposing of company’s substantial business; mergers and demergers; removal of auditors, shifting the registered office from one state to another.

The next milestone is a shareholding of over 50% (it could even be 50% plus one share). With this, the shareholders gets an ability to manage most of the affairs of the company. This is because it is in a position to pass ordinary resolution (i.e., those resolutions which require a simple majority). However, the shareholder will still not be able to pass any special resolution on its own. That will only be possible if the shareholder holds at least 75%. At this level, virtually the shareholder controls all the aspects of the company as it is in a position to pass all “special resolutions”.

While determining the level of shareholding, a critical question is whether a company pursuant to its by-laws make the provisions more strict than a provided in the Act that means, can a company provide that its ordinary resolutions will be passed as special resolutions. There is nothing specifically provided for this in the Act. However, there are some judicial precedents where it is held that the provisions in the by-laws can be made stricter than the Act. But those precedents are based on specific facts of that case. For example, in one case it was held that a company can provide for a higher quorum for a meeting of board of directors than as provided by the Act. These are specific cases but there is no generic rule for this. In this regard, it is worth noting the concept “entrenchment” provisions. It is a new provision in the Act. This provides that company’s by-laws can provide for provisions that can only be altered by a higher level of shareholders' approval instead of a special resolution. Therefore, by law now, if the shareholders want, the amendments could only be effected with a unanimous vote or a higher threshold than 75%, say by a 90% vote. Now it is seen that important matters agreed between shareholders are being entrenched. Once any provision is entrenched, the same has to be informed to the Registrar of Companies (ROC). For a new company, the ROC can be informed of the entrenched provisions at the time of company’s incorporation. For existing companies, ROC can be informed within 30 days from the date of entrenchment.

The decision on what level of shareholding to be taken can never be a straight answer. In addition to thinking about is from a legal perspective, the commercial decision of the parties is also important. Certain rights which cannot be achieved and protected through a certain level of shareholding can be achieved through contractual arrangement between shareholders.

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