The term Differential Voting Rights or DVRs is referred to as the differentiation in rights provided to shareholders who contributes equity share capital. DVRs can give a shareholder either more voting rights or less voting rights. In India, the concept of DVR was first introduced in 2008 by TATA Motors. After that, four more companies issued their shares with DVRs. DVR is becoming a fast-growing concept in India which is very beneficial to the promoters who want to retain their control in the management of the company. DVRs can either superior voting rights or inferior voting rights. The Companies Act, 2013 enumerates a provision for DVRs and also, SEBI plays a very vital role in the case of DVRs as it provides a framework for the issuance of shares with DVRs.
The capital contributed by the owners of the company is called the Share Capital. Share capital can be of two types i.e. equity share capital or preference share capital. The holder of these share capitals has certain voting rights. However, equity share capital is also classified with differential voting rights concerning the dividends or holder’s respective shares. This is referred to as Differential Voting Rights or DVR. In other words, shares that provide differential rights as to voting or dividends to a holder are considered as DVRs. They can be of two types i.e. shares with superior voting rights and shares with inferior voting rights. Superior voting rights are those on which there can be multiple votes on a single share whereas inferior voting rights are those where on a single share, there is only a portion of voting rights.
A company gives DVR on equity shares to maintain control of the management and also improve the capital structure of the company. When a company issues equity shares with DVRs, there is a capital increase and the management control remains with the promoters of the company. This system of DVRs on equity is share is very beneficial for the owners who want to retain the management of the company along with an increase in capital.
The Companies (Amendment) Act, 2000 amended Section 86 of the Companies Act, 1956 (now 2013) through which the concept of DVR was introduced in India. Previously the section provided that a company limited by shares can only have equity share capital and preference share capital but vide the Companies (Amendment) Act 2000, the said section allowed the equity share capital to have DVRs. However, the present companies act i.e. Companies Act, 2013 also provides the issuance of equity share capital with DVRs.
DVR under the Companies Act, 2013
Section 43 (a)(ii) of the Companies Act, 2013 (the Act) provides for equity share capitalwith DVRs as to dividends or voting rights. The said section is similar to Section 86 of the Companies Act, 1956. The Act also provides the holders of equity share capital, a right to vote on every resolution that is offered to the company under Section 47 (1)(a) of the Act. When a company issues shares, generally there is only one share one vote but when it issues shares with DVRs, there can be one share and more than one vote or less than one vote. However, a share issued with less than one vote has a higher rate of dividend.
In India, the issuance of DVRs on shares was first used by the TATA Motors in 2008. After this, in 2009, Pantaloons Retails (now Future Enterprises) and Gujarat NRE Coke Limited issued shares with DVRs. Also, in 2011, the Jain Irrigation System issued DVRs on shares. Presently, only inferior voting rights are issued on shares and the superior voting rights are not allowed.
Conditions for Issuance of Shares with DVRs
Rule 4 of the Companies (Share Capital and Debenture) Rules (SCDR), 2014 provides for certain conditions to be fulfilled before the issuance of shares with DVRs. Those conditions are as follows:-
- The issue of DVRs should be authorized by the Articles of Association of the company.
- The issue of DVRs should also be authorized by an ordinary resolution passed by the company at the general meeting of shareholders.
- The voting power of shares with DVRs must not exceed 74% (previously 26%) of the total post-issue paid-up share including ordinary shares.
- The company must not have made any default in payment of dividends or borrowed loans or repayment of deposits and also, no default in filing of annual return for the last 3 financial years.
- The company must not have been penalized for any offense since the last 3 financial years by any court or tribunal.
- The company must have a consistent track record of distributable profits in the last 3 financial years.
Merits and Demerits of Issuing Shares with DVR
While issuing shares with DVRs, certain merits and demerits are also faced by the issuing company and also the investor which can be classified as follows:
- Issuing shares with DVRs is beneficial for a company as it raises more capital.
- A company can also retain control in the management.
- A company can fund large projects.
- It is beneficial to issue shares with DVRs for an investor as there is an increase in dividends and also the shares are discounted.
- It provides quick returns rather than voting rights to the investors.
- A company faces a loss due to the discounted rate of shares while issuing them with DVRs.
- The minority shareholders lose confidence in the company.
- It is not beneficial for the investors as there can be a misuse of voting power by the promoters.
- There is also an absence of awareness about this kind of share issue.
- It is also against the interest of shareholders from the viewpoint of the investors.
- It is not beneficial for the investors who are interested in voting rights and a long term capital gain.
Regulation of Shares with DVRs
The debate in India regarding the issuance of shares with DVRs lead to a circulation of a ‘Consultation Paper’ by the Securities Exchange Board of India (SEBI) to obtain public comments on the said debate in March 2019. This Consultation Paper on the issuance of shares with DVRs was to devise a structure for the regulation of shares with DVRs and it can be categorized under two heads that are:
- Issuance of shares of the companies whose equity shares are already listed, and
- Issuance of shares of the companies whose equity shares are not listed but are proposed for public offering.
It is also stated by SEBI in the said consultation paper that DVRs with special voting rights would help the promoter led companies to retain the control of the management and the rights of the shareholders. Also, SEBI permitted the issuance of shares with special and fractional voting rights principally for the new technology companies that have no or little need for debt financing. This issuance of shares to investors with superior or fractional voting rights has been considered as a viable option for raising equity share capital. The consultation paper issued by SEBI also scrutinized some rules and requirements to be followed to issue shares with DVRs.
Framework for Issuance of DVR Shares
A company with superior voting rights shareholders intending to take on an Initial Public Offering (IPO) of the ordinary shares that are about to be listed, have to comply with the following conditions:
- The issuer company should intensively use technology, data analytics, biotechnology or nanotechnology, information technology, intellectual property to provide services, business platforms, and products with an addition in value.
- The shareholder with superior voting rights should be a part of the promoter group and his net worth should not exceed INR 50 million.
- The promoters or founders in the issuer company are the only ones who are issued shares with superior voting rights.
- Shares with superior voting rights can only be issued by way of passing a special resolution in the general meeting of shareholders.
- The promoters or founders of the issuer company must have held the shares with superior voting rights at least for 6 months before the filing of Red Herring Prospectus.
- The ratio of shares with superior voting rights should be minimum 2:1 and maximum 10:1 as compared to the ordinary shares.
List-in and Lock-in
After the issuer company has completed the IPO, it needs to list-in the superior voting rights shares with the stock exchanges. Until the superior voting rights shares are converted into the ordinary shares, lock-in restrictions are imposed upon them after the completion of IPO. There can be no pledge upon the shares during the lock-in period and no transfer can be made between the promoters of such shares.
Rights of Shares with Superior Voting Rights
The total voting rights of shareholders with superior voting rights including ordinary shares cannot exceed 74% of the total voting power and such shares with superior voting power must be considered at par with the ordinary shares in every respect.
Enhanced Corporate Governance
The enhanced corporate governance of companies that have shareholders with superior voting rights shall consist of at least 2/3 of the Committees (excluding Audit Committee which shall have only Independent Directors) and ½ of the Board with the Independent Directors as prescribed by the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 [SEBI (LODR) Regulation].
The shares with superior voting rights will be considered as ordinary shares in terms of voting rights after the IPO has been made by the issuer company under the following situations:
- When there is a removal or appointment of the independent director and/or auditor.
- When there is a voluntary winding up of the company.
- When there is change control of the management of the company.
- When there are related party transactions according to the SEBI (LODR) Regulations that also involves the shareholders with superior voting rights.
- When the Memorandum of Association and Articles of Association are being changed without affecting the superior voting rights shares.
- When there is a voluntary initiation of the resolution plan under the Insolvency and Bankruptcy Code and utilization of funds for the purposes other than business.
- When a special resolution is passed regarding delisting or buy-back of shares.
Conversion of Shares with Superior Voting Rights
In case of happening of certain events, the shares with superior voting rights are automatically converted into ordinary shares. Those events or circumstances can be time-based or event-based. The shares can be converted:
- When it is the 5th Anniversary of the listing though it can be extended once for up to 5 years by a special resolution. The shareholders with superior voting rights would not be allowed to vote on such a resolution. This is a time-based circumstance where the shares are automatically converted.
- When the shareholder of superior voting rights himself resigns, or there is a merger or acquisition of a company, or there is a demise of the shareholder. These are event-based circumstances where the shares are converted.
Fractional Right Shares
There should be no issue of shares with fractional rights as stated by SEBI. However, they may be issued upon gaining experience from the use of superior voting rights on shares.
Amendments to SCDR
- Rule 4(1) clause (d) of SCDR was amended by the government notification on 16th August 2019. The provision that required a company to have a consistent track record of distributable profits in the last 3 financial years to issue shares with DVRs was removed.
- Rule 4(c) of SCDR previously stated that the voting power of shares with DVRs must not exceed 26% of the total post-issue paid-up share including ordinary shares but after the amendment, it is increased to74% as mentioned above.
DVRs on shares were very much needed in India. Until 2008, the concept of DVR was not even known by the Indian companies. The framework laid down for the issuance of shares with DVRs by SEBI is very beneficial for the new tech companies whose major operations are concerned with using technology to provide services. Also, through issuing shares with DVRs, the shareholder’s control on the management of the company is retained which works in the interest of the promoter and also the growth prospects of the business. Therefore, it is very advantageous for the minority shareholders as they continue to retain their control over the firm.
Frequently Asked Questions (FAQs)
- What are differential voting rights or DVRs?
- What is the provision for DVR under the Companies Act, 2013?
- What are the conditions for issuing shares with DVRs?
- What is the framework provided to issue shares with DVRs?
- What were the amendments made in Companies (SCDR) Regulations, 2014?