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Proposal to amend the law on re-classification of shareholders – A step in the right direction

Finsec Law Advisors

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To broaden the scope and simplify the process for re-classification of shareholders of listed companies, SEBI has issued a consultation paper titled ‘Provisions pertaining to Re-classification of shareholders’. The consultation paper has proposed a much-needed amendment to Regulation 31A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”).

Presently, Regulation 31A of the LODR (“Reg 31A”) permits re-classification of shareholders under three limited scenarios. These include cases of i) transmission/succession/inheritance of shares by an inheritor; ii) a new promoter replacing the previous promoter subsequent to an open offer or in any other manner and; iii) a company becoming professionally managed without an identifiable promoter. Except for the first scenario, such re-classifications are permitted pursuant to satisfaction of several conditions. These include the requirement that the outgoing promotor must not be exercising control or enjoying special rights in the company and must obtain the shareholders’ approval for the reclassification. As Reg 31A encapsulates only limited scenarios for re-classification of shareholders, companies in the past have approached SEBI under the SEBI (Informal Guidance) Scheme, 2003, to obtain approval to re-classify promoters as public shareholders.

Under the proposed amendment to Regulation 31A of the LODR (“ProposedReg 31A”), SEBI has proposed a uniform process for re-classification of shareholders and a single set of conditions for all situations of re-classification of shareholders. Unlike Reg 31A, the Proposed Reg 31A, does not allow the concerned promoter to act as “key managerial person” in the company for any period of time after the re-classification. Additionally, the Proposed Reg 31A has introduced conditions on listed companies making a request for re-classification of shareholders. These conditions include requirements such as the company must be complaint with the minimum public shareholding requirements, and its shares must not be suspended from trading on the stock exchanges. Further, SEBI is empowered to relax any of the condition for re-classification in specific cases, if SEBI is satisfied about the non-exercise of control by the outgoing promoter or persons acting in concert.

However, there are certain concerns that may be brought to light with respect to the Proposed Reg 31A.

Is shareholders’ approval necessary in all circumstances?

As provided in Reg 31A, the Proposed Reg 31A mandates obtaining a shareholders’ approval for all cases of re-classification of shareholders, except for cases of transmission/succession/inheritance of shares. This requirement should not be made mandatory in all circumstances. For instance, if the outgoing promoter holds less than 10% of the voting power and does not exercise control in the company, which has another controlling promoter, and all other conditions specified in the Proposed 31A are satisfied, seeking the approval of the shareholders might have no relevance. Further, this requirement under the Proposed Reg 31A is contrary to the stance taken by SEBI in several of SEBI’s informal guidances, wherein SEBI had allowed promoters with nominal shareholdings to be re-classified as public shareholders without seeking a shareholders’ approval.

Why should only promoters be allowed to initiate the process of re-classification?

Unlike Reg 31A, the Proposed Reg 31A allows the process of re-classification to be initiated only by a promoter and therefore, a company will be unable to re-classify promoters holding nominal shareholdings in the interest of the company. If a promoter holding nominal shares and having no control or special rights over a company is declared a ‘wilful defaulter’, the concerned company will be barred from making a public issue of equity shares under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009. In such scenarios, the company should be given the power to initiate the process for re-classification of the concerned promoter to a public shareholder.

Bar on ‘wilful defaulters’ and cooling off period.

SEBI has not provided any reasons for imposing a blanket bar on ‘wilful defaulters’ from being re-classified as public shareholders. As discussed earlier, imposing such a restriction may be against the interests of the company.  Further, SEBI has not provided any reason for having a six-month cooling off period between the board meeting of the directors and the shareholders’ meeting with respect to the process of re-classification of shareholders. On account of the six-month cooling off period, the process of re-classification will be delayed and the recommendations of the board of directors may become obsolete and redundant by the time the shareholders are to consider the proposed re-classification and take a decision on the matter.

To summarise, SEBI’s attempt to amend Reg 31A is a move in the right direction as it will broaden the scope and simplify the process of reclassification of shareholders. It will be interesting to see if and how SEBI further modifies the Proposed Reg 31A in the future based on comments received from market participants.