Issues in reclassification of listed companies’ promoters

By Roopal Kulsrestha and Komal Modi, Shardul Amarchand Mangaldas & Co
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In India, a promoter is generally understood as a person in control of a company. A change in the promoter of a listed company is perceived as sufficiently significant to affect the company’s share price.

Consequently, the Securities and Exchange Board of India (SEBI) subjects promoters to stringent disclosure requirements and a high degree of accountability. Further, SEBI has recently mandated stock exchanges to freeze all promoter holdings in certain cases of non-compliance by listed companies.

Roopal Kulsrestha Partner Shardul Amarchand Mangaldas & Co
Roopal Kulsrestha
Partner
Shardul Amarchand
Mangaldas & Co

It is for this reason that persons identified as promoters under law (because they are named as such in the prospectus or the offer document) but no longer in control of the company and who have transferred all or almost all of their shareholding in the company often wish to rid themselves of the “promoter” tag. However, a person does not cease to be a promoter of a company merely by ceasing to be in control of the company or by transferring all of its shares. This is a matter of particular concern for financial investors in listed companies.

In September 2015, SEBI, following recommendations of its Primary Market Advisory Committee, implemented its framework for reclassification of promoters of listed companies as public shareholders under regulation 31A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

Simply put, the new regulation allows stock exchanges to reclassify promoter shareholding as public shareholding if the concerned promoters do not exercise any direct or indirect control over the affairs of the company.

SEBI has also clarified that any increase in the level of public shareholding pursuant to reclassification of a promoter will not be counted towards achieving the prescribed 25% minimum public shareholding requirement. This was done as SEBI noticed that companies frequently opted for reclassification of promoters merely to circumvent the 25% limit.

Regulation 31A expressly provides for reclassification of promoter shareholding: (1) in cases of transmission/succession/inheritance; and (2) subject to the approval of the company’s shareholders and provided that the outgoing promoter does not have any special rights, in cases of (a) change of promoter, where the outgoing promoter (together with the promoter group and persons acting in concert) holds not more than 10% of the paid-up equity capital of the company; and (b) the company becoming professionally managed without an identifiable promoter.

No specific provisions have been made for any other circumstances in which promoter shareholding is sought to be reclassified as public shareholding. Although the regulation specifically sets out the requirement for shareholder approval where there is a change of promoter and where the company becomes professionally managed, the regulation is silent on the applicability of such a requirement in all other circumstances.

Further, the procedure and checklist prescribed by the Bombay Stock Exchange in this regard includes obtaining shareholder approval as a step, suggesting that it is mandatory to seek such approval in all cases of reclassification.

Komal Modi Associate Shardul Amarchand Mangaldas & Co
Komal Modi
Associate
Shardul Amarchand
Mangaldas & Co

However, in October 2016, SEBI in an informal guidance to Alembic Pharmaceuticals clarified that shareholder approval was not required for reclassification of five persons belonging to the promoter group who cumulatively held 1.45% of the equity share capital of the company. In that case, the five promoters were unconnected with any activity of the company; did not, directly or indirectly, exercise any control over the company; and did not have any special rights. As is typical, SEBI stated that this informal guidance was based on the information furnished by the company and that different facts may lead to a different result.

SEBI gave a similar view in August 2016 on a request for informal guidance from Krebs Biochemicals and Industries in respect of reclassification where the persons belonging to the promoter group neither held any shares, nor exercised control over the company’s affairs.

Thus, it appears to be possible to seek dispensation from the requirement of obtaining shareholder approval other than where expressly mandated (i.e. in cases of change of promoter and the company becoming professionally managed as mentioned above). This assumes significance in companies which do not strictly fall within the meaning of “professionally managed” under the regulations and which have persons classified as promoters who neither exercise any control nor possess any special rights.

Roopal Kulsrestha is a partner and Komal Modi is an associate at Shardul Amarchand Mangaldas & Co.
The views expressed in this article are those of the authors and do not reflect the position of the firm.

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