The case for facilitating tracker shares in India

By Akila Agrawal, Amarchand Mangaldas
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Tracker shares (also known as tracking shares) are a type of share that “tracks” or depends on the financial performance of a specific business unit or operating division of a company, rather than the operations of the company as a whole. If the unit performs well, the value of the tracker shares may increase, irrespective of the performance of the rest of the company. This article examines the concept of tracker shares in other jurisdictions and its viability in India.

Current situation

Tracker shares are prevalent in the US and some European countries. Companies including General Motors, AT&T, Genzyme Corporation and Sony Communications have issued and listed tracker shares for specific units.

Akila Agrawal Partner Amarchand & Mangaldas & Suresh A Shroff & Co.
Akila Agrawal
Partner
Amarchand & Mangaldas & Suresh A Shroff & Co.

Issuance of tracker shares is viewed as an alternative to spinning off or demerging the units into separate companies. It enables a company to unlock the value of a specific unit without creating a separate entity or governance structure and also without losing management control. It ultimately provides the benefits of a separate valuation of the division without having to undertake a process of restructuring. Also, the benefits of the credit rating of the parent will be retained by the unit.

Issuing tracker shares is sometimes referred to as an “internal spin-off”. The salient features of tracker shares in general are: (a) they do not have voting rights; (b) dividend rights are based on the earnings of the tracked unit or division; (c) they do not have a claim on the assets of the company in the event of liquidation. In some cases, tracker shares have a conversion right, whereby they could be converted into another class of shares either at the option of the issuer or upon sale of the tracked asset.

Legislation in India

In India, the Companies Act, 1956, inhibits the issuance of tracker shares, especially by public companies or private companies that are subsidiaries of public companies. The reasons are: (a) sections 85 to 89 of the Companies Act restrict the types of share capital that may be issued by public companies and issuance of tracker shares is not expressly permitted; (b) it is not possible for a public company to issue shares with nil voting rights; (c) section 205 of the Companies Act requires dividends to be paid only out of distributable profits. So, if the tracked unit is making profits, but the company as a whole is not making profits, it will not be possible to declare dividends on the tracker shares.

Additionally, if the public company is listed, clause 28A of the Listing Agreement restricts listed companies from issuing shares in any manner which may confer on any person superior rights as to voting or dividends vis-à-vis the rights attached to equity shares that are already listed. Therefore, public companies today have to undergo the tedious process of demergers or spin-offs in order to unlock the value of specific undertakings.

It may be possible for private companies in India that are not subsidiaries of public companies to issue tracker shares as a variation of preference shares, as the restrictions under sections 85 to 89 of the Companies Act are not applicable to such companies. As far as dividends are concerned, private companies may declare dividends on tracker preference shares based on segmented accounting and results of the tracked unit.

Proposed changes

Given the limitations of the provisions of the Companies Act, legislative facilitation could help Indian companies to benefit from the tracker shares model. The JJ Irani Committee in its 2005 report proposed the introduction of tracker shares to track the financial performance of one or more business undertakings and to participate in dividends declared by the company from the profits of that particular division. The report recommended tracker shares as a means of increasing the depth of the Indian capital markets.

The Companies Bill, 2011, seeks to provide companies with the freedom to issue different classes of equity shares including shares with differential dividend rights. It may be a good idea for the legislature to examine the usefulness of tracker shares and expressly facilitate their issuance under the new Companies Act. This would help conglomerates with business units that have different growth trajectories to exploit value to the benefit of all stakeholders.

Having said that, any legislative measure in this regard should be coupled with safeguards against misuse of such instruments. It is important that the instrument be transparent. Companies that issue tracker shares should maintain high standards of corporate governance to balance the conflicting interests of two or more groups of shareholders.

Akila Agrawal is a partner at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the author and do not reflect the position of the firm.

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