Cardinal Principle:
The cardinal principle of Company law, as enshrined under Section 47 of the Companies Act, 2013 ( “the Act”)provides that every equity shareholder shall have the right to vote on every resolution placed before the company and his voting right on a poll shall be in proportion to his shares in the paid-up equity share capital of the company.
This section broadly corresponds to Section 87 of the Companies Act, 1956. Voting rights are recognized as a valuable property right of a shareholder. While the property right is no longer a fundamental right in India, no person can be deprived of such right without the authority of law under Art. 300A of the Constitution. Currently, there are only very few provisions in the Act where the shareholders are dis-franchised because of conflict of interest like Section 188 of the Companies Act, dealing with related party transactions, which prohibits a related party from voting on any resolution where such related party is interested. Voting rights are always vested in shareholders whose names appear in the register of members of the company.
Voting Rights Pooling Agreement-
Voting right agreements are now statutorily recognized in the definition of “control” under section 2(27) of the Act and Regulation 2(1)(e) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulation, 2011 (hereinafter referred to as “Takeover Regulation”).
A shareholder is entitled to get bound by a contract to exercise his/her voting right as directed by another person and such arrangement/ agreement is often called a shareholders pooling agreement (hereinafter referred to as “Pooling Agreement”). In its decision in Rolta India Ltd. v Venire Industries Ltd.[1], the Bombay High Court held that:
“Regarding pooling agreement, it may be noted that it is an agreement between two or more shareholders which generally provides that in exercising any voting rights, the shares held by the shareholders shall be voted as provided therein; it is a contract to the effect that the shares held by them shall be voted as one single unit. The shareholders bind one another to vote as they mutually agree. In a pooling agreement, each shareholder retains sole ownership of shares binding himself only to vote for a specific person or in a certain way. These agreements are enforceable because the right to vote is a proprietary right. The right to vote may be aided and effectuated by a contract. Generally, pooling agreements are thought of with the control of private companies and smaller public companies. (See LAW QUARTERLY REVIEW, Vol. 84, p. 561).”
In this context, it is worth quoting from the commentary of Grahm Stedman & Janet Jones: SHAREHOLDERS AGREEMENTS[2] [3], examines the effects’ of shareholders’ agreements. It is as follows:
- A voting agreement is enforceable between the parties by injunction which may be either prohibitive [Greenwell v Porter[4]] preventing the shareholder from voting in contravention of the agreement or mandatory [Puddephatt v Leith[5]] compelling him to vote by the wishes of the other party.
- The effect of the voting agreement on the company will depend upon the voting control that the shareholder concerned can exercise.
- As a company is only concerned with its registered shareholders, it will be bound to accept a vote made in contravention of a voting agreement; the remedy for the breach will lie between the parties to the agreement. However, the company could be joined in as a party to the agreement to give effect to its terms.
- A voting agreement (which is not ancillary to any transfer of an interest in shares) will not normally be caught by a pre-emption clause. Thus, if a company wishes to discourage transfers of control over its shares in this way it should adopt a disenfranchisement provision.
- It seems that a personal undertaking by a shareholder to vote per the wishes of another will cease to affect a transfer of the shares in question and that there is no implied term that the shareholder undertakes not to transfer his shares to ensure that the other party is not deprived of his rights under the voting agreement. Greenhalgh v Mallard[6]. Neither will the voting agreement be binding on transferees in such circumstances, even with notice. Thus, for a voting agreement to continue to be effective, it should be accompanied by a restriction on the transfer of the shares.
- A director of a company who accepts the benefits of a voting agreement from a shareholder will be obliged to disclose it as a director’s interest under section 324. [Please note that in the Indian context, this will have to be disclosed under section 184 of the 2013 Act]
- In the case of a public company, such a benefit may constitute a 3% or 10% notifiable interest under sections 198 to 220 of the Act. [In the Indian context see section 184 of the 2013 Act].
- Another effect may be to constitute one company a subsidiary or subsidiary undertaking of another by the definitions contained in sections 736 and 258 of the Act. [In the Indian context see sections 2(46) and 2(87) of the 2013 Act].
- The effectiveness of a voting agreement depends upon the holder of voting rights being able to exercise his votes as he thinks fit. This is a general principle which the courts have been willing to uphold. See Northwest Transportation Co. Ltd. v Beattie[7], Regal (Hastings) Ltd. v Gulliver[8] and Northern Counties Securities v Jackson & Steeple[9].
Implication under Section 90 of the Act and the Companies (Significant Beneficial Owners) Rules, 2018
Since, Section 89(10) categorically refers to Section 90 under the Act for the definition of ‘beneficial interest’, such pooling agreement would be considered in the identification of Significant Beneficial Ownership for Section 90 under the Act read with Companies (Significant Beneficial Owners) Rules, 2018.
Implication of Pooling Agreement under the FEMA, 1999
If a resident Indian were to enter into a voting rights pooling agreement with a non-resident shareholder, the question which arises is whether such voting rights pooling arrangement has to be for a consideration which satisfies the requirement of pricing guidelines stipulated in Rule 21 of FEM (Non-Debt Instrument) Rules, 2019 (hereinafter referred to as “NDI Rules, 2019”) which effectively means that such transaction cannot be done below the fair market value of such voting right. Take for instance a non-resident who acquires a 60% equity stake in an Indian company from a resident Indian shareholder at the fair market value, as per the above provision, but does not pay any separate consideration for the voting rights, whether such an arrangement would violate Rule 21 referred to above.
To answer this question, one needs to examine the nature of voting right pooling agreement. In such an agreement there is no transfer of voting rights but only a contractual commitment to vote by the directions of a non-resident shareholder, the registered owner and the beneficial owner of shares will continue to be the Indian resident shareholder. Such a shareholder has only made a contractual commitment to vote following the instructions received from a non-resident shareholder. However, if the resident Indian shareholder were to disregard such instruction, the only remedy the non-resident shareholder would have is to sue the Indian shareholder for a breach of contract for which he may claim either an injunctive relief under Section 39 of the Specific Relief Act, 1963 or damages for the breach of contract.
It is therefore possible to argue, that even in such a scenario, the pooling agreement is with non-resident shareholder, and there is no need to comply with the pricing guidelines stipulated in Rule 21 of NDI Rules, 2019.
Can Voting Rights be decoupled from the shares?
This legal position is settled by the judgment of the Bombay High Court in World Crest Advisors LLP v. Catalyst Trusteeship Limited & Ors., where it was held that:
“I have been taken through the provisions of the Companies Act, Depositories Act, and the 1996 Depositories Regulations (replaced by the 2018 Regulations) from which it is clear that only a shareholder listed as a member in the Register of Members of a Company is entitled to exercise voting rights over the shares. This was also held by the Supreme Court in LIC Vs. Escorts Ltd. In Vodafone International Holding BV, the Supreme Court recognized the doctrine against decoupling of shares i.e., right to vote cannot be decoupled from the shares but nevertheless held voting agreements to be valid and enforceable. Such agreements do not conflict with the doctrine that voting rights cannot be decoupled from the shares.”
In the case of World Crest Advisors LLP v. Catalyst Trusteeship Limited & Ors., the Deeds of Pledge authorized the Pledgee to exercise voting rights regarding the pledged shares. Further, independent POAs were executed under which Plaintiff has appointed the Pledgee as its proxy in law, including to vote at Dish TV’s shareholder meetings. It is well settled that a proxy / Power of Attorney or a contractual obligation to vote in a particular manner is not to be misconstrued as decoupling the right to vote from the share.
Implications under Regulation 31B of Listing Obligations and Disclosure Requirements
It is debatable whether such voting rights arrangements would qualify as special rights granted to the shareholder of a listed entity under Regulation 31B of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements), 2015. The SEBI Board Note dealing with the introduction of Regulation 31B notes that – “Some of the common types of special rights granted by companies are Nomination Rights, Veto Rights / Affirmative voting, Information Rights, Anti-Dilution Rights, Right of First Refusal, Tag Along Rights, Divestment Rights, etc”. If it can be called as “special right” then its continuation would require the approval by the shareholders in a general meeting by way of special resolution once in every five years starting from the date of grant of such special right.
Implications under the Accounting Standards:
Such Pooling Agreement could also trigger consolidation of the financial statements of the investee with the investor under the accounting Standard Ind AS 110 if it leads to a determination that the investor has the power over the investee.
Implications under Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulation, 2011
Given the definition of ‘control’ under Regulation (2)(1)(e) of the Takeover Regulation, such pooling agreement would be considered in determining the control if a change in control for the triggering of the Takeover Regulation.
Concluding Thoughts
The Pooling agreements are internationally accepted as the legitimate way of pooling voting rights between two contracting shareholders. There are also various recent precedents where vote pooling arrangements have been provided for, under a change in control of a listed company[10]. There is no transfer of beneficial interest of the shares nor does such arrangement give any ownership rights over the shares to the person in whose favour such pooling agreement has been executed. There are implications under the provisions of the Act, SEBI regulations, and Accounting Standards which one needs to be mindful of while executing such an agreement. The legal enforceability of the pooling agreement is not in doubt except in some exceptional circumstances when it leads to the oppression of a minority or if the voting agreement or if the direction received is repugnant to the provisions of the Act or the Articles of the company.