Author – By Upscale Legal
INTRODUCTION
The credit for the boom of the startup industry in India is undeniably going to equity investors. These are the investors who purchase the shares of an entity in the hope that the purchased shares’ value will increase and will generate gains in the form of capital. Affirmative voting rights are the contractual rights that are allotted to specific investors, these rights are outlined in the Shareholders’/joint ventures agreement(SHA/JV). These rights put an obligation on the company to take certain decisions outlined in the agreement on the topics covered under affirmative voting rights. These voting rights enable the investors to vote on matters of paramount importance and have a say on those matters which may be detrimental to their interests,[1] matters such as Mergers and Acquisitions, issuing new shares, etc. These rights protect the investor’s interest; it also acts as a bridge between the management and the shareholders and enables the success of a company in the longer run.
Some perks of affirmative voting rights:
Investors to protect their interest in the investment demand affirmative voting rights in a number of matters such as if there is an amendment in the structure of the share capital, an amendment in charters of the company, or a removal/appointment of key position holders, issuance/dilution of shares, etc. There are some investors who demand affirmative rights over matters that concern day to day operations of the company as well.[2]
These rights enable investors with more control over the company’s management and direction. This becomes beneficial for them as it makes their investment protective. Moreover, it is also beneficial for the company. Since the investors have greater stakes in the company’s success in which they invest, they are more likely to be more productive, effective, and alert in the company’s activities and decision-making process.
It is very important for every company to ensure that affirmative rights allotted to an investor do not become a hindrance to conduct day to day activities seamlessly and effectively. It should be ensured that affirmative rights are not resulting in a transfer of control of the company.
Affirmative Rights v Control
The definition for ‘control’ under section 2(27) of the Companies Act, 2013 is an inclusive definition.
In the case of Arcelor Mittal India Pvt. Ltd. v. Satish Kumar Gupta, the definition of “control” was clarified by the Hon’ble Supreme Court of India(Supreme Court), by which the definition was classified into two categories:
- De jure control: As per this, control is determined by the ability of an individual to appoint a majority of directors.
- De facto control: As per this, control is determined by the ability of an individual to have control over the management/policy decisions of an entity.
The Supreme Court further clarified and explained the terms:
Management decisions: These are the decisions that govern the day-to-day running of a company.
Policy decisions: These decisions are long-term decisions that do not include day to day running of a company.[3]
Affirmative Voting rights are held by investors on certain matters which have already been discussed above. If having these rights amounts to having “control” over a company is to be seen through the lens of judicial precedence.
In Subhkam Ventures (I) Private Limited v. SEBI[4], it was held by the Appellate Tribunal that the affirmative voting rights are merely to protect the interest of the investors, hence, the inclusion of such rights in the Shareholder/Joint Venture Agreements does not amount to acquiring control over the company. It also made a distinction between negative control and positive control. It does not end here; this case was further appealed to the Supreme Court and even though the case was disposed of due to some other reasons/change in circumstances, it was held by the Supreme Court that the decision of the Securities Appellate Tribunal cannot be considered as a precedent.
In Rhodia SA v. SEBI, it was held by the Securities Appellate Tribunal that while affirmative voting rights concerning day-to-day management decisions may not amount to control, these rights will amount to control with respect to the structural and strategic decisions of the company.[5]
In Arcelor Mittal India Pvt. Ltd. v. Satish Kumar Gupta, it was held by the Hon’ble Supreme Court, that the entity has positive control of the target company, as it held 32% shares, was in rightful power to appoint an equal number of directors as other shareholders, and also was allotted specific affirmative rights in the SHA.
In Swedish Match Ab & Anr. V SEBI, it was held by the Hon’ble Supreme Court, that when there is a change in the majority of voting rights via any amendment to the memorandum of association or by any other means in which there is a requirement that a resolution must be passed by the shareholders in a general meeting, it can be said that there is a change in control of a company. Hence, if an SHA includes provisions that prescribe the approval of a resolution in a general meeting by shareholders having affirmative voting rights, such provisions may be deemed as a form of “control.”
Potential Disadvantages of Affirmative Voting Rights
There is no doubt that in some extreme cases, affirmative voting rights can be a double-edged sword for a company. While it can be considered beneficial for equity investors, in some cases it can lead to limiting the flexibility of a company in decision-making. As discussed above in some cases, it will not be an exaggeration to say that when a company as per affirmative voting rights is obliged to seek the approval of the equity investors for day-to-day management decisions, it can lead to delays in the company’s operation. This can lead to tussles which results in unwanted litigation.
Conclusion
In conclusion, we have discussed the role of equity investors having affirmative rights in India arising out of contractual relationships with the target entities. These rights allow equity investors to vote on matters of paramount importance that may affect their interests and protect their investment by having a say. However, it is very pertinent to ensure the target entities that these rights do not hinder the smooth functioning of the company. It was also discussed whether affirmative rights amount to having acquired “control” over a company through the lens of various judicial/tribunal decisions. After analyzing these decisions, it will be fair to say that it will always depend upon case to case to see if the affirmative rights are amounting to “control” over a company. It can be said that affirmative rights taking the shape of control over the company may lead to potential disadvantages such as limiting the company’s flexibility as far as day-to-day management is concerned which can further lead to a tussle between investors and the target company.
[1]http://docs.manupatra.in/newsline/articles/Upload/8B6D46C0-61D7-4308-ADAC-DCC4C1419C2E.2-C__SEBI.pdf
[2] https://www.ediplis.com/affirmative-rights-term-sheet/
[4] Appeal No. 8 of 2009
[5] https://taxguru.in/sebi/interpretation-control-sebi-takeover-regulations.html
