India: Interested Shareholders May Lose Vote

Last Updated: 21 July 2011
Article by Lalit Kumar

The Securities and Exchange Board of India (Sebi) has proposed to suitably amend a portion of Clause 166 of the Companies Bill, 2009, disallowing interested shareholders from voting on special resolutions required for related-party transaction. Sebi made this recommendation to the ministry of corporate affairs following its board meeting on February 7. The recommendation is based on the investigation conducted into the Satyam scam and was made with the objective to protect small and diversified shareholders in listed companies from abusive related-party transactions. This is not the first time Sebi is moving to disallow interested shareholders from voting on resolutions. For instance, Sebi regulations allow delisting only if the votes cast by the 'public shareholders' (which excludes promoters) in favour of delisting are at least twice the number of votes cast by 'public shareholders' against it.

In effect, the shareholding power of the interested promoter shareholders will not be sufficient to implement the decision of delisting. Now, Sebi is recommending that this principle be extended even to related party transactions. Broadly, Clause 166 states that the consent of the board of directors has to be sought before any contract or arrangement with a related party is executed on certain kinds of transactions listed under the clause. Some of the transactions are sale, purchase or supply of goods or materials , disposing or buying properties, leasing of property, availing or providing services, etc. The clause goes on to add that shareholders consent by way of special resolution (3/4th majority) will be required for these related party transactions if the company's paid-up capital or the transaction value of the related party contracts exceeds a prescribed amount.

However, Clause 166 exempts those contracts that are in the ordinary course of business and are executed at 'arm's length' basis. Therefore shareholders approval will be required only when related party contracts are not in the ordinary course or when the company's capital or the transaction value of such contracts exceeds a certain amount. It is this portion of the clause that the Sebi is seeking to amend by disallowing interested shareholders from voting. Sebi assumes that by debarring the interested shareholders, a fair and an impartial resolution will be passed on that contract and that will protect the small and diversified shareholders.

Under the existing Companies Act, 1956, directors of public limited companies are not permitted to vote in situations where there is conflict of interest i.e., on those contracts or arrangements in that they are directly and indirectly interested. Not only this, their presence is not counted to determine quorum for discussion on those contracts and arrangements . Further, the Act also requires directors to disclose their nature of interest in contracts and arrangements in which they are interested. These obligations are rightly imposed on the directors because they have fiduciary duties towards the company. As far as the shareholders are concerned , it is a settled principle in Indian jurisprudence that unlike directors , a shareholder is entitled to consider his own interest without regard to the interest of other shareholders and does not owe any fiduciary duty. Hence, they are free to exercise their voting power in any manner they wish that may or may not be in the interest of the company or the fellow shareholders.

Sebi's recommendation to cast an obligation on the shareholders not to vote in situations of conflict of interest will be a major departure from the existing position under the Companies Act. Minority shareholders will, however , be delighted and will welcome this change as it will protect their interests from an interested majority shareholder who is armoured with sufficient shareholding to have the resolution passed to its advantage. Such a proposal, if implemented, will stop the interested shareholder right at the time when voting on a matter takes place, instead of the prejudiced minority later seeking relief under the oppression and mismanagement provisions of the Companies Act. This is just a beginning and only a recommendation.

It is not known what favour it will find with the ministry of corporate affairs and whether at all it will finally find a place in the new Company Act - which itself has been waiting for an extremely long to see the light of the day. Further, a lot of deliberations will be required if at all this recommendation has to be finally implemented, including determination of what constitutes an "interested shareholder" and "related party transaction" , exemptions , etc, in cases of certain related party transactions. For now, one can wait and watch.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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