India: Veto Rights Relating To Quorum And Voting On Resolutions - Whether Enforceable Under The Indian Companies Act, 1956?

It is quite common to observe in most of the Joint Venture Agreements ('JVA') that certain special rights or (veto rights as these are commonly known) retained by the JV parties qua Board meetings and General meetings. These rights are invariably incorporated in the Articles of Association (the 'Articles') of the Joint Venture Company. Generally these rights provides for the presence and / or affirmative vote of the JV parties to pass a resolution or to take a decision. The basic fabric of the Indian Companies Act, 1956 ('the Act') is democracy. In Board meeting or General meeting the principles of corporate democracy is stressed by providing for simple majority votes in most of the cases and three fourth majority for certain cases which require special resolution. Though there is no special resolution in the case of Board meeting, there is no prohibition either to provide for the same in the articles.

The professional opinion on these special rights is equally divided. The contention of the pro-group is that the Act provides for the framing of its own Articles for a company and since these rights are associated with the management of the company there is no bar to have such provisions in the Articles. On the contrary, the anti-group contends that these special rights are not in consistent with the provisions of sections 9,28,86,87 and 287 of the Act. This article examines the validity and enforceability of such veto rights.

In Latin"Veto" means "I forbid". The term, according to New Webster's Dictionary, means "power or right of forbidding; to withhold assent to; to reject". Thus, veto rights mean the right to forbid or withhold assent or to reject. In other words, it is a special right given to a person to reject a proposal. As anybody can agree to or reject any proposal, one may ask, what is special in veto. The importance or specialty of veto is that when exercised it rejects the proposal inspite of the proposal having majority assent.

Generally in the case of joint Ventures the JV parties provide certain special rights such as mandatory presence to form a valid quorum, mandatory affirmative vote to pass a resolution etc to each of them or any one of them, in the articles of association of the Joint Venture company. These rights are provided for to protect the interests of the parties. Though commonly these special rights are termed as veto rights, in stricter sense they are not veto rights for these rights are purported to block the formation of quorum or passing of resolutions by not exercising the rights. Thus, in real sense, these rights are Reverse Veto Rights ('RVR').

The term "Quorum" means, according to New Webster's Dictionary "the number of members that must be present at a meeting to make its transaction valid". Thus quorum is the least number of members who are required to be present at a meeting of a body of persons so as to make it a valid meeting. If the quorum is not present no meeting can be held.

Section 287 of the Act stipulates that the quorum for a meeting of the Board of directors of a company shall be one-third of its total strength or two directors whichever is higher. What this section prescribes is a statutory minimum quorum for conducting a valid Board meeting. While calculating the one-third of the strength, any fraction therein has to be rounded of to one. Thus, for example one-third of 5 directors shall be 2; and one-third of 7 shall be 3 and so on.

The quorum as stipulated by the Act is the minimum quorum required under the Act. There is no prohibition for a company to fix a higher quorum than the statutory quorum¹. For example, say the articles may provide for one -half of the strength of the Board or 5 directors or all the directors as quorum. However, the quorum requirement, in any event, should not be lesser than the statutory minimum. Thus, in any case, at least two directors are required to form a valid quorum.

This is normally known as "mandatory presence". When this right is provided for in the Articles of a company, a quorum is said to have been present only when a particular person puts his presence. The quorum fails, in spite of having the minimum number of the quorum, if such a mandatory presence is not made.

Generally the clause providing for such mandatory presence right is worded in the following manner.

Let us assume that there are 5 directors and the quorum fixed is 3 directors. Group "A" has three nominees and Group "B" has two nominees. If at a meeting all the nominees of A are present but nominees of B absent themselves (reasons could be anything), whether there is a valid quorum or not? Likewise, let us assume there are 5 members 3 representing Group A and 2 representing Group B. If at a general meeting when the two members representing Group B present and Group A absents themselves, whether there is a valid quorum?

The power of the articles to fix a higher quorum than that of the statutory quorum extends only to the number of persons to form a quorum and it does not extend to a particular person belonging to a particular group. The reason is that, quorum denotes a "minimum number" out of the total numbers and not a particular person. If at all any particular person's presence is required, as a sine qua non for constituting a quorum, the language of section 287 would have been totally different. The intention of the Act is to prescribe the minimum number of persons to form a quorum so that a meeting can be held and as long as the number of persons required to form a quorum is present.

According to Section 9 of the Act any provision in the articles contrary to the provisions contained in the Act, to such extent of repugnancy, is void. Even The provisions of Table A, if run against the provisions of the Act, shall be void. The Madras High Court² held that if the provisions in the articles patterned on the regulations of Table A or even the very regulations of Table A are found to be repugnant to any express provision of the Act, the court will not hesitate to declare the articles or the regulations of Table A void. The court further observed that any article in the Articles of any company is couched in a wide language in this behalf it will be the duty of the court to read the said clause or article consistent with the statutory provisions. If such harmonious reading is not possible, the clause in table A or the relevant article contained in the Articles of a company will have to yield to the provisions contained in the statute.

Where the articles of the company provided for circulation of resolution without being required to circulate the draft resolution to the directors for passing a circular resolution was struck down as being repugnant to section 289³.

The freedom provided, under section 28 of the Act, to modify Table A and to have its own regulations, ipso facto, does not authorise any company to provide for regulations which give a "special right" to any particular group or person holding same kind of share capital. Rights are associated with shares and equal rights are ensured for every class of shareholders within their class. In this context it is pertinent to mention that the Supreme Court⁴ has held that one section of the Act could not have intended to prevent what another section on the same Act made legal.

In view of the above discussion the non- presence of the veto member will not invalidate the quorum of the meeting. The ideal way to ensure the compulsory presence of any particular person would be to fix the number of quorum at such a figure that without the presence of a particular person quorum could never be constituted. In the above example, the quorum could have been fixed at 4 directors so that the presence of the nominee of Group B is ensured without falling foul with the statutory provision. In the same manner instead of fixing the quorum for general meeting at 2, it could have been fixed at 3 which will ensure the mandatory presence of Group A.

This is normally known as "affirmative vote". When this right is provided for in the articles of association of a company, a resolution is said to have been passed only when a particular person casts his affirmative vote. The resolution fails, inspite of having majority of votes, if such an affirmative vote is not casted.

Generally the clause providing for such affirmative voting right is worded in the following manner.

Suppose Group A has 76% and group B has 24%. Group B rejects an ordinary resolution and a special resolution though the resolutions were supported by Group B. Whether the resolutions are said to have been passed or not?

The first question which arises is whether such affirmative voting rights can be provided under the Act? Section 87 of the Act confers with equal voting right on all shareholders belonging to the same class. Thus, in terms of the provisions of section 87 special voting rights cannot be provided to members of the same class.

However, section 86 of the Act, provides for the issue of equity shares with differential rights as to voting, dividend or otherwise. For this there ought to be two different classes of equity shares, one is the normal equity share with normal rights and the other is the special equity share with special voting rights. In view of this, special voting rights can be given to a particular class of shares and not to a particular group or a person belonging to the same class. Though different class of equity shares with different voting rights can be issued, the special right can be given by providing for graded votes, say Class A shares will have one vote and Class B shares will have two vote per share.

Nowhere the Act says that only with the affirmative vote of a particular person or group a resolution can be passed. Conversely, the Act nowhere stipulates that a resolution shall fail when a person, having affirmative vote, fails to cast the vote. Thus, in order to defeat a resolution the votes cast against it should be more than the votes cast for it in the event of ordinary resolution. Similarly in the case of special resolution the votes cast for the resolution should be three times the votes cast against it. In other words, in a meeting a resolution can be defeated only by casting votes against it and not by absenting or refraining from casting vote.

In view of this the affirmative voting right of Group B, will not stand in the way of passing resolutions by Group A, provided the requirements of the Act are satisfied. The only manner in which Group A can defeat a special resolution is by holding at least 26%; and an ordinary resolution can be defeated by only holding 50% shares.

Company law is based on the principles of shareholders democracy and as such the majority will always hold sway. Veto rights are measures intended to protect the interests of the minority group. Certain basic rights, which are the bedrock of corporate democracy, such as attending the meeting, voting thereat etc are not amenable to modification in contrary to the substantive legal provisions of the Act. Even if the Articles contain such clauses, the enforcement of the same through a court of law will not be possible. Hence, the better manner to protect the interests of the minority group or a JV partner is to ensure the same within the four walls of legally permitted methods.