3. India case study

Abstract

This chapter on India highlights the long-standing importance of company groups in India’s economy and focuses particularly on two major laws that apply to such groups in India: the Companies Act, 2013 applying to all companies, and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, applying to listed entities. The chapter describes the rationale for India’s regulatory approach, highlighting important issues and concerns with respect to company groups. These include issues such as disclosure of capital structures and control arrangements; the rights to obtain information about other entities in the group; the framework with respect to related party transactions; and risk management, control systems and group policies.

    

Introduction

World over, companies exist through group structures—i.e. they are a part of a group of companies that are linked through ownership and/or other mechanisms to exercise control—for a variety of reasons including business, legal and governance.

Such holding-subsidiary relationships are often prevalent because of various advantages that such structures may offer to the companies/group. For instance, such structure may facilitate reduction of risk at the holding company level by exporting the same to subsidiaries. Subsidiaries may also facilitate diversification of the business of the corporate group; they can also be in the form of special purpose vehicles for holding companies to enter into acquisitions or joint ventures. Such structures may also enable segregation of different businesses including specific assets and liabilities relating to such business into separate entities and also specific funding into such businesses.

While the group structure may help to fulfil many business objectives as stated above, it is also fraught with certain dangers/concerns. The most common of such concerns pertain to related party transactions arising out of the conflict of interest that is inherent in a group structure. In countries such as India, where there are dominant controlling shareholders (promoters), the concern is exacerbated since such situations lend themselves to an increased possibility of abuse. More serious concerns such as those pertaining to siphoning off of funds, tax evasion, use of such structures to create shell companies, masking of unaccounted funds, etc. may also arise in several group structures.

Therefore, regulators around the world have put in place various filters to address these concerns and ensure robust group governance.

In India, the concept of group structures is as old as company law itself, which runs more than a hundred years. Companies exist through groups and there are different purposes for which group companies are formed. The very issues that have plagued group structures around the world have found their examples in the Indian context too; this has led to the regulators enacting law to facilitate groups while keeping a check on the negatives.

This case study is primarily based on two major laws that apply to company groups in India—the Companies Act, 2013 and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (SEBI LODR Regulations). While the former applies to all companies, the latter applies to listed entities in particular.

This chapter attempts to explain various concerns in India regarding company groups and the requirements which have been put in place to address these concerns. An attempt has been made to explain the regulatory requirements in a simplified manner in the five sections in the case study, with detailed technical provisions referenced through notes providing web links to the legal texts at the end of this chapter.

Context, background and national discussion

Prevalence of group structures in India

The most prevalent form of group structures in India is through holding company-subsidiary relationships. A figurative explanation of a simplified company group structure is given below for reference.

Figure ‎3.1. Explanation of a simplified company group structure

Several of such companies at different layers may become ‘associates’ of each other since they belong to the same group.

Accordingly, many unlisted and listed entities1 in India are part of group structures. These structures may be created for different purposes that may be functional, financial, administrative, legal, etc.

A preliminary study of the top 500 listed entities in India by market capitalisation2 indicates the following:

1. 1. Every listed entity in the top 500 by market capitalisation has at least one subsidiary (including step-down subsidiaries in several cases) or a holding company or an associate3.

2. 2. On a simple average and median basis, a listed entity has around 18 and six subsidiaries /associates/holding company in totality respectively.

3. 3. 20 listed entities among the top 500 have 100 or more subsidiaries /associates /holding companies in totality, the highest being company with 308 subsidiaries/associates/holding company. These may be considered as entities belonging to large groups.

4. 4. On the other hand, it may also be noted that 297 entities (~2/3^rd of the total number of entities) have less than ten subsidiaries/associates/holding companies in totality.

Several countries have cross-shareholdings as a major form of group structure. However, in India, the pyramid structure, mainly revolving around holding company-subsidiary relationships, is the most common construct of company group structures as can be seen from the data above.

Definition of ‘company groups'

While the term ‘company group’ per se is not defined in company law/accounting law/securities law in India, the terms group company4’, ‘holding company5’, ‘subsidiary6’ and ‘associate company7 have been defined under the Companies Act, 20138/SEBI Regulations/Indian Accounting Standards.

The following two main criteria have been laid down under the Companies Act, 2013 for determining whether a company is a subsidiary of another company:

1. 1. control over the composition of the board of directors of such company

2. 2. exercise/control over more than one-half of the total share capital of such company (whether directly or together with one or more of its subsidiary companies)

For the determination of whether a company is an associate company of another company, the test of ‘significant influence’ is laid down under the Companies Act, 2013. Therefore, a company is considered to be an associate of another company if such other company has a significant influence in it (but which is not its subsidiary company). Significant influence has been defined to means control of at least 20 percent of total share capital, or of business decisions under an agreement.

Legal requirements and concerns

While the legal requirements have been detailed in section two of this chapter, broadly, India has several legal/regulatory requirements with respect to group entities (holding companies/subsidiaries/associates).

Quite a few legal requirements have been laid down for all companies—listed and unlisted, public and private—under the Companies Act, 2013. Therefore, in case of group structures, which constitute only unlisted companies, the provisions of the Companies Act, 2013 will apply to all such companies in the group. However, if any of the entities in the group is a listed entity, additional requirements are laid down in SEBI Regulations with respect to such structures with a view to protect the interest of the public investors.

In case of listed entities, the requirements significantly differ if the listed entity itself is a holding company vis-à-vis a structure whether the listed entity is a subsidiary of another company as explained in detail in section two of this chapter.

The legal requirements and issues of concern differ depending on the characteristics of the group. The legal/regulatory requirements with respect to a holding company-subsidiary relationship are generally much higher compared to that with/between associates.

While the concerns regarding complex group structures have been detailed in section two, broadly, the concerns on group structures in India are largely similar to the concerns globally on such structures such as lack of transparency, potential abuse of related party transactions, etc.

Main elements and rationale for the current regulatory approach

Regulatory requirements—Overview

The Companies Act, 2013 and SEBI Regulations address specific situations in the company group context, broadly:

1. 1. requirements with respect to all companies under the Companies Act, 2013

2. 2. additional requirements if one or more listed entity/entities is part of the group (under SEBI Regulations):

   1. a. requirements if the listed entity is the holding company and has subsidiaries

   2. b. requirements if the listed entity itself is a subsidiary (i.e. it has a holding company/where another company is its ‘promoter’ (it may be noted that the term ‘promoter’9 may be largely unique to India)

Specific regulatory requirements

The specific regulatory requirements as per the aforesaid classification are as under:

• Legal requirements for all companies under Companies Act, 2013:

The legal requirements with respect to subsidiaries, associates and holding companies in Companies Act are given below:

1. 1. Restriction on the number of layers of subsidiaries10: Accordingly, no company shall have more than two layers of subsidiaries, excluding one layer of wholly owned (100%) subsidiaries.

2. 2. Subsidiary company not to hold shares in its holding company.11 No company shall, either by itself or through its nominees, hold any shares in its holding company and no holding company shall allot or transfer its shares to any of its subsidiary companies and any such allotment or transfer of shares of a company to its subsidiary company shall be void (subject to certain conditions).

3. 3. Mandatory annual consolidation of accounts and disclosure of subsidiary accounts12: Where a company has one or more subsidiaries, in addition to annual standalone financial statements, it is required to prepare a consolidated financial statement of the company and of all the subsidiaries (listed/unlisted) in the same form and manner as that of its own. Such financial statements are required to be presented to the annual general meeting of the company along with the presentation of its financial statements. (It may be noted that listed entities are mandatorily required to submit consolidated accounts on a quarterly basis under SEBI Regulations.)

4. 4. Disclosure of subsidiary accounts13: Every company having a subsidiary or subsidiaries is required to:

   • place separate audited accounts in respect to each of its subsidiary on its website, if any;

   • provide a copy of separate audited financial statements in respect to each of its subsidiaries, to any shareholder of the company who asks for it. Further, a company is required to, along with its financial statements to be filed with the Registrar, attach the accounts of its subsidiary or subsidiaries that have been incorporated outside India and which have not established their place of business in India.

5. 5. Disclosures pertaining to subsidiaries, holding companies and associates in the Annual report on shareholding, current investments, dividends, provisions for losses etc.14 and disclosure of various particulars of subsidiary companies in the annual return submitted to the Registrar of Companies15

6. 6. Provisions pertaining to merger and amalgamation of companies, including between a holding company and its wholly owned subsidiary.16

7. 7. Conditions with respect to related party transactions such as consent of the Board of Directors, shareholder’s approval (majority of minority), disclosures, etc. apply to transactions of the company with its holding company/ subsidiary/ associate companies (if not in ordinary course of business or not at arm’s length). However, shareholders’ approval is not required for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval. The detailed framework for related party transactions is given in section 4.

8. 8. Employee Stock Options may be provided to the directors, officers or employees of a company’s holding company or its subsidiary17.

9. 9. Restrictions on buyback of own shares through subsidiaries18.

10. 10. Restriction on investment through more than two layers of investment companies: A company, unless otherwise prescribed, is not permitted to make investment through more than two layers of investment companies. However, certain exemptions are given in this respect19.

11. 11. Conditions for determining the independence of a director for appointment on the Board of Directors of a company as an Independent Director includes checks on relationship/ interest of such director with respect to holding, subsidiary or associate company as well20.

12. 12. Debar on appointment of auditor associated with holding/ subsidiary/ associate companies21, right of access to records of subsidiaries is given to auditors22 and restrictions are placed on auditors of a company providing non-audit services to its holding / subsidiary company23.

13. 13. Restriction on non-cash transactions with directors is also applicable to directors of holding/ subsidiary/ associate companies24.

14. 14. Every company is required to keep at its registered office, a register containing such particulars of its directors and key managerial personnel as may be prescribed, which shall include the details of securities held by each of them in the company or its holding, subsidiary, subsidiary of company‘s holding company or associate companies25.

These generally apply to all companies—unlisted and listed. Nevertheless, some of the provisions may apply only to a certain set of companies e.g. companies exceeding a certain size.

• Additional legal requirements with respect to listed entities where the listed entity is a holding company:

If a listed entity has a subsidiary/subsidiaries, apart from the requirements under the Companies Act, 2013, additional requirements are specified for listed entities under the SEBI LODR Regulations. The detailed requirements under the SEBI LODR Regulations are given below:

1. 1. Concept of material subsidiaries (whose income or net worth exceeds 10% of the consolidated income or net worth respectively).26

2. 2. Mandatory consolidation of accounts on a quarterly basis (with effect from 1 April 2019) In this respect, the statutory auditor of a listed entity is required to undertake a limited review of the audit of all the entities/ companies whose accounts are to be consolidated with the listed entity. Further, the listed entity is required to disclose the effect on the financial results of material changes in the composition of the listed entity, if any, including but not limited to business combinations, acquisitions or disposal of subsidiaries and long term investments, any other form of restructuring and discontinuance of operations.27

3. 3. Criteria for determining independence of an independent director includes a check on whether such director/ his relatives is related to the holding/ subsidiary/ associate company including pecuniary relationships, key managerial positions etc.28

4. 4. Stricter norms for related party transactions vis-à-vis the requirements under Companies Act, 2013 such as related parties (whether or not they are related to that particular transaction) not being permitted to vote to approve when material transactions are put to vote to shareholders, increased disclosures etc. The detailed framework for related party transactions is given in section 4.

5. 5. Detailed obligations on the listed entity, its board of directors and audit committee with respect to the subsidiaries and certain powers given to the shareholders of the listed entity, including, inter-alia, the following29:

   • An independent director on the board of the listed entity to be appointed on the board of material unlisted subsidiaries (Specifically for this provision, the threshold for material subsidiary is considered as 20%).

   • Obligation on the audit committee to review financial statements of unlisted subsidiaries (especially investments made by subsidiaries) and to review utilisation of loans to/advances to/investments in the subsidiaries exceeding a certain threshold.

   • Obligation on the board of directors of the listed entity with respect to minutes of board meetings of the unlisted subsidiaries, significant transactions & arrangements by the unlisted subsidiaries, sale of subsidiaries which are material and not in normal course of business.

   • Restriction on disposal of shares in material subsidiaries.

   • Restrictions on sale/disposal/leasing of material assets of a material subsidiary.

   • Provisions to apply to listed subsidiaries which are itself holding companies in respect to their subsidiaries.

   • Secretarial audit for material unlisted subsidiaries along with that of the listed entity by a practicing company secretary.

   • Group governance unit/Committee/policy (discretionary requirement).30

   • Listed entity to disclose separate audited financial statements of each subsidiary on its website in respect of a relevant financial year, uploaded at least 21 days prior to the date of the annual general meeting which has been called to inter-alia consider accounts of that financial year.

   • Disclosure of all events or information with respect to a subsidiary, which are material for the listed entity. In this regard, sale or disposal of any subsidiary of the listed entity is deemed to be a material event, requiring disclosure to the stock exchanges.

   • Disclosure in the annual report of the listed entity, of the total fees for all services paid by the listed entity and its subsidiaries, on a consolidated basis, to the statutory auditor and all entities in the network firm/network entity of which the statutory auditor is a part.

   • Detailed norms with respect to schemes of arrangement where one or more of the entities are listed entities (not applicable for merger of a wholly owned subsidiary with its holding company subject to filing of the schemes with the stock exchanges).

• Legal requirements with respect to listed entities where listed entity is itself a subsidiary/ has a parent company/ promoter:

In India, most of the listed entities have ‘promoters’. The term 'promoters' in India is generally used to denote those persons instrumental to the time of formation of the company and those who are in control of the company, through shareholding and/or management or otherwise. Therefore, a company who is in control of a listed entity (including a holding company having control over the listed entity) is termed as a ‘promoter’ of that entity.

Several SEBI Regulations impose obligations on the promoters as well as on the listed entities with respect to such promoters.

Some of the major obligations/requirements on the listed entity with respect to promoters are as under:

1. 1. Related party transactions: In case of transactions with promoters who are related parties, stringent norms such as approval from the audit committee, approval from shareholders (for material transactions where related parties31 are not permitted to vote to approve the resolution), disclosures, etc. apply.

2. 2. Disclosures on transactions with certain promoters: The annual report of a listed entity is required to include disclosures of transactions of the listed entity with any person or entity belonging to the promoter/promoter group which hold(s) 10% or more shareholding in the listed entity.

3. 3. Independence criteria: The listed entity must ensure a certain minimum number of independent directors on its board of directors. One of the tenets of independence is that they should not be related to the promoters of such listed entity/its holding company.

4. 4. Disclosure of shareholding of promoters/promoter group: All entities falling under promoter and promoter group are required to be disclosed separately in the shareholding pattern submitted by the listed entities to the stock exchanges.

5. 5. Conditions for re-classification: A listed entity is permitted to re-classify a promoter/person belonging to promoter group as a public shareholder only on satisfaction of certain conditions.

6. 6. Disclosures of promoter related material events: Certain events such as fraud/defaults by promoter are deemed to be material events and are required to be disclosed by the listed entity to the stock exchanges as soon as possible but no later than 24 hours of occurrence of the event.

7. 7. Restriction on remuneration to promoter executive directors: The fees or compensation payable to executive directors who are promoters or members of the promoter group, are subject to the approval of the shareholders by special resolution in general meeting, if (i) the annual remuneration payable to such executive director exceeds INR 50 million or 2.5% of the net profits of the listed entity, whichever is higher; or (ii) where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5% of the net profits of the listed entity.

Some major obligations/restrictions on promoters with respect to a listed entity are as under:

1. 1. A certain minimum contribution required from promoters in case of a public issue and lock-in provision on such contribution to ensure ‘skin-in-the-game’.

2. 2. Restrictions on preferential allotment of securities to promoters.

3. 3. Detailed disclosure obligations on the promoters with respect to changes in their shareholding, change in control, etc., especially keeping in mind requirements under SEBI's Takeover and the Prohibition of Insider Trading Regulations.

4. 4. Restrictions/conditions imposed with respect to sale of shares by promoters if such persons are ‘insiders’ as per the Prohibition of Insider Trading Regulations.

5. 5. Contravention of SEBI Regulations, circulars, etc. may invite freezing of shareholding of promoters/promoter group entities.

Monitoring of financial conglomerates

The importance of addressing systemic risk and supervising Financial Conglomerates came to the forefront subsequent to the 2008 global financial crisis. Monitoring of Financial Conglomerates (FC) got a renewed focus in India with the establishment of the sub-group of Inter Regulatory Forum, under the aegis of FSDC (Financial Stability and Development Council) Sub Committee. Financial conglomerate supervision involves assessment of systemic risk posed by a FC group; the focus here being inter-connectedness of group entities and inter-linkages in the financial system.

An FC is defined “on the basis of its significant presence in two or more market segments out of 5 segments (namely, Banking, Insurance, Capital Market, Non-Banking Finance and Pension Fund)”. Based on the criteria for identifying financial conglomerates, certain groups have been identified as FCs in India with different regulators acting as the Principal regulators for different FCs depending on the major segments of business.

One of the key processes of existing FC monitoring mechanism includes holding discussions with the executives of the identified FC Group on a regular intervals. These discussions with FC group executives provide the opportunity to understand the Group’s focus & business strategy as well as to discuss issues like conglomerates’ risk management strategies, system of monitoring of intra-group transactions and exposures, among others and also communicate supervisory concerns, if any.

Rationale for regulatory approach—Important issues and concerns with respect to company groups

As stated earlier, group structures around the world, while having several benefits to various stakeholders, may also give rise to several areas of concern. Many of the issues that have plagued group structures around the world have examples in the Indian context too.

Accordingly, many issues and concerns have been debated and discussed in detail in India in the context of company groups which form the broad foundation for the specific legal requirements with respect to company groups as stated above.

A major concern in complex group structures is the lack of transparency and opaqueness in approach, governance, finances, strategy, etc. The Kotak Committee on corporate governance, in its report to SEBI dated 5 October 201732 made detailed recommendations to SEBI on enhanced monitoring of group entities and improvement in group governance. The broad rationale of the Committee on these recommendations is reproduced below:

“As companies grow in scale and operations go global, businesses become more complex. Business and structural compulsions (both legal and financial) often necessitate the creation of holding and operating entities. The Committee notes that several listed entities in India operate through a network of entities--where some companies have over 200 subsidiaries, step-down subsidiaries, associates, and joint ventures. While investors hold direct equity only in the listed holding company, they have valued the entire business structure at the time of investment. Therefore, it is important for boards to ensure that good governance trickles down to the entire structure. Accordingly, to provide for better transparency on the governance levels of downstream investee entities of the listed entity and to improve the monitoring of the listed entity at a consolidated level, the following recommendations have been made by the Committee….”

Such complexities and opaqueness often present an opportunity to camouflage the actual financials, usage of funds, flow of funds, intra-group transactions, leverage, etc. across the group which may get submerged in the myriad of information that such structures often present. Such opaqueness and complexity in information affect not just the shareholders but a large number of stakeholders including lenders and even the regulators/tax department/government. It is also possible that some of the groups may use such complex structuring for potential diversion of funds, avoidance of tax, concealment of actual leverage, etc.

Another concern that such group structures often generate a potential abuse of related party transactions, especially by the controlling/dominant shareholders to the detriment of the minority shareholders. Similar concerns also exist in India, which are exacerbated by the existence of a large number of promoter-led companies in India. Hence, it may be observed that regulatory requirements with respect to related party transactions are very stringent in India, especially in comparison to global requirements.

Disclosure and the right to information

As is in most of the countries in the world, India has a disclosure based regulation. A disclosure based approach to regulation needs to be dynamic and evolutionary since the essence is in the disclosure. Therefore, SEBI has been continuously focusing its efforts to build robust disclosure practices by trying to have a dynamic approach to regulation. The Ministry of Corporate Affairs has also, on its part, made a giant stride with the new Companies Act, 2013. These efforts have contributed to India being ranked 7^th in the world on the parameter 'Protecting Minority Investors'33as per the latest rankings of World Bank with respect to ‘Ease of Doing Business’.

Disclosure of capital structures and control arrangements of the company

Capital structures and control arrangements and changes thereon are reflected from the disclosures relating to financial results and shareholding patterns filed by companies periodically.

Disclosure of capital structures and control arrangements provide two major sources of information relevant to company group structures:

1. 1. Disclosures of shareholding pattern of a company gives an insight into the holding structure of that company thereby providing a bird’s eye view of companies in the group which are in control of the concerned company in the group structure.

2. 2. Disclosures of investments/assets of a company gives an insight into the holding by the company into subsidiaries/layers of subsidiaries in the group which are controlled by the concerned company in the group structure.

Accordingly, the regulatory requirements in India with respect to disclosure of shareholding and control arrangements of a company largely focus on disclosures on both the above areas. Details of the same are given hereunder:

1. 1. Disclosure of shareholding pattern:

   1. a. Disclosure of shareholding pattern of a company is required both under Companies Act, 2013 (applicable to all companies) and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (applicable to listed entities).

   2. b. Such disclosures, inter-alia, include the following:

As per Companies Act, 2013, in the annual return34

1. i. Category-wise shareholding e.g. promoters (Indian / foreign), public shareholders (institutions / non-institutions), etc.

2. ii. Detailed requirements with respect to shareholding of promoters including names of the promoters, shareholding, shares pledged/encumbered, change in promotor shareholding (shareholding at the beginning and end of the year, date-wise increase / decrease specifying reasons), etc.

3. iii. Details of top ten shareholders.

4. iv. Shareholding of directors and key management personnel

As per Companies Act, 2013, in financial statements35:

1. v. For each class of share capital, the following is required to be disclosed:

   • shares in respect of each class in the company held by its holding company or its ultimate holding company including shares held by or by subsidiaries or associates of the holding company or the ultimate holding company in aggregate

   • shares in the company held by each shareholder holding more than 5% shares specifying the number of shares held

As per SEBI LODR Regulations, on a quarterly basis36:

1. 1. 1. vi. A summary statement of shareholding, including:

         • Category-wise breakup (promoter & promoter group, public shareholders)

         • Fully-paid up, partly paid up shares

         • Number of Voting Rights held in each class of securities

         • Number of Shares pledged or otherwise encumbered

         • Number of Locked in shares

      2. vii. Detailed disclosures on shareholding of promoter and promoter group

      3. viii. Detailed disclosures on shareholding of public shareholders including break-up of holding by institutions, government and non-institutions (Names of the shareholders holding 1% or more than 1% of shares of listed entity are to be disclosed in public category)

   2. c. In addition to the immediate shareholders of the company, as stated above, Companies Act, 201337 and SEBI LODR Regulations also require disclosure of details of significant beneficial owners (holding directly or indirectly at least 10% of the shares) of the company.

   3. d. In addition to the above, SEBI Takeover Regulations also require regular disclosures, from time to time, if a person/persons acting in concert acquire(s) shares or voting rights in a company beyond a certain threshold. These Regulations also require detailed disclosures to be made with respect to pledge / encumbrance of the shares of promoters.

2. 2. Disclosure of subsidiaries/associates/joint ventures:

   1. a. Under annual disclosures by a company required as per the Companies Act, 201338:

      1. i. Disclosures in the balance sheet under ‘Investments’ need to specifically include names of the subsidiaries (including step-down subsidiaries) in which investments have been made and the nature and extent of the investment so made.

      2. ii. Disclosures in the consolidated financial statements also include detailed disclosures on the share of the subsidiaries, associates and joint ventures in the consolidated net assets, profit and loss, etc. This ensures disclosures pertaining to not only the subsidiaries of the company but also its associates and joint ventures.

      3. iii. A company is also required to additionally disclose a list of subsidiaries or associates or joint ventures which have not been consolidated in the consolidated financial statements along with the reasons for not consolidating.

   2. b. Additionally, SEBI has recently mandated listed entities to submit consolidated results every quarter, which ensures an overall picture of the listed entity and its subsidiaries taken together.

Facets of control other than shareholding

While the disclosures pertaining to shareholding of the company as specified above address one facet of control of the company, holding companies/promoters may also exercise control through other facets. Therefore, disclosure of such other facets are also equally important for a stakeholder to understand the details of the entities who exercise control over the company through non-shareholding facets.

Two major such facets of control are through differential voting rights and shareholder agreements. There are regulatory requirements pertaining to the same in India which are detailed hereunder:

1. Disclosure of voting rights

While Companies Act, 2013 permits a company to have share capital with differential rights as to dividend, voting or otherwise, it is subject to certain conditions. With respect to disclosures of such structures, disclosure of shareholding pattern of a company needs to be separate for each class of shares (including those with differential voting rights).

It may be noted that while dual class shares are permitted to be issued in India (subject to certain conditions), the same is not yet prevalent in India and only a handful of companies have adopted the same. With respect to the listed entities and entities intending to list, SEBI has recently issued a framework for issuance of superior voting rights shares (SR shares); the key provisions are as given below:

a. Eligibility: A company having SR shares is permitted to do an initial public offering (IPO) of only ordinary shares to be listed on the Main Board, subject to fulfilment of eligibility requirements of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (SEBI ICDR Regulations) and the following conditions:

• The issuer company is a tech company i.e. intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition.

• The SR shareholder should not be a part of the promoter group whose collective net worth exceeds INR 5 billion. While determining the collective net worth, the investment of SR shareholders in the shares of the issuer company shall not be considered.

• The SR shares have been issued only to the promoters/ founders who hold an executive position in the company.

• The issue of these SR shares has been authorized by a special resolution passed at a general meeting of the shareholders.

• SR shares have been held for a period of at least 6 months prior to the filing of Red Herring Prospectus (RHP).

• SR shares have voting rights in the ratio of minimum 2:1 to maximum 10:1 compared to ordinary shares.

b. Listing and Lock-in: SR shares shall also be listed on Stock Exchanges after the issuer company makes a public issue. However, SR shares shall be under lock-in after the IPO until their conversion to ordinary shares. Transfer of SR shares among promoters is not permitted. No pledge/ lien is allowed on SR shares.

c. Rights of SR shares: SR shares shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions. The total voting rights of SR shareholders (including ordinary shares), post listing, shall not exceed 74%.

d. Enhanced corporate governance: Companies having SR shareholders shall be subject to enhanced corporate governance as follows:

• At least ½ of the Board and 2/3^rd of the Committees (excluding Audit Committee) as prescribed under SEBI LODR Regulations shall comprise of Independent Directors.

• Audit Committee shall comprise of only Independent Directors.

e. Coat-tail Provisions: Post-IPO, the SR Equity Shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one SR share shall have only one vote) in the following circumstances:

• Appointment or removal of independent directors and/or auditor

• In case where promoter is willingly transferring control to another entity

• Related Party Transactions in terms of SEBI LODR Regulations involving SR shareholder

• Voluntary winding up of the company

• Changes in the company’s Article of Association or Memorandum - except any changes affecting the SR instrument

• Initiation of a voluntary resolution plan under IBC

• Utilization of funds for purposes other than business

• Substantial value transaction based on materiality threshold as prescribed under LODR

• Passing of special resolution in respect of delisting or buy-back of shares; and

• Any other provisions notified by SEBI in this regard from time to time.

f. Sunset Clauses: SR shares shall be converted into ordinary shares in following circumstances/ events:

• Time Based: The SR shares shall be converted to Ordinary Shares on the 5th anniversary of listing. The validity can be extended once by 5 years through a resolution. SR shareholder would not be permitted to vote on such resolutions.

• Event Based: SR shares shall compulsorily get converted into ordinary shares on occurrence of certain events such as demise, resignation of SR shareholders, merger or acquisition where the control would be no longer with SR shareholder, etc.

g. Fractional Rights Shares: Issue of fractional rights shares by existing listed companies is not allowed. The need for allowing issue of fractional rights shares by listed companies may however be reviewed after gaining enough experience with the use of SR shares.

2. Disclosure of shareholder agreements

Under the SEBI ICDR Regulations, at the time of an IPO, the offer document is required to contain the key terms of all subsisting shareholders’ agreements, if any (to be provided even if the issuer is not a party to such an agreement, but is aware of such an agreement). Subsequent to listing of the securities, any shareholder agreements (to the extent that it impacts management and control of the listed entity) are required to be disclosed as material events within the timelines as specified. These two requirements ensure disclosures pertaining to shareholder agreements both before and after an IPO.

Additionally, agreements of the promoters/controlling shareholders whereby they pledge their shares to a third party may impact the nature of control such person exercises over the said company. Therefore, disclosures have also been required under the SEBI LODR Regulations and the SEBI Takeover Regulations, with respect to promoters encumbering the shares they hold in the company.

Right to information about other entities in the group

The right of information that various entities in the group (including promoters/controlling shareholders/subsidiaries) have with respect to other entities in the group and the overall flow of information between various companies in the group signify the nature and extent of relations between the companies in the group. Therefore, the regulatory requirements surrounding such right to information assumes paramount importance.

Generally, with respect to such right for information, the following are two major types of information that may be sought from a company:

1. 1. information which is already in the public domain (disclosed by the company to the stock exchanges)

2. 2. information which is unpublished and price sensitive.

In the first case, the issue of seeking such information from the company may not arise since the same is already in the public domain.

In the second case, in India, there are several restrictions on seeking of such information from the company under the SEBI (Prohibition of Insider Trading) Regulations, 2015 . The broad requirements in this regard are as under:

1. 1. No insider shall communicate, provide or allow access to any unpublished, price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.

2. 2. The board of directors of a listed company shall make a policy for determination of “legitimate purposes” as a part of “Codes of Fair Disclosure and Conduct” formulated under the SEBI (Prohibition of Insider Trading) Regulations.

3. 3. Any person in receipt of unpublished price sensitive information pursuant to a “legitimate purpose” shall be considered an “insider” for purposes of these regulations and due notice shall be given to such persons to maintain confidentiality of such unpublished price sensitive information in compliance with these regulations.

4. 4. The board of directors shall ensure that a structured digital database is maintained containing the names of such persons or entities as the case may be with whom information is shared under this regulation along with the Permanent Account Number or any other identifier authorised by law where Permanent Account Number is not available. Such databases shall be maintained with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering of the database.

Accordingly, any person (including subsidiaries, shareholders, etc.) may seek unpublished price sensitive information from the company and obtain such information only if it satisfies the conditions as specified above along with other trading restrictions as specified in the Prohibition of Insider Trading Regulations.

Intra-group transactions, guarantees and commitments

While section three provides regulatory requirements with respect to disclosures on control arrangement between various companies in the group, section four attempts to provide details of regulatory requirements with respect to transactions between such companies in the group.

Transactions between various companies in the group, which could be in the nature of sale of goods/services, purchase/lease of property, borrowing relationships, including guarantees, allocation of costs, often provide several advantages to the companies in terms of economies of scale, lower transaction costs, etc. Hence, related party transactions are a normal feature of business in company groups and often have a significant impact on the financial position of the company/group. Notwithstanding these advantages, such transactions also have a significant potential for abuse in view of conflict of interest involved. Hence, regulators across the world have attempted to introduce requirements in order to have a check on such abuse.

In India, a majority of companies continue to be promoter–driven entities with significant shareholding being held by the promoter/promoter group. Therefore, protection of the interests of minority shareholders, especially those of the retail shareholders assumes even more importance. In this context, checks and balances on related party transactions are crucial for good governance of the companies and to prevent abuse by majority shareholders/related parties. Therefore, India has stringent requirements with respect to related party transactions for companies, especially listed entities.

Regulatory provisions with respect to related party transactions in India

Both the Companies Act, 201339 and SEBI LODR Regulations40 have several stringent requirements with respect to related party transactions. A summary of such requirements in placed below:

1. 1. Approval of the audit committee and the board: Under SEBI LODR Regulations, all related party transactions by a listed entity require prior approval of the audit committee. Nevertheless, for repetitive transactions, the audit committee is permitted to grant omnibus approval for related party transactions proposed to be entered into by the listed entity subject to certain conditions.

2. 2. After approval of the audit committee, certain transactions are also required to be approved by the board of directors of the company (Companies Act 2013).

3. 3. Approval of shareholders for material transactions: In case of material related party transactions, approval of shareholders is required both under Companies Act, 2013 (for all companies) and SEBI LODR Regulations (for listed entities). Specific thresholds have been laid down under the Companies Act, 2013 and rules specified thereunder and under SEBI LODR Regulations for determination of materiality of the transactions.

4. 4. Voting by shareholders (majority of minority): In order to ensure protection of interest of minority shareholders, the Companies Act, 2013 requires that no shareholder shall vote on a resolution, to approve any contract or arrangement which may be entered into by the company, if such member is a related party.

5. 5. SEBI LODR Regulations, applicable to listed entities, have more stringent requirements wherein a related party is not permitted to vote to approve a resolution, whether the entity is a related party to the particular transaction or not.

6. 6. Disclosure of related party transactions: Both Companies Act, 2013 and SEBI LODR Regulations have detailed norms with respect to disclosure of related party transactions on an annual basis. Additionally, for listed entities, recently, disclosures on related party transactions have been made mandatory every half-year and on a consolidated basis.

It may be noted that SEBI has on 27 January, 2020, placed for public comments a consultative paper with respect to related party transactions.

Disclosure with respect to guarantees

Under Companies Act, 2013, there are detailed provisions under various Sections41 which provide for restrictions, disclosures, approval and other requirements with respect to a guarantee given by a company. Such disclosures and other requirements with respect to guarantees are applicable to any guarantee/surety provided by the company to any person, irrespective of whether or not the person is part of the company group. Nevertheless, if the same is a related party transaction, the aforesaid provisions on related party transactions shall apply.

Disclosures of guarantees primarily form a part of the contingent liabilities in the balance sheet of the company. Further, it may also be noted that in general, the accounting standards with respect to off-balance sheet items have been strengthened under the new Ind-AS accounting standards modelled on the lines of IFRS adopted globally.

Under SEBI LODR Regulations, giving of guarantees or indemnity or becoming a surety for any third party is required to be disclosed by a listed entity as a material event (to be disclosed as soon as possible, not exceeding 24 hours from the date of occurrence of the event) if the same is material as per the materiality policy of the entity.

It may be noted that SEBI has on 6 March, 2020, placed for public comments, a consultative paper with respect to guarantees provided by a listed entity.

Implementation and monitoring of risk management, control systems and group policies

In general, the board of directors of a company is expected to ensure that appropriate systems of control are in place, in particular, systems for risk management, financial and operational control as far as that specific company is concerned. However, in a group structure, countries differ on obligations of the board of directors of the company as far as overseeing, monitoring and evaluating the implementation of existing risk management systems and compliance with law and relevant standards within the group (especially its subsidiaries) are concerned.

In India, certain basic obligations have been laid down on the board of directors of a company under Companies Act, 2013 as far as development and implementation of a risk management policy for the company is concerned including identification therein of elements of risk, if any, which in the opinion of the board may threaten the existence of the company. Further, under the Companies Act, 2013, an obligation has been imposed on the audit committee to evaluate the internal financial controls and risk management systems.

Under SEBI LODR Regulations (applicable to listed entities), there are certain general obligations on the board of directors (including board committees) with respect to risk management and control as well as specific obligations with respect to subsidiaries:

1. 1. General obligations on the board of directors (including board committees) with respect to risk management and control:

   1. a. The functions of board of directors including reviewing and guiding of risk policy and ensuring the integrity of the listed entity’s accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for risk management, financial and operational control, and compliance with the law and relevant standards.

   2. b. The listed entity is required to lay down procedures to inform members of board of directors about risk assessment and minimisation procedures.

   3. c. The board of directors is responsible for framing, implementing and monitoring the risk management plan for the listed entity.

   4. d. The role of the audit committee includes evaluation of internal financial controls and risk management systems.

   5. e. The board of directors of the top 500 listed entities (based on market capitalisation) are required to constitute a Risk Management Committee. The board of directors is required to define the role and responsibility of the Risk Management Committee and may delegate monitoring and reviewing of the risk management plan to the committee and such other functions as it may deem (including cyber security).

2. 2. Specific obligations on the board of directors (including board committees) with respect to subsidiaries, especially with respect to risk management and control:

   Certain specific obligations with respect to subsidiaries have been specified in SEBI LODR Regulations (primarily Regulation 24) as under:

   1. a. At least one independent director on the board of directors of the listed entity is required to be a director on the board of directors of an unlisted material subsidiary (income/net worth exceeding 20% of the consolidated value).

   2. b. The audit committee of the listed entity is required to review the financial statements, in particular, the investments made by the unlisted subsidiary.

   3. c. The minutes of the meetings of the board of directors of the unlisted subsidiary is required to be placed at the meeting of the board of directors of the listed entity.

   4. d. The management of the unlisted subsidiary is required to periodically bring to the notice of the board of directors of the listed entity, a statement of all significant transactions and arrangements (exceeding 10% of total revenues/expenses/assets/liabilities of the unlisted subsidiary) entered into by the unlisted subsidiary.

   5. e. Where a listed entity has a listed subsidiary, which is itself a holding company, the aforesaid provisions apply to the listed subsidiary in so far as its subsidiaries are concerned.

   6. f. The audit committee is required to review the utilisation of loans and/or advances from/investment by the holding company in the subsidiary exceeding INR 1 billion or 10% of the asset size of the subsidiary, whichever is lower.

Additionally, where the listed entity has a large number of unlisted subsidiaries, SEBI has issued a circular stating that:

1. a. The listed entity may monitor their governance through a dedicated group governance unit or Governance Committee comprising the members of its board of directors.

2. b. A strong and effective group governance policy may be established by the entity.

3. c. The decision of setting up of such a unit/committee or having such a policy shall lie with the board of directors of the listed entity.

However, it may be noted that the aforesaid requirement of group governance unit/committee/policy is not mandatory on the listed entity. It is the discretion of the listed entity as to whether or not to have such a unit/committee/policy.

Conclusion

The Indian Government and regulators have, over the years, acknowledged various concerns with respect to group structures and have actively introduced various requirements in order to strengthen the governance at the group level. The cap on the maximum number of subsidiaries has been a landmark step in this direction. The requirements prescribed by SEBI with respect to related party transactions by listed entities are one of the most stringent in the world.

Various recent steps of SEBI and the Government also show the focus of India in this direction. For instance, keeping in mind the realities and concerns with respect to information sharing within the group, requirements with respect to information sharing have recently been issued by SEBI under its Insider Trading Regulations. In case a listed entity has many subsidiaries, SEBI has also laid down that the entity may, at its discretion, form a group governance/unit/policy for improving group governance. Other recent initiatives such as strengthening of related party definition and disclosures, mandatory consolidated quarterly financial results, enhanced role of the audit committee to review utilisation of loans/advances/investments to subsidiaries, etc. are also measures which go to exemplify the emphasis on group governance.

Nevertheless, capital markets and the business environment are very dynamic, and robust disclosure, monitoring and enforcement regimes need to evolve to contribute positively to the transparency and efficiency of the corporate framework. India has, particularly during the past few years, zealously pursued such a regime so as to ensure clean disclosures and improved governance so that they add value to all stakeholders. The only way is forward.

References

Ministry of Corporate Affairs of India (2013), India Companies Act 2013, http://ebook.mca.gov.in/default.aspx.

OECD (2015), G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, https://doi.org/10.1787/9789264236882-en.

SEBI (2019), List of all SEBI regulations, https://www.sebi.gov.in/sebiweb/home/HomeAction.do?doListing=yes&sid=1&ssid=3&smid=0.

SEBI (2018), Circular of 10 May, https://www.sebi.gov.in/legal/circulars/may-2018/circular-for-implementation-of-certain-recommendations-of-the-committee-on-corporate-governance-under-the-chairmanship-of-shri-uday-kotak_38905.html

SEBI (2017), Report of the committee on corporate governance, https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

World Bank (2019), World Bank Doing Business Database on India, http://www.doingbusiness.org/en/data/exploreeconomies/india

Notes

← 1. The term ‘listed entities’ is used in SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 to refer to all entities, in whatever legal form (company or otherwise), which are listed on a recognised stock exchange.

← 2. Based on the data provided by National Stock Exchange based on the latest available submissions by these entities.

← 3. Based on the annual reports submitted to the National Stock Exchange and the annual returns filed under the Companies Act, 2013.

← 4. Refer to regulation 2 (1) (t) of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 for the definition of ‘group company’, available at the following link: https://www.sebi.gov.in/legal/regulations/jan-2020/securities-and-exchange-board-of-india-issue-of-capital-and-disclosure-requirements-regulations-2018-last-amended-on-january-01-2020-_41542.html.

← 5. Refer to section 2 (46) of Companies Act, 2013 for the definition of ‘holding company’, available at the following link: http://ebook.mca.gov.in/default.aspx.

← 6. Refer to section 2 (87) of Companies Act, 2013 for the definition of ‘subsidiary / subsidiary company’. The concept of a subsidiary is also significant from the point of view of presentation of financial statements. The Indian Accounting Standard 27 (IAS 27), which is also converged with the IFRS, specifies that the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity are consolidated financial statements. The IAS 110, which deals with consolidated financial statements, states that:

An investor (read 'holding company') controls an investee (read 'subsidiary company') if and only if the investor has all the following:

(a) power over the investee;

(b) exposure, or rights, to variable returns from its involvement with the investee; and

(c) the ability to use its power over the investee to affect the amount of the investor’s returns.

The IAS 110 also states that an investor that holds more than half of the voting rights of an investee has power over the investee.

← 7. Refer to section 2 (6) of Companies Act, 2013 for the definition of ‘associate company’.

← 8. The company law in India was governed by the Companies Act, 1956 for more than 50 years, till it was replaced, recently in 2013, by the Companies Act, 2013. So, though most of the companies that exist today in India, including their subsidiaries, have been incorporated under the provisions of the Companies Act, 1956, for the purpose of this paper, provisions of the extant law i.e. the Companies Act, 2013 are referred to.

← 9. According to section 2(69) of the Companies Act, 2013 the term ‘Promoter’ has been defined as:

A person who has been named as such in a prospectus or is identified by the company in the annual return in section 92; or

A person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or

A person who is in agreement with whose advice, directions or instructions the board of directors of the company is accustomed to act.

← 10. This is a new requirement in Indian Company law; there were no such restrictions in the previous Company law. For detailed provisions, refer to section 2 (87) of the Companies Act, 2013 read with Companies (Restriction on number of layers) Rules, 2017.

← 11. Section 19 of the Companies Act, 2013

← 12. Section 129 (3) of the Companies Act, 2013

← 13. Sections 136 (1) and 137 (1) of the Companies Act, 2013

← 14. Schedule III of the Companies Act, 2013

← 15. Section 92 (1) of the Companies Act, 2013

← 16. Section 233 of the Companies Act, 2013

← 17. Section 2 (37) of the Companies Act, 2013

← 18. Section 70 (1) (a) of the Companies Act, 2013

← 19. Section 186 (1) of the Companies Act, 2013

← 20. Section 149 (6) of the Companies Act, 2013

← 21. Section 141 (3) of the Companies Act, 2013

← 22. Section 143 (1) of the Companies Act, 2013

← 23. Section 144 of the Companies Act, 2013

← 24. Section 192 (1) of the Companies Act, 2013

← 25. Section 170 (1) of the Companies Act, 2013

← 26. Regulation 16 (1) (c) of SEBI LODR Regulations

← 27. Regulation 33 and Schedule IV of SEBI LODR Regulations

← 28. Regulation 16 (1) (b) of SEBI LODR Regulations

← 29. Regulations 24, read with Schedule II, 24A, 30 read with Schedule III, 37, 46 (2) (s) and Schedule V of SEBI LODR Regulations.

← 30. SEBI Circular dated May 10, 2018, available at the following link: https://www.sebi.gov.in/legal/circulars/may-2018/circular-for-implementation-of-certain-recommendations-of-the-committee-on-corporate-governance-under-the-chairmanship-of-shri-uday-kotak_38905.html

← 31. In addition to the persons included as ‘related parties’ as defined in SEBI Regulations, a person or entity belonging to the promoter or promoter group of the listed entity and holding 20% or more of the shareholding in the listed entity is deemed to be a related party.

← 32. https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

← 33. http://www.doingbusiness.org/en/data/exploreeconomies/india

← 34. Format of the annual return (Form MGT-7) is prescribed under section 92 (1) of the Companies Act, 2013, available at the following link: http://www.mca.gov.in/MinistryV2/companyformsdownload.html

← 35. Schedule III of the Companies Act, 2013

← 36. Regulation 31 of SEBI LODR Regulations along-with SEBI Circulars dated November 30, 2015 (https://www.sebi.gov.in/legal/circulars/nov-2015/disclosure-of-holding-of-specified-securities-and-holding-of-specified-securities-in-dematerialized-form_31140.html) read with Circulars dated December 07, 2018 (https://www.sebi.gov.in/legal/circulars/dec-2018/disclosure-of-significant-beneficial-ownership-in-the-shareholding-pattern_41245.html) and March 12, 2019 (https://www.sebi.gov.in/legal/circulars/mar-2019/modification-of-circular-dated-december-7-2018-on-disclosure-of-significant-beneficial-ownership-in-the-shareholding-pattern_42324.html)

← 37. Refer to rules relating to significant beneficial ownership under Companies Act, 2013, available at the following links: http://www.mca.gov.in/Ministry/pdf/CompaniesOwnersAmendmentRules_08020219.pdf and http://www.mca.gov.in/Ministry/pdf/CompaniesSignificantRules_01072019.pdf

← 38. Schedule III of Companies Act, 2013.

← 39. For detailed provisions for related party transactions under Companies Act, 2013, refer to sections 2(76), 177 (4) and 188 of the Companies Act, 2013.

← 40. For detailed provisions for related party transactions under SEBI LODR Regulations, refer to regulation 23 and part A of Schedule V of SEBI LODR Regulations.

← 41. Sections 179, 185, 186 and Schedule III of the Companies Act, 2013.