Section 163 – Option to adopt Principle of Proportional Representation for Appointment of Directors (Chapter XI)

As per the company’s laws, the appointment of directors in a company is usually done through simple majority by passing a resolution in the General Meeting of shareholders or by Board of Directors (BOD) in Board Meetings. Generally, a simple majority is the thumb rule to elect all the directors and even a share as large as 49 per cent may not succeed in appointing a director. This may put at risk the interests of minority shareholders in a company. To take the edge off this drawback of the minority shareholders, Section 163 of the Companies Act, 2013 (Section 265 of the erstwhile Company Act, 1956) provides an opportunity for the minority shareholders so that they could constitute a BOD by way of proportional representation.

Example: Suppose in XYZ Ltd., there are a hundred shareholders divided into two groups of eighty shareholders and twenty shareholders. The eighty shareholders together have contributed INR Twenty lakhs towards the capital of the company, whereas the twenty shareholders together have contributed INR Eighty lakhs towards the capital of the company. Here, if we go by the rule of majority the 80 shareholders will be in an authority. In such cases, the principle of proportional representation comes handy.

Bare Act Extract of Section 163 of Companies Act, 2013

Notwithstanding anything contained in this Act, the articles of a company may provide for the appointment of not less than two-thirds of the total number of the directors of a company in accordance with the principle of proportional representation, whether by the single transferable vote or by a system of cumulative voting or otherwise and such appointments may be made once in every three years and casual vacancies of such directors shall be filled as provided in sub-Section (4) of Section 161.”

Explanation:

  • Section 163 of the Companies Act, 2013 starts with ‘Notwithstanding ——‘. Thus, the provision of this Section overrides all other Sections of the entire Companies Act, 2013. Wherever anything written in the Act will not be applicable if Section 162 is adopted.

For example, Section 162 of the Companies Act, 2013 provides for the appointment of directors to be voted individually and as such provisions of Section 162 are contrary to those of Section 163. But, due to the overriding authority of Section 162, it prevails over Section 162.

  • Section 163 is not mandatory. It will be applicable only if the Articles Of Association (AOA) of the company gives the authority for a proportional appointment.
  • The BOD constituted can be for a tenure of 3 years. After a span of 3 years, it has to be reconstituted. It is important to note that Section 163 is a way to constitute a BOD and not a single director and it is not a type of directors like nominee director or additional director.
  • The directors appointed through Section 163 cannot be removed by the procedure enunciated under Section 169 of the Companies Act, 2013. The reason being, Section 169 follows the majority rule. If it prevails, as soon as the minority constitutes the BOD, the majority may remove them.
  • If any casual vacancy arises, it has to be filled by an alternate director as provided in sub-Section 4 of Section 161 of the Companies Act, 2013.
  • Section 163 is applicable to all private as well as public companies. During the reign of the Companies Act, 1956 Section 265 was applicable only to public companies and private companies who are subsidiaries of the public companies.
  • Section 163 is not applicable to the following:

a) A Government company in which the entire paid-up share capital is held by the Central Government or State Government or held by one or more of the State Governments.

b) A subsidiary of a Government company, referred to in (a) above, in which the entire paid-up capital is held by the Government. (Notification dated 5th June 2015).

  • If AOA authorizes, a company can appoint only 2/3 of the directors using proportional representation. For example: if the BOD should have 12 directors, only 8 (2/3 of 12) can be appointed by proportional representation, the rest 4 have to be appointed as per the rule of the majority.
  • Methods of appointment through proportional representation:

a) Single Transaction Vote

b) Cumulative voting

c) Other methods

a) Single Transaction Vote: In this, the names of the candidates are entered in the ballot paper. Each shareholder gets a single vote. The voter indicates his first, second and third preference on the ballot paper against the directors. If the candidate gets the required number of votes as decided earlier (known as quota), he gets elected. Quota = (Total no. of votes divided by position + 1) +1. The excess of votes over the quota is transferred to the second preference and so on. For example, a ballot paper has 4 candidates (A, B, C & D), the voter writes his preference against them. The total number of votes is 5000. Therefore the quota = (5000/4+1) +1 = 1000+1=1001. If B gets over and above 1001 votes the excess votes are redistributed to the rest of the candidates. In the second step, if C gets the least vote, those votes are again redistributed among the rest. The process is so repeated until the desired candidates are selected.

b) Cumulative voting: Each shareholder is entitled to one vote per share multiplied by the number of directors to be elected. In cases, where multiple candidates are being considered for multiple positions each shareholder has the option of placing all of his votes towards one seat or he can choose to split his votes across multiple candidates.

For example: Suppose a shareholder is holding 500 shares with one voting per share and the election is for 5 directors, the shareholder has 2500 votes (500 x 5). Under cumulative, the shareholder can choose to vote all 2500 votes on a single candidate, or 1000 votes to one candidate and 1500 to another or any other manner the shareholder desires. Whereas, in the case of a single transaction voting system the shareholder would be able to vote only for a single candidate his 500 votes.

c) Other methods: the company may adopt may another method which is provisioned in the articles and are approved by the members by the company.

This is a brief explanation of Section 163 of the Companies Act, 2013 which deals with proportional representation of directors.

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