There are a few subtle changes in the Companies Act, which bring about challenges in voting rights for different classes of shares and still be able to meet the requirement of balance of equity : preference in total voting rights.
Earlier to the Companies Act 2013 (Act), private companies could determine voting rights of equity(including differential rights) and preference shareholders as per their convenience, because of the Saving section 90 of old Companies Act, 1956.
The Act now has increased the boundaries for voting rights for preference shares, which now includes any resolutions which directly affect the rights attached to preference class and any resolution for the winding up of the company or for the repayment or reduction of its equity or preference share capital.
Issuing shares with differential rights has become more prescriptive and restrictive in the Companies Act, 2013. New startups may find it difficult to meet the precondition of consistent track record of distributable profits for last 3 years.
In private equity deals (angels, VC) who opt for preference shares as the instrument, then having a list of matters (called as Reserved Matters) which requires the preference shareholder voting, then the Act enables it. However, the proviso describes that the “proportion of the voting rights of equity shareholders to the voting rights of the preference shareholders shall be in the same proportion as the paid-up capital in respect of the equity shares bears to the paid-up capital in respect of the preference shares”. It looks like additional language is required to be captured in the shareholders agreement at the time of investment, to protect the affirmative consent by the investors.
This balance (pro-rata of equity: preference) gets murky when there is a class of shares with differential voting rights.
Shares with differential voting rights:
Any company, whether private or public, will now have to comply with the below requirements.
– a declared dividend to its shareholders or
– repayment of its matured deposits or
– redemption of its preference shares or debentures that have become due for redemption or
– Payment of interest on deposits or debentures
– Repayment of loans from banks and public financial institutions or interest thereon
– Payment of dividend on preference shares
– Payment of statutory dues for employees
– Depositing moneys into the Investor Education and Protection Fund.
(Our comment: Would an earlier default now made good still be considered as default under this clause, given there is a separate clause on “subsisting default”? )