Managing shareholder activism

Updated: Apr 16 2014, 08:38am hrs
The Ministry of Corporate Affairs and Sebi have been working to bring several regulatory changes in order to make companies more accountable to shareholders. However, the changes suggested by the regulators will have teeth only when the minority shareholders and institutional shareholders exercise their rights.

The careful modelling of corporate governance norms in the new Companies Act, 2013 (Act) and Sebis decisive move to amend the listing agreement for consonance with the new Act is to give adequate teeth to the minority shareholders.

Let us scrutinise some of the amendments to the corporate governance code and try and analyse the extent to which they may have an impact.

The new Act intends to put a stop on abusive related-party transactions (RPT), similar to the controversies we have seen in the past. In order to prevent diversion of companys funds by majority shareholders, this provision bars any related-party from voting on any RPT in a general meeting. Additionally, the new rules prescribe that company promoters must seek a prior approval from the audit committee for any material RPT. These requirements seem to be on the same lines as those that exist in several other jurisdictions.

As far as Sebi is concerned, the noose may prove to be calamitous for even genuine transactions and could lead to interference in the governance of a company. In addition to the requirement that locks out related-parties from voting in such transactions, the further condition imposed, of special resolution by disinterested shareholders, effectively shifts the decision

power to minority shareholders. Typically, the related-parties are promoters, holding a majority stake in the company.

The new majority of minority rule allows any ill-intentioned minority shareholder, holding a substantial stake, to frustrate any such RPTs, making it very difficult for the companies to pass such transactions. Rather than giving complete control to minority shareholders, the regulator could have taken a more even-handed approach. One may contend that a mere

special resolution itself restrains any misapplication by majority. Shouldn't the mandatory approval from the audit committee, headed by independent directors, be considered as sufficient safeguard

Another likely impact might be felt on the transactions between holding companies and their subsidiaries. By stating that the RPT guidelines would not be applicable on the dealings done at arms length, the legislature did attempt to save genuine transactions. However, who determines the commercialsis it the board of the company or the regulator or some public interest litigation

The new Act provides to minority-shareholders the right to initiate Class Action Suits (CAS). The Act entitles a minimum of 100 members/depositors, harbouring a common interest, to bring a legal suit against the companyas a group. Moreover, it permits even a member holding more than 10% of the issued share capital to file a CAS. The aggrieved shareholders may decide to sue a company against illegal or imprudent activities, and further claim for suitable damages. With an objective of precluding trifling claims, the applicants would be required to pay a penalty of maximum R1 lakh, if the Tribunal terms the suit frivolous. However, the impact of such a right will be beneficial if such suits are settled quickly. What effect will this change have if it takes 20 years to settle the dispute!

Another notable amendment is in the form of exit options offered to the investors by the new Act. In accordance with Section 27(2), dissenting shareholders have an option to exit the company, in the event that they are not in agreement with any variations incorporated into the draft red herring prospectus (DRHP) or objects for which the prospectus was drawn out.

Sebi recently asked mutual funds to record specific rationale supporting their voting decision with respect to their vote proposal. Records have to be now disclosed on a quarterly basis. This move comes after Sebi had asked mutual funds, a few years earlier, to take active role in the companies where they held shares and disclose information relating to voting on an annual basis.

The times are changing and it cannot be denied that the ecosystem of shareholder activism has taken a turn. The institutional investors have been certainly fired up with the latest refinement of corporate governance regulations. Equally, we must also not strangle the decision-making power of the boards with the veil of corporate governance.

The new rules of the game have been set. Nevertheless, intervention of regulator umpire will be still crucial in conducting a fair play between companies and institutional investors.

With inputs from Abhilaksh Gaind

Sidharrth Shankar

The author is partner, J Sagar Associates, Advocates and Solicitors. Views are personal