The Interplay between Affirmative Voting Rights & Control

Over the years, Indian jurisprudence has consistently evolved in its interpretation of ‘control’ of corporate entities/bodies, especially in context of conglomerate/group structures wherein multiple holding and subsidiary companies have been incorporated. While there are adequate judicial interpretations detailing the scope of the definition of ‘control’, it has become a challenge for many promoters of companies to understand whether affirmative voting rights or veto rights, that are usually included in the shareholders’ agreements and joint venture agreements, amount to acquiring ‘control’ under the Companies Act, 2013 and the relevant Securities and Exchange Board of India regulations. Such analysis is pertinent in order to (a) identify the obligations/compliances applicable to a promoter of a company; and (b) determine the trigger points for a change in control provisions for which the company would have to take sector specific approvals.

What is ‘Control’?

The definition for ‘control’ under the Companies Act, 2013[1] and the relevant Securities and Exchange Board of India regulations[2], is an inclusive definition. The Supreme Court of India, in the case of Arcelor Mittal India Private Limited vs. Satish Kumar Gupta[3] (“Arcelor Mittal Case”), has discussed the definition of ‘control’ at length, and has broadly categorized the definition as (a) de jure control, where ‘control’ is determined by the right of a person (along with persons acting concert) to appoint majority of directors; and (b) de facto control, where ‘control’ is determined by the ability of a person to control the management or policy decisions of the company. The Supreme Court has also specifically expanded the terms (a) ‘management decision’ to mean a decision regarding the day to day running of the company; and (b) ‘policy decision’ to mean a decision that takes into account beyond day to day affairs of the of the company, i.e., long term decisions.

The Securities Appellate Tribunal, in Subhkam Ventures Private Limited vs SEBI[4](“Subhkam Ventures Case”), analyzed the ability of a person to have a positive and active control. It observed that a proactive power would include the ability of a person to command the target company on what he/she wants to do by creating or controlling a situation through taking the initiative. When a person possesses the power to prevent a company from doing what the company wants to, it cannot be considered as positive control.

‘Control’ & Affirmative Voting Rights

Affirmative voting rights are rights included in the articles/shareholders’ agreements, which are held by certain investors/shareholders to prevent the company from undertaking certain identified matters. Whether holding such affirmative voting rights amounts to acquiring ‘control’ has been exhaustively analysed by courts and tribunals in India.

The Securities Appellate Tribunal, in Subhkam Ventures Case, specifically analyzed whether affirmative voting rights amount to acquiring ‘control’. The tribunal held that affirmative voting rights related provisions are merely provisions to protect the interests of the investor/shareholders. Therefore, inclusion of such provisions cannot be considered as acquiring ‘control’. However, the Subhkam Ventures Case was appealed to the Supreme Court of India and during the pendency of the proceedings, the case was disposed due to change in the circumstances of the case. The Supreme Court of India in its disposal order stated that the question of law is kept open and the order of the Securities Appellate Tribunal cannot be considered as a precedent.

In Rhodia SA vs SEBI[5], the Securities Appellate Tribunal held that since the appellant had affirmative voting rights regarding significant transactions of the company, the same could be interpreted as having ‘control’. However, it is important to note that in the said case, the appellant had a call option where it had the right to acquire all the shares in the target company and during pendency of such call option right, the appellant had retained the aforesaid affirmative voting rights.

In Re: Clearwater Capital Partners (Cyprus) Limited[6], the Securities Exchange Board of India observed that affirmative consent provisions contained in the inter-se agreement with the target company, are merely provisions to protect the interests of minority investors and do not enable them to formulate any policies in the target company. Therefore, the same cannot be construed to be acquiring controlling interests of the target company.

In the ArcelorMittal Case, the Supreme Court of India, considering the circumstances of the case  wherein an entity with regards to a target company (a) held 32% of the shareholding (approximately); (b) had the right to appoint equal number of directors, like other shareholders; and (c) had certain specific affirmative rights in the shareholders’ agreement, held that such an entity would be considered to be in positive control of the target company. In Swedish Match Ab & Anr vs Securities & Exchange Board[7], the Supreme Court of India, while analyzing the provisions of erstwhile SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, held that a change in control may occur by change in the majority of the voting rights in the Company and also, by any amendment to the memorandum of association or by any other mode which necessitates a resolution to be passed by the shareholders in a general meeting. Therefore, it can be concluded that in case the veto rights or affirmative voting provisions under a shareholders’ agreement have any provisions which require passing a resolution in a general meeting, such provisions could be considered as ‘control’.

Conclusion

From the aforementioned precedents, it can be concluded that the tribunal and courts have differed in their  approach, based on the facts and circumstances of each case, in considering whether affirmative voting rights amount to acquiring ‘control’.

While the Subhkam Ventures Case cannot be considered as a precedent, the ArcelorMittal Case refers to the analysis made by the Securities Exchange Board of India pertaining to positive and proactive control versus a negative power and applies the said test developed in Subhkam Ventures Case. In cases wherein it has been interpreted that existence of such voting rights would be construed as acquiring ‘control’, the courts/tribunals have taken a holistic understanding of the surrounding circumstances of the relevant contract. As the Securities Exchange Board of India in the Subhkam Ventures Case metaphorically stated, in order to understand whether the affirmative voting rights or veto rights held by a person amount to ‘control’, the test would be to understand if the relevant person has control of the steering, brakes and accelerator of the entity.

The views and opinions expressed in this article belong solely to the author and do not reflect the position of TLH, Advocates & Solicitors.

[1]  As per Section 2(27) of Companies Act, 2013, ‘control’ is defined under the Companies Act, 2013 to include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

[2] Regulation 2(e) of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers), 2012 and Regulation 2(i) of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018

[3] AIR 2018 SC 5646

[4] SEBI Order in Appeal No. 8 of 2009 dated January 15, 2010

[5] SAT order in Appeal No. 36/2001 dated November 7, 2001

[6] SEBI Order No. WTM/GM/EFD/DRAIII/20/MAR/2017 dated March 31, 2017

[7] [2004] 54 SCL 549 (SC)