Right to Equity with Differential Rights – Private Company

Jayashree Swaminathan | May 2016

In today’s corporate world, there are numerous incentives offered by a company to potential investors in order to invite such investors to become shareholders of the company. A practice adopted by companies to offer such incentives is to issue and allot equity shares, having differential rights, to a shareholder.

Shares with differential rights have a combination of ‘different rights’ e.g. shares may be issued with:

Different voting rights e.g. share are issued with higher voting rights/management rights for saturating management control;
Different dividend rights; or
Different other rights; or
A combination of any two or more of (i), (ii) and (iii)1.

The Companies Act, 1956 (“Old Act”) incorporated the right of companies to issue equity share capital with differential rights. The said act included various provisions that governed issuance of equity shares attached with differential rights and that dictated restrictions which had to be followed by the issuing company. However, the said act carved an exception for private companies and such companies were exempt from complying with the aforementioned provisions.

The Companies Act, 2013 (“New Act”) is in line with the Old Act when it comes to providing companies with the option of issuing equity share capital which has differential rights. Section 43 of the New Act, states:

“The share capital of a company limited by shares shall be of two kinds, namely:-

Equity share capital –

With voting rights; or
With differential rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed;

Preference share capital”

The New Act, in section 43, explicitly states that a company, which is limited by shares, has the choice of issuing equity share capital with differential rights as to dividend, voting or otherwise as long as the company complies with the applicable provisions and rules. The ancillary rule to this section records various criteria and conditions that a company must follow, fulfil and comply with before, during and after issuance of equity share capital with differential rights. Furthermore, the language of the said section makes no distinction between a private company and a public company, thereby making the section equally applicable to both.

In addition to this, the New Act, in section 47, dictates that, an equity shareholder of a company limited by shares shall, during a poll, implement his voting right in proportion to his shares in the paid up equity share capital of the said company.

“S.47 (1) Subject to the provisions of section 43 and sub-section (2) of section 50,

Every member of a company limited by shares and holding equity share capital therein, shall have a right to vote on every resolution placed before the company; and
His voting right on a poll shall be in proportion to his share in the paid up equity share capital of the company.”

Thus, the aforementioned section operates to restrict the differential rights conferred upon an equity shareholder where such shareholder enjoys differential rights in the form of higher voting rights qua his shareholding. This is so because higher voting rights can be exercised by an equity shareholder only when voting is done through a poll. Incase voting takes place by show of hand, each shareholder has only one vote even if he holds equity shares with differential voting rights.

Thus, on first glance, it would seem that the New Act has curtailed the freedom given to private companies, under the Old Act, with respect to issuing equity share capital with differential rights. However, the Ministry of Company Affairs (“MCA”), through its notification dated 5th June, 2015 (“Notification”), exempted private companies from the ambit and applicability of section 43 and section 47 of the New Act provided the memorandum of association or the articles of association of such companies so provides Through this Notification, the MCA has aligned the understanding in the Old Act with that of the New Act vis-à-vis issuance of equity share capital with differential rights.

Further, considering that section 48 of the New Act, relating to the variation of shareholders’ rights, has not been notified by the MCA, the corresponding section of the Old Act shall apply. The concerned section of the Old Act is section 106 which states:

“Where the share capital of a company is divided into different classes of shares, the rights attached to the shares of any class may be varied with the consent in writing of the holders of not less than three-fourths of the issued shares of that class or with the sanction of a special resolution passed at a separate meeting of the holders of the issued shares of that class –

If provision with respect to such variation is contained in the memorandum or articles of the company, or
In the absence of any such provision in the memorandum or articles, if such variation is not prohibited by the terms of issue of the shares of that class.”

It is pertinent to note that the variation referred to in the aforementioned section is variation to the prejudice of any class of shareholders, and not any variation adding to or enhancing rights of any class. It is only where a variation involves the curtailment of the rights of any class or classes of shareholders, the consent or sanction of such class or classes will be necessary2.

Therefore in the light of the aforementioned provisions of the New Act and the Notification, it can be concluded that a private company has the right to issue equity share capital with differential rights under the New Act. Further, a private company need not comply with section 43 and section 47 of the New Act, along with the applicable ancillary rules, if the Memorandum of Association or the Article of Association of the said private company provides for such exemption.

About Author

Jayashree Swaminathan

Jayashree Swaminathan is currently working as the Chief Executive Officer at UnComplycate. With over 30 years of a proven track record advising corporates on their governance, risk and compliance mandates, Jayashree has been eyeing at a visionary approach to create a 100% compliant India Inc. With compliance as per passion, she possessed added skills in terms of business acumen in form of improving the financial performance, operating efficiency, cost control, revenue enhancing initiatives, practical system improvements, business development enhancement capabilities, etc.