The Indian business landscape is mainly composed of family-run businesses. Keeping in mind the country's close-knit joint family culture, Indian regulators have been cautious of family members owning and controlling a business together.
Regulation 2(1)(pp) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations 2018 (SEBI ICDR) provides a broad definition of the term 'promoter group', which includes any immediate relatives of the promoter and entities in which such relatives have a more than 20% stake. Being a member of the promoter group of a listed company entails rigorous disclosure and compliance obligations under various Securities and Exchange Board of India (SEBI) regulations. In fact, in its consultative paper of 23 November 2020, SEBI noted that there was a need for further clarification under Regulation 31 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (SEBI LODR) with regard to disclosing the names of the persons who are promoters or belong to the promoter group even if they hold a nil shareholding in a listed company.
Despite the general perception, not all is smooth sailing among Indian families. Owing to disputes or otherwise, families often separate businesses among themselves, with family members disassociating themselves completely from each other's businesses. When a family member runs a business independently, other relatives prefer not to be liable for the compliances and liabilities imposed on the promoter group. However, in case of listed companies, it is challenging for the promoter's family members to be excluded from being categorised as promoters or a promoter group – even if they have no association with the company.
Regulation 31A of the SEBI LODR provides the procedure for promoters and persons belonging to the promoter group of a listed company to be reclassified as public shareholders. Such reclassification is permitted only if the promoter seeking reclassification and "persons related to the promoter seeking re-classification":(1)
- together do not hold more than 10% of the voting rights, exercise control over the company's affairs (directly or indirectly) or have any special rights through formal or informal arrangements, including shareholders' agreements; and
- are not represented on the board of directors or acting as key managerial personnel.(2)
Subsequent to a reclassification, these two conditions must be maintained perpetually and for at least three years, respectively, from the date of reclassification. Failure to meet this requirement will result in the person in question being automatically reclassified as a promoter or person belonging to the promoter group.
Promoters seeking reclassification must submit an application to the board of directors of the listed company, justifying the reclassification and demonstrating how the above conditions are satisfied. Based on the board's recommendations, the shareholders of the listed company (other than the promoter seeking reclassification and persons related to such promoter) must approve the proposal through an ordinary resolution, except if such promoters are exempt from seeking shareholder approval in terms of the proviso to Regulation 31A(3)(a). Thereafter, an application must be made to the stock exchanges, which can approve the proposal, subject to the promoter in question having complied with the conditions specified in Regulation 31A.
The conditions for reclassification must be satisfied not just by the promoter seeking reclassification, but also by cumulatively taking into account, among other things, the shareholding percentage and control rights of persons who are related to such promoter. Regulation 31A(3) of the SEBI LODR contemplates that even a single person belonging to a promoter group can be eligible to seek reclassification. However, where one member of the promoter family seeks to be reclassified and the remaining members would continue to hold a shareholding of upwards of 10%, or exercise control or have managerial roles in the company, the exiting promoter group member will be unable to prove that they are compliant with Regulation 31A(3)(b) of the SEBI LODR and will therefore be ineligible to initiate the reclassification process.
In the absence of objective criteria allowing the reclassification of promoter family members, contradictory precedents have arisen over the past two years. On the one hand, SEBI issued informal guidance to Mirza International Limited rejecting the reclassification of two married daughters of the promoter (who collectively were to hold more than 10% of the total voting rights in the company but had no involvement in the management of the listed company) on the ground that the daughters, together with their immediate relatives (ie, their father and mother), would continue to hold more than 10% of the total voting rights in the company.(3)
Conversely, in the matter of CERA Sanitaryware Limited, the stock exchanges permitted the reclassification of the brother of the existing promoter (the controlling shareholder of the company). In this case, the brother had inherited the shares of the company through the will of his deceased mother after being separated from the business for 15 years. The stock exchanges permitted the reclassification even though the brother was not technically eligible to initiate the process to seek reclassification as, under Regulation 31A(3)(b), his immediate relative (ie, the controlling shareholder) continued to hold more than 10% of the voting rights in the listed entity.
It is understandable that SEBI may not wish to provide flexibility to promoter families where there is no separation. However, in genuine cases (eg, where a family dispute arises), the legal regime becomes a hurdle to reclassification.
Reclassification pursuant to family settlements
SEBI considered the issue of family settlement among promoters in its Discussion Paper on Reclassification of Promoters as Public 2015. This discussion paper evaluated an example of reclassification of a joint promoter who had entered into a registered family separation agreement due to a family dispute and transferred the majority of his holding in some of the family's companies to the other joint promoter. Among other things, the discussion paper proposed that in case of a separation agreement between the members of a promoter group, a member of the promoter group should be able to reclassify their shareholding to the public category if, prior to the reclassification:
- the separation agreement is duly registered under the Registration Act 1908; or
- the material terms of the separation agreement are disclosed to the stock exchanges.
However, this proposal does not seem to have seen the light of day under any of the SEBI regulations.
The SEBI LODR remain silent on the issue of family settlement agreements even after multiple rounds of amendments to Regulation 31A. In its 25 March 2021 board meeting, SEBI approved various amendments to Regulation 31A of the SEBI LODR with a view to rationalising the existing framework for promoter reclassification. Said amendments were notified on 5 May 2021 through the SEBI (Listing Obligations and Disclosure Requirements) (Second Amendment) Regulations 2021, wherein SEBI, among other things, allowed relaxations to the timelines for reclassification and an exemption from the requirement to obtain shareholder approval in cases of reclassification pursuant to a divorce and where the promoter, together with people related thereto, does not hold more than 1% of the total voting rights.(4) However, SEBI does not appear to have considered introducing a separate process to address the issue of family settlement agreements.
Prior to the amendment of Regulation 31A in 2018, a specific provision allowed SEBI to relax any reclassification condition in specific cases if it was satisfied as to the non-exercise of control by the outgoing promoter or its persons acting in concert. However, following the removal of this provision, the only recourse available in such cases is to:
- request informal guidance from SEBI and hope for a positive response before initiating the reclassification process; or
- seek a formal exemption under Regulation 102 of the SEBI LODR from strict compliance with Regulation 31A before initiating the reclassification process.
To rule out subjectivity, SEBI could consider introducing specific carve-outs from the compliance requirements of Regulations 31A(3)(b) for exiting promoter family members, pursuant to a formal separation agreement with the remaining promoters. Since the safeguards of stock exchange approval and provision of automatic reclassification in case of a violation of Regulation 31A(3)(b) already exist, persons found in breach of a separation agreement can always be reclassified as promoters. This small amendment could go a long way in helping genuine reclassification requests arising out of formal family separations.
On 11 May 2021 SEBI released a discussion paper inviting comments regarding shifting from the concept of promoter and promoter group to the concept of person in control or controlling shareholders. The rationale behind initiating the discussions was to avoid identification of persons who are not involved with the business of a company as a promoter group and to provide for the changing nature of ownership of listed companies. Although a final decision will not be made for some time, if at all, it could bring significant changes to the concepts of promoter and promoter group as they are understood today.
Endnotes
(1) The term 'persons related to the promoter' has been defined with reference to the definition of a 'promoter group' under the SEBI ICDR and includes the following categories, in case of an individual:
- an immediate relative of the promoter, which means any spouse of that person or any parent, brother, sister or child of the person or of the spouse;
- any body corporate in which 20% or more of the equity share capital is held by the promoter or an immediate relative of the promoter, or a firm or Hindu undivided family in which the promoter or one or more of their relatives is a member;
- any body corporate in which a body corporate as provided for in the second bullet above holds 20% or more of the equity share capital; and
- any Hindu undivided family or firm in which the aggregate share of the promoter and their relatives is equal to or more than 20% of the total capital.
(2) In terms of Regulation 31A(1) of the SEBI LODR read with Regulation 2(1)(pp) of the SEBI ICDR.
(3) Informal guidance issued to Mirza International Limited, 10 June 2020, SEBI/HO/CFD/CMD1/OW/2020.
(4) SEBI (Listing Obligations and Disclosure Requirements) (Second Amendment) Regulations 2021, 5 May 2021, SEBI/LAD-NRO/GN/2021/22.
