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06 August 2020
Indian law and practice regarding property and inheritance have traditionally been patriarchal. Unfortunately, married daughters are often not regarded as the heir apparent to their family's estate and business, and sons continue to be the 'chosen ones'. Many families are reluctant to pass their business wealth and assets onto their married daughters due to the perceived risk that the property ends up being controlled by their daughters' in-laws. This is even more pronounced for promoter families with significant holdings in public listed companies. How can such promoters pass on their business wealth to their daughters, and can they do so without losing control over the company?
The Securities and Exchange Board of India (SEBI) recently issued informal guidance which dealt with the issue of a promoter gifting his shares to his married daughters and the implications under the relevant listed company regulations.
By way of a 12 March 2020 application, Mirza International Limited sought informal guidance from SEBI in relation to the promoter and promoter group reclassification norms applicable to listed companies.
The application stated that Rashid Mirza – the promoter and managing director of Mirza International Limited, who held an 11.27% shareholding therein – wished to gift his shareholding to his daughters (the proposed transfer). The application stated that as Mirza's daughters were living independent lives, had no role in the company's management and held no shares in the company at that time, they were not listed as company promoters or members of the promoter group.
According to the application, following the proposed transfer, Mirza's daughters would need to be included in the company's promoter group, in line with the definition under Regulation 2(1)(zb) of the SEBI Issue of Capital and Disclosure Requirements (ICDR) 2009. According to the ICDR, a company's 'promoter group' includes:
Thus, Mirza's daughters qualified as members of the company's promoter group.
In light of the above, Mirza's daughters wanted to be reclassified from members of the company's promoter group to public shareholders. However, Regulation 31A(3)(a)(i) of the SEBI (Listing Obligation and Disclosure Requirements) Regulation 2015 (LODR) provides that promoters who seek reclassification must make a request for such with the listed entity, setting out their rationale. Regulation 31A(3)(b) of the LODR further provides that promoters who seek reclassification cannot collectively hold more than 10% of the total voting rights in the listed entity (the reclassification threshold).
Accordingly, pursuant to the proposed transfer, the daughters qualified as part of the company's promoter group. Thus, if they sought reclassification as public shareholders in the company, their cumulative shareholding would need to fall below the reclassification threshold.
Hence, the application for informal guidance was filed, seeking clarification as to whether Mirza's married daughters were eligible to be reclassified as public shareholders on the basis that they lived separate lives and did not participate in the company's management.
The informal guidance passed by SEBI on 10 June 2020 stated that by virtue of the definition of a 'promoter group' under the ICDR, the daughters of Mirza (a promoter of the company) were his immediate relatives and thus automatically formed part of the promoter group. Daughters of promoters – even those who are married, living independently and uninvolved in the company in any managerial capacity – must still be treated as part of the promoter group.
According to SEBI, the daughters were part of the promoter group not only by virtue of being immediate relatives of the managing director, but also on the basis of Regulation 31A(6) of the LODR, which states that the recipient of a gift of shares held by a promoter or a member of a promoter group will immediately be classified as a promoter or member of the promoter group.
SEBI stated that Regulation 31A(3)(b) of the LODR clearly sets out the eligibility conditions for reclassification from a member of a promoter group to a public shareholder. However, by virtue of Mirza's daughters' collective shareholding in the company totalling more than the reclassification threshold, pursuant to the proposed transfer, they did not satisfy the condition set out under the LODR and were thus not eligible to seek reclassification.
In its informal guidance, SEBI clarified that both married and unmarried daughters have equal footing under the definition of 'immediate relatives' provided in Regulation 2(1)(zb) of the ICDR.
This informal guidance reveals that SEBI's approach is to treat promoter groups strictly and daughters of promoter groups, irrespective of their marital status or involvement in the business, as promoters. However, some families may use this as another ground not to let their married daughters share in their business wealth.
As the informal guidance is non-binding and specific to the case at hand, it is hoped that SEBI will implement a more nuanced policy regarding family dynamics and the reclassification threshold.
Is there anything that families can do to overcome this? Yes, this issue can be handled through careful planning. Instead of gifting such shares to children directly, a trust can be a better tool. In addition to shifting the administrative burden from the hands of children, trusts also transfer all of the economic benefits of the underlying shares to the children or beneficiaries of such trusts. Parents can set up discretionary trusts for their children and remain trustees. This allows them to retain a certain level of control over the shares. The assets of said trusts may include shares in a listed company, which must be transferred to trusts in line with SEBI's 22 December 2017 circular.
If done properly, the parents (as trustees) can continue to manage the underlying shares and the business, preserving the consolidated holding within the parent's block and allowing the children to enjoy any dividends and capital gain benefits that may arise. Further, varied terms may be applied to married and unmarried children with regard to how they may inherit any assets bequeathed thereto. How and when parents pass any shares to their daughters, via a trust or otherwise, remains their prerogative.
Once daughters have received assets in their name, they should undertake careful planning to ensure that the assets are passed on correctly – it is each family's prerogative to assess whether such assets must be passed along the lineage of their daughters' in-laws. Intestate succession laws often provide for undesirable outcomes. If family members employ succession planning tools, such as a will, during their lifetime, they will have proper control over how assets are passed on. Promoters and their family members must act early and take proper steps to weigh the various succession planning options available and understand how best to use them to avoid adverse implications under the law.
For further information on this topic please contact Rishabh Shroff or Varsha Reddy at Cyril Amarchand Mangaldas by telephone (+91 22 2496 4455) or email (firstname.lastname@example.org or email@example.com). The Cyril Amarchand Mangaldas website can be accessed at www.cyrilshroff.com.
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