Golden Shares

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Golden Shares surfaced and pioneered in the beginning of 1980s in Great Britain during the prime ministership of Margaret Thatcher and their purpose has remained practically the same. In the nineties, the European Union witnessed the chief wave of privatization and several states implemented legal arrangements with a view to avert the dangers of having to do away with state’s influence on management of these privatized companies.[1] The main aim of Golden shares was to safeguard the State’s strategic interests by maintaining special rights in privatized companies. This, it did by affording power to the holder, that are, under the applicable corporate law, only available to a majority shareholder.[2] Golden shares were issued at the onset completely, and at present, predominantly to the Governments to maintain a veto power or voting rights so as to ensure that strategic businesses do not wither away. It is interesting to look at Golden shares from the perspective of issuing these to the Investors. In India, a listed company cannot issue golden shares but a private company may as there are no restrictions imposed thereon. This Article analyses the issuance of Golden shares to the investors along with DVR provisions.

Meaning and Evolution:

            A Golden share is a type of share that gives its shareholder veto power over changes to the company’s charter. A golden share holds special voting rights, giving its holder the ability to block another shareholder from taking more than the ratio of ordinary shares. Ordinary shares are equal to other ordinary shares in profits and voting rights. These shares also have the ability to block a takeover or acquisition by another company.[3]

            The privatization trend of late 90s, on the other hand, was primarily due to budgetary reasons, as the Maastricht Treaty urged member States to reduce public debts, as a precondition for the introduction of the Euro. Other incentives for denationalization were the will to change ownership structures and to develop capital markets.[4] However, nowhere in Europe did privatization really put end to state interference based on a variety of specific decisions and information rights.[5] Several instruments relating to decision making process were used.[6]

These shares have come to be known for special rights and were founded during the privatization movement and allowed governments to retain control over entities that were to be sold off by the Government to the private sector.[7]It was believed to be necessary and justifiable on the grounds that governments could, notwithstanding privatization, continue to implement certain policy objectives considered to be in public interest.[8] The popularity of the golden share grew in the eighties in the U.K. when the U.K. Government privatized a string of well-known entities including British Aerospace, British Airways, British Gas and British Petroleum[9]. Almost all former state owned enterprises issued a special type of share, Golden Share, to a representative of the Government as a condition of privatization.[10]

It can thus be understood that Golden shares gained momentum because of state’s concern for strategic privatized companies being important to employers and tax-payers, companies with large financial power and influence on a state’s economy as also because privatized companies have substantial effect on public policy. Golden shares acted as an effective safeguard for these state interests and protected companies against takeovers. However, it has also been said that the reason of primary importance for the development of these prerogatives was the absence of an adequate regulatory framework in the EU level at the time of their development.

Concept of Golden Shares and Preliminary Purpose:

The three fundamental reasons for which Golden Shares were created and have survived are to preserve and safeguard the interests and protect firstly,strategic privatized companies that are important as tax-payers and employers, secondly, the companies that have large financial power and influence over a state’s economy and thirdly, privatized companies that have substantial effect on public policy and security. Protection of these companies against takeovers, however, was the reason secondary only to the absence of any adequate regulatory framework at EU level at the time of their development

Golden shares confer divergent special rights of several subject matters, including (a) Right to appoint company directors and members of the Board; (b) Right to limit representation of foreign company directors; (c) Right to veto and decision rights in the general meetings; (d) Right to influence fundamental company decisions, e.g. dissolution of the company, mergers and takeovers and any other structural changes, sale of substantial assets, amendment of company’s articles of association, liquidation of the company; (e) Obligation to obtain authorization of the State before certain decisions or transactions; (f)Rights to influence and restrict the acquisition of shareholding of the company in question.

1

Differential Voting Rights Provisions:

Since golden shareholders have veto voting rights in the reserved matters which other equity shareholders do not, these shares fall under the category of differential voting rights shares. Section 43 of the Companies Act, 2013 recognizes two types of shares: Equity and Preference Shares; and Shares with differential voting rights are recognized under the head of Equity Shares.

The Companies (Share Capital and Debentures) Rules, 2014 have prescribed prerequisites for issuance of these shares. The authority to issue these shares should be passed by Ordinary Resolution in General Meeting. Differential Rights Shares cannot exceed twenty six per cent of the total post issue paid up capital including any previous differential shares issue. The company should have a consistent track record and should not have defaulted in filing returns and statements prescribed by law neither should have been penalized by Court or Tribunals during last three years. Besides this, in three years immediately preceding the financial year of issue, it should not have defaulted in payment of declared dividend to its shareholders or repayment of its matured departments or payment of preference shares.

The Rules further require that the Company should not have defaulted on repayment of loans from banks and public financial institutions or interest thereon, payment of dividend on preference shares, payment of statutory dues for employees and depositing moneys into the investor Education and Protection Fund. Further the company should not have been penalized in last three years for any offence under RBI, SEBI, SCRA, FEMA or any other Special Act under which such companies are being regulated.[11]

Companies (Share Capital and Debentures) Rules, 2014 require the disclosure of relevant details in the shareholders notice, like, total number of such shares to be issued, details of the different rights, percentage of shares with differential rights to the total post issue paid up equity share capital, the reasons and justifications for issuance, price at which such shares are proposed to be issued, change in control (if any) and other details in Explanatory Statement and Director’s Report in required by Companies (Share Capital and Debentures) Rules, 2014.[12]

Thus, Golden Shares can only be issued by an Indian Company after compliance to the abovementioned laws. Differential voting rights are of two types: rights that are superior than that of ordinary voting rights or are inferior than ordinary voting rights.

  1. Golden Shares: whether source of Superior voting rights?

A Report prepared for the European Commission titled Special rights of public authorities in privatized EU companies in the Microeconomic impact[13]regards Golden Shares as special rights with superior voting rights in order to preserve the influence of government over the companies they privatized. The rights conferred by Golden shares are often treated synonymously with Equity shares with superior voting rights.[14]

However, SEBI issued a Circular in 2009 with reference to equity shares already listed; the present scenario as it stands, disallows issuance of shares with superior voting rights by listed companies with a view to avoid possible misuse by persons in control to the detriment of public shareholders. Golden shares, thus, cannot be issued by listed companies on equity shares already listed. Unlisted companies may still have freedom to structure such shares.

The present regimes thus prohibit listed companies from issuing golden shares, unlisted companies, however are comparatively free to issue these, but would have to comply with the Companies Act, 2013 and the Companies (Share Capital and Debentures) Rules, 2014. In case that Golden share in particular fact scenario fall under the category of superior voting rights, these could be issued subject only that the ordinary shares are issued with inferior voting rights and would ultimately be discounted in voting rights (less than one voting right).

  1. Consolidation of Control: Compliance

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 define Control to include the right to appoint majority of the directors or to control management or policy decisions exercisable by virtue of their shareholding or management rights or shareholders agreement or voting agreements. Some of the rights typically covered by Golden Shares do pertain to control.

No person can acquire voting rights which taken together with shares or voting rights, held by him and by persons acting in concert with him entitle him to exercise twenty-five percent or more of the voting rights in such target company unless the acquirer makes a public announcement of an open offer for acquiring shares of such company. In case of acquisition of control by voting rights, the acquirer would have to make a public announcement of an open offer for acquiring shares of such company. Thus, the issuance of golden shares, depending on the right vested in the holder, will require to be through public announcement and open offer.

The Takeover Code provides for exemptions for inter se transfer within groups including Inter Se transfer between promoters, PACs, Shareholders (PACs) and companies owned by them on the condition that (i) acquisition price per share should not be higher than 25% of the volume weighted average market price for a period of 60 trading days preceding the date of issuance of notice for the proposed inter se transfer (ii) The acquirer needs to intimate the stock exchange(s), the details of the proposed acquisition at least four working days prior to the proposed acquisition, (ii) Additionally, promoters or PACs should be disclosed as such for atleast three years prior to the proposed acquisition.[15]

  1. Foreign Exchange Management Authority Regulations:

Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Second Amendment) Regulations, 2016 published by the Reserve Bank of India defined ‘Control’ to include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements. Thus, companies with foreign holder of golden share would be considered as a company controlled by person resident outside of India, and the implications under FEMA will follow.

Advantages and Disadvantages of issuing Golden Shares to Investors

ISSUANCE OF GOLDEN SHARES ADVANTAGES DISADVANTAGES
Performance Impact Empirical evidence suggests that controlling interests can lead to enhanced performance, however, this is more likely to happen when majority control comes from a matching economic stake; in this way the economic interests of majority and minority shareholders are associated and the investment risk is allocated proportionately.[21] There is no sturdy verification that DVRs provide the companies with an enhanced atmosphere for long-term setting up and implementation. In a recent literature review of this topic, academics concluded that “the evidence suggests that companies with dual-class structures tend to have lower governance quality”.[22]For example, in an empirical study of dual class structure in the United States, the authors concluded “we find that firm value is positively associated with insiders’ cash-flow rights, negatively associated with insiders’ voting rights, and negatively associated with the wedge between the two.” The authors go on to say that “a majority owner of a private company can rationally choose to sacrifice some firm value in order to maintain private benefits of control”. That may be well and good for the controlling owner, but it also suggests that these private benefits come at the cost to minority investors.[23]
High-tech sector Differential ownership and control structures are increasingly seen in the sector, where long-term thinking is needed to support improvement and invest in technologies, products and solutions that will drive growth in the long-term. However, over time, insulation from market forces can be a risk in itself as it can lead to companies losing agility and seeing their own business models being disrupted. [24]
Hostile Takeover Most useful for prevention of a hostile takeover and dilution of voting rights.  
Loan Benefits For the purpose of taking loan or a quasi-loan from holding company or a subsidiary of a holding company[25] Golden share can be issued in one company to another giving it rights over the composition of the board only and therefore creating a group, i.e. holding and subsidiary company, it can be used to establish a group situation. Establishing a group through operation of a golden share would avoid the prohibition on loans as outlined above by creating a group structure and will have the added benefit of not having to give up voting or equity rights.[26]  

The reasons and basis on which golden shares came into existence are for ensuring that the business values are not withered away. Thus, issuance of golden shares to valued and trusted investors would be beneficial in ensuring stability in the direction of the company. Typically, issuing these to the founders, angel investors could prove beneficial for the company when it grows big and control becomes diversified. Policy decisions such as mergers or takeovers and selling important assets of the company are pertinent to the Company and issuance of golden shares ensures that they are taken in a particular direction.

  1. Step Suggestions[27]

In order to make the company more attractive to the public, while issuing golden shares, steps should be taken to:

  • Articulate the rationale for the need of differential ownership and control structures and identify the specific circumstances under which these would be beneficial to the company and its shareholders[28]
  • Assess whether alternative measures can be taken to address the issues without creating differential ownership and control structures.
  • Introduce an annual review of differential ownership and control structures by the board.
  • Introduce a sunset provision for any differential ownership and control structures (e.g. 5 years from the IPO date or departure of the management team at the IPO, whichever is shorter).
  • Ensure minority shareholders have an equal say in decisions that can materially impact the investment case for the company (e.g. major M&A transactions, change of control, etc.).
  • Ensure robust governance and control structures, including an independent board, separate Chairman/CEO roles, a conflicts committee, etc.
  1. Issue Tenured voting rights

Tenured or time-based voting, i.e. additional voting rights acquired based on the length of shareholding, such as double voting rights in France, is regarded by some commentators as a compromise solution that encourages longer-term investment without perpetuating the dominance of a certain group of shareholders – as is the case with differential share ownership structures. While appealing in theory, and potentially a better solution than other differentiated structures, tenured voting rights present a very high risk for minority shareholders and institutional investors in particular.[29] This could be the issuance criteria for Golden Shares.

Tenured voting rights carry all the risks associated with differential ownership and control mechanisms, including misalignment of economic interest and control and management entrenchment. In addition, this approach reduces transparency of ownership and control structures. For example, assessments of company-specific risks associated with multiple class share structures are often undertaken prior to investing. In the case of tenured voting rights, changes in ownership and control structures are much less predictable, which creates instability and increases investment risk. Tenured voting rights can also have an unintended consequence of encouraging undue shareholder activism by guaranteeing activist shareholders enhanced voting power and influence over a period of time.

[1]https://repository.ihu.edu.gr/xmlui/bitstream/handle/11544/267/ZisisChatzigiannakos_4410_assignsubmission_file_Golden SharesAnd the Jurisprudence of the ECJ.pdf?sequence=1. (last visited 24th May, 2018).

[2] Ibid.

[3] https://www.investopedia.com/terms/g/goldenshare.asp#ixzz5EmngOfKY(last visited on 17th May, 2018).

[4]https://repository.ihu.edu.gr/xmlui/bitstream/handle/11544/267/Zisishatzigiannakos_4410_assignsubmission_file_Golden Shares And the Jurisprudence of the ECJ.pdf?sequence=1 (last visited 24th May, 2018).

[5] Ibid.

[6] Ibid.

[7] https://www.bigsocietycapital.com/sites/default/files/pdf/Golden Share Report.pdf (last visited on 7th May, 2018).

[8] Ibid.

[9] Ibid.

[10] Ibid.

[11] https://novojuris.com/2014/05/06/issuing-of-shares-with-differential-rights-companies-act-2013/ (last visited on 22nd May, 2018).

[12] https://novojuris.com/2014/05/06/issuing-of-shares-with-differential-rights-companies-act-2013/ (last visited on 22nd May, 2018).

[13] Oxera, Special rights of public authorities in privatized EU companies: the microeconomic impact, Report prepared for the European Commission in November 2005.  http://ec.europa.eu/internal_market/capital/docs/2005_10_special_rights_full_report_en.pdf (last visited on 22nd May, 2018).

[14] https://www.financialexpress.com/archive/golden-shares-a-reality-even-before-official-nod/766119/ (last visited on 22nd May, 2018).

[15] https://www.pwc.in/assets/pdfs/services/m-a-takeover-book-final-lowres.pdf (last visited on 22nd May, 2018).

[16]https://books.google.co.in/books?id=hmaZtXVmLeAC&pg=PA59&lpg=PA59&dq=brazil+golden+share+in+cvrd&source=bl&ots=h6SZKJlWh5&sig=eiNAgkWW-F15NLZ0qbHGEzB6upY&hl=en&sa=X&ved=0ahUKEwi2pPnKz7HZAhVG6Y8KHZh-AJIQ6AEINDAD#v=onepage&q=brazil%20golden%20share%20in%20cvrd&f=false.

[17] Financial Express’ Report, 2011, http://www.financialexpress.com/archive/golden-shares-a-reality-even-before-official-nod/766119/

[18] Ibid.

[19] The Hindu Business Line’s Report, 2012, https://www.thehindubusinessline.com/companies/LampT-Metro-Rail-hands-over-%E2%80%98Golden-Share%E2%80%99-to-Andhra-Pradesh-Govt/article20396607.ece.

[20]Concession Agreement for Hyderabad Metro Rail (MRTS) Project between The Government of Andhra Pradesh and M/s. L&T Hyderabad Metro Rail Private Limited,http://www.gajendrahaldea.in/pdf/Hyderabad_Metro_Rail_Project.pdf

[21] Ibid.

[22]David Larcker and Brian Tayan, “Corporate Governance Matters”, Second Edition, Pearson Education Inc., 2016.

[23]Paul A. Gompers, Joy Ishii and Andrew Metrick, ”Extreme Governance: An Analysis of Dual Class Firms in the United States” Review of Financial Studies 23 (2010): 83-120.

[24]At ICGN’s 2016 Academic Day in San Francisco, co-partnered with the Rock Center for Governance at Stanford University, the technology sector was a particular focus in the debate relating to differential ownership rights.

[25] https://www.icgn.org/differential-share-ownership-structures (last visited on 28th May, 2018).

[26] Wide practice in Ireland.

[27] International Corporate Governance Network, https://www.icgn.org/members-1 (last visited on 28th May, 2018).

[28] Mandatory under the Companies (Share Capital and Debentures) Rules, 2014.

[29] https://www.icgn.org/members-1 (last visited on 28th May, 2018).

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