Why the new minimum public shareholding requirement need not cause undue worries

What's the next move, Mr. Promoter?

The recent notification on June 4, 2010, by the Central Government requiring all listed companies to raise their level of minimum public shareholding to 25% has raised a lot of concerns amongst corporates. A detailed analysis of the notification may be found on the Indian Corporate Law blog (with particularly interesting comments). The Hindu Business Line points out that there are a total of about 180 listed companies, including MMTC, NMDC, NTPC, Hindustan Copper, SAIL, Wipro, Reliance Power, Jaiprakash Power Ventures and DLF which will now have to raise their public shareholding. While the Central Government has itself stated that it is open to a modification of the notification if required, as of today the notification is valid as law and so it is important to see what impact the notification will have on companies which do not or are not able to comply with its requirements.

At the outset, we must note that the newly inserted Rule 19A, which is the applicable provision to existing listed companies, requires the increment in public shareholding to be made in the manner specified by SEBI. The SEBI has not, so far, specified any manner in which this may be done. Hence, companies may have some breathing space until SEBI comes up with a clarification. Nevertheless, they may still want to be prepared for the new law, and what could be the potential costs for them in the event they are unable to comply with the increased requirements.

There are two possible consequences with non-compliance of the provisions – delisting and penalties.

Delisting

A reference to delisting grounds is made under Section 21A(1) of the Act, which states that:

“A recognised stock exchange may delist the securities, after recording the reasons therefore, from any recognised stock exchange on any of the ground or grounds as may be prescribed under this Act.”

What are the grounds prescribed under the Act? The Central Government notification states that it is made in exercise of the power under Section 30(2)(ha) of the SCRA, which states that the Central Government may make rules to provide for:

“[T]he grounds on which the securities of a company may be delisted from any recognised stock exchange under sub-section (1) of section 21A.”

Interestingly, in the body of the rules, it is not mentioned anywhere that non-compliance with the same would result in invocation of the delisting procedure. Interestingly, even the Delisting Regulations, 2009, state that the shares of a company may be compulsorily delisted by the Stock Exchange on any ground prescribed in the rules made under Section 21A of the Securities Contracts Regulation Act. The Central Government, in making reference to Section 30(2)(ha) of the SCRA, which allows it to make rules to prescribe grounds under Section 21A of the SCRA, has thus, validly made the rules. Unfortunately, the rules nowhere state that non-compliance is a ground for compulsory delisting. The reason that the situation is uncomfortable is because the Central Government has claimed to invoke a particular power, but has not actually exercised it in the body of the instrument. One will have to actually refer to the power that the government seeks to invoke in the preamble of the rules, to gather the intention of the government. The government, however, does not make such intention clear from the text of the rules. In that event, can the rules be held to prescribe delisting conditions, as they do not state anywhere that non-compliance with them would result in delisting? There is too much implicit reading required to be done to believe that the rules prescribe the grounds on which the shares of a company may be delisted.

Penalties

The Securities Contracts Regulation Rules, 1957 do not prescribe penalties for a violation of their mandate. Hence, we refer to the parent legislation, the Securities Contracts Regulation Act (SCRA), 1956 for the purpose. Section 23 of the Act states that:

“If a company . . . fails to comply with the listing conditions or delisting conditions or grounds or commits a breach thereof, it . . . shall be liable to a penalty not exceeding twenty-five crore rupees.”

What are the delisting or listing conditions being referred to? As shown in the paragraph above, it is possible to argue that the rules in their amended form do not presently prescribe a delisting condition.

Let us then refer to listing conditions. The SCRA makes a reference to listing conditions, in Section 21, which is as follows:

“Where securities are listed on the application of any person in any recognised stock exchange, such person shall comply with the conditions of the listing agreement with that stock exchange.”

So, is the present notification by the Central Government a listing condition?

Note that the listing condition being referred to in the act is the condition under the listing agreement with the stock exchange. Clause 40A of the BSE Listing Agreement states that:

“The company agrees that in the event of the application for listing being granted by the Exchange, the company shall maintain on a continuous basis, the minimum level of non-promoter holding at the level of public shareholding as required at the time of listing.”

Rule 19(2)(b) of the SCRR has been amended to state that for initial listing, a minimum of 25% public shareholding is required, which can be 10% in the event the post-issue capital of the company is more than 4000 crore rupees. However, even in that case, the company shall increase its public shareholding by at least 5% per annum from the date of listing, so as to ultimately bring it to 25%.

The question that arises from this is whether Clause 40A of the Listing Agreement is a 'live' clause, that is, when it says that the minimum level of non-promoter holding should be as required at the time of listing – whether it means that for any company it should be what it was when that particular company was listed? It should mean that, because in plain and clear terms, it purports to state the requirement should be 'as required at the time of listing', which means we refer back to the time when the company was listed, and we check the requirement that existed at that time for it to be listed. Now, to stay continuously listed, an existing company would have to maintain that level of public shareholding. In such a case, for existing companies with less than 25% shareholding, it should not be a violation of the Listing Agreement. Further, the Listing Agreement may have to be amended to reflect the changed requirement under the amended notification of the Government.

A second way of interpreting the Listing Agreement would be to interpret it as a 'live clause', to mean that the requirement for continuous listing is the level which is required to be maintained by any company for initial listing, at any given point of time. This would imply that, post the notification of June 4, 2010, as the level of public shareholding for initial listing has been increased to 25%, the level of continuous listing for all existing companies has also increased to 25%. This would be a strained interpretation, as it makes more sense to believe that when each existing listed company agreed to the Listing Agreement at the time of being initially listed, it is more reasonable to presume that they agreed that they would maintain their public shareholding at the same level as that required at the time that they were listed, unless words make it more clear that another meaning is more evident.

Well, now comes the interesting part. Rule 19A of the SCRR, inserted by the amendment of June 4, 2010 states that a company shall maintain 25% minimum public shareholding. So, in this instance, is this a listing condition? Well, Section 23E refers to the listing condition of the agreement, and not the rules, and this condition is prescribed by the rules, so the penalty should not be that under Section 23E. Does an already listed company then have to suffer no penalty?

The answer is, of course not. An already listed company which does not comply with the above requirement would be liable to a penalty, but one which is much less, that is, under Section 23H of the SCRA,which states that:

“Whoever fails to comply with any provision of this Act, the rules . . . for which no separate penalty has been provided, shall be liable to a penalty which may extend to one crore rupees.”

So what is the advantage of this? The obvious advantage is that the penalty for violation in such a case is 25 times less, that is, one crore rupees, instead of the previous twenty five crore rupees.

Endnote

Well, at the end, we are still left behind with one confusion – when does compulsory delisting of a company take place? The SEBI had in its older Delisting Guidelines, 2003, clearly provided that a stock exchange may delist the shares of a company if trading in them had been suspended for 6 months, and also on any of the 'norms' as mentioned in Schedule III to the guidelines. The Schedule made a clear reference, to eight norms, including Clause 40A of the Listing Agreement. The new Delisting Regulations, 2009 introduced in June last year merely state that compulsory delisting is permissible on any of the grounds under the SCRR. As of now, barring the amendment (which merely evinces an inchoate intention to allow delisting by stock exchanges), there are no grounds in the SCRR mentioned for delisting. The reference to the Listing Agreement has not been reiterated in the new Regulations, and of course, the items in Schedule III are gone.