SEBI's Consultative Paper on Promoter Reclassification: Pleaser or Teaser?

The promoter focused model of corporate governance is unique to India. It symbolizes, perhaps most importantly, overall control of a listed company. The promoter tag, however, comes with its share of regulatory obligations and restrictions. It is therefore not surprising that existing promoters who have sold majority stake and relinquished control of a listed company, are keen to be reclassified as public shareholders (if they intend to stay on as passive shareholders) or be declassified as promoters (in case of a complete exit).  

To this end, India’s securities market regulator, the Securities and Exchange Board of India (“SEBI”), had issued a ‘Consultation Paper’ on re-classification of promoters and promoter group on 23 November 2020, suggesting certain modifications to the process of reclassification of existing promoters of listed companies. A brief analysis of such revisions is set out below:  

1. Increase in minimum shareholding: Currently, one of the requirements to be fulfilled by the promoter/promoter group before making a re-classification request is to ensure that their cumulative shareholding in the listed entity does not exceed 10%. SEBI has aptly proposed to raise this requirement to promoters and persons related to promoters not holding 15% or more of the total voting rights. Such revision is reflective of ground realities of public market deals where outgoing promoters are often left, by choice or on account of deal structure, with a stake exceeding 10%. In turn, such promoters face various difficulties such as forced sell down of shares (often at a sub-optimal price), in order to achieve re-classification. This also helps incoming investors better structure deals by enabling more efficient re-classification, and not remain hostage to outgoing promoters first completing a sell-down to become eligible for re-classification.  

2. Gestation period: Presently, there is a mandatory minimum waiting period of at least 3 months between the meeting of the board of directors and the date of meeting of the shareholders to consider the reclassification request made by the promoters. This intervening period is proposed to be brought down to a mandatory minimum of one month, thereby enabling a speedier reclassification. The maximum time period of 6 months between the board and shareholders meeting remains unchanged.  

3. Reclassification in case of open offer: Perhaps the most pragmatic (and equally important) proposal is to exempt outgoing promoters from following the standard reclassification process in transactions involving a mandatory open offer. The proposal requires such outgoing promoters to state their intent for reclassifying in the open offer documents – an aspect which is typically agreed upfront at the time of deal structuring. This is a welcome proposal as it would greatly increase the efficiency in achieving reclassification in Public M&A deals. Having said that, it would be interesting to see if this provision may be utilized in hostile takeovers involving an open offer, to try and reclassify existing promoters as mere public shareholders (subject of course to satisfaction of other re-classification conditions).  

4. Uncooperative/untraceable promoters: The promoter re-classification process is typically initialled by the promoter itself. In cases where pursuant to an open offer, the erstwhile promoter is uncooperative (with respect to re-classification of its promoter status) or untraceable, it has been proposed that the listed company be entitled to reclassify such erstwhile promoters without following the entire re-classification process. Instead, reclassification would be permitted if the erstwhile promoters are not in control of the listed entity and are not traceable or are uncooperative, and genuine efforts have been made in reaching out to such promoters. This is certainly pegged to be a useful tool in a listed company’s arsenal to clean-up archaic remnants on its shareholding pattern. At the same time, with the term uncooperative open to interpretation, any reclassification based on such characteristics is likely to be subject to challenge.   

5. Court / regulatory order: Another proposal is to automatically reclassify promoters, where such reclassification is a natural consequence of a court or regulatory order. Currently reclassification is permitted pursuant to an insolvency resolution process, however, there is no mention of wilful defaulters or fugitive economic offenders being automatically reclassified.  

6. Board decision: To fix a visibly minor (but important) loophole in the existing regulations which do not prescribe a time frame for holding the initial reclassification board meeting, SEBI has proposed a time frame of one month for the board of directors of a listed company to consider the reclassification request of the outgoing promoters.  

7. Promoter till re-classified: SEBI has also clarified that an existing promoter entity shall continue to be classified as a promoter even when it holds minuscule or nil shares in the listed company. While this is already an existing market practice, the dictate clarifies the incumbent requirement explicitly. 

The proposed reclassification regime will naturally streamline the process for promoter reclassification, as several gaps are being filled and timelines tightened. Once implemented, the revised norms are likely to benefit both incoming and outgoing promoter communities. Overall, a definite win-win, only with a few loose ends.  

Note: The article has been co-authored by Mr Abhishek Dadoo, Partner, Khaitan & Co and Ms Pavi Jain, Principal Associate, Khaitan & Co.