10 Governance Structure Of The Companies

Prof. Anil Kumar Rai

Introduction:

In seeking to understand the Corporate Governance structure of a Company, we have to take into account two basic factors which would be at work to create the structure. The first factor which would be there is that wherever there is a divergence between ownership of an asset and control over it, certain duties will be imputed by law upon the person who is in control of the asset. Further new duties may be added or the implied duties may be diluted by contract, but there has to be a certainty as to who is bound and to what extent. Law of trust is a perfect example of this situation where there is distinction drawn between the legal owner (the person in control) and the beneficial owners (real owners i.e. property exists to their benefit). Further examples of it may be drawn from law of agency and the law of partnership. The second factor which works in determining the contours of corporate governance structure is the fact that whenever the state imparts legal personality upon an entity which is not natural, it will generally provide for rules of ascription. The statute which will grant recognition to the legal personality of an artificial person will be the primary source of ascription of action upon the artificial person, in order to ensure that its own decisions and acts should bind it and there should be minimal source of discord in future as to the binding nature of the action upon the artificial person. Statutes or charters which created local bodies, universities etc, follow this principle in laying down the broad norms for decision making process by which decisions could be ascribed to the body, while giving it enough discretion to formulate its own bye laws, regulations rules etc. There would not be much of a difference where the statute instead of creating an artificial person, allows an artificial person to come into existence provided norms laid in it are followed. Only it may provide for a greater scope for experimentation and provide for an authority to oversee that the norms for recognition of personality are followed. Examples of this approach are the cooperatives and companies. If the entity is for a single purpose; the degree of flexibility allowed will be lower, which we witness in cooperatives. The rules are there not just for the ascription of decisions but also in doing so, how to reconcile the different interests which may interact, taking into account the purpose of the entity.

DIFFERENT INTERESTS IN THE COMPANY AND THEIR SAY IN COMPANY’S AFFAIRS

Artificial personality of a company and limited liability of shareholders of most of them brings into focus the interests of creditors vis a vis that of the shareholders, who happen to be the owners of the company. The statute will not only have to reconcile it and give a degree of protection or comfort to the creditors, it also needs to reconcile the varying interests of the shareholders. To do this it will need to take into account the nature of the company. A private company needs to be given more flexibility as it is more in the nature of a partnership. At the other end of the spectrum, a listed public company will have an amorphous mix of persons as shareholders, with bare interaction with each other and few having a say in the management of the affairs of the company. In such a situation it becomes necessary to give a greater say to the shareholder of a public company and ensure the existence of structures so that he is not cheated or deprived of his rights. Unlike the shareholder of a private company, who usually was a party to the Articles of Association or derived his rights via them and many a times has management say this may not be so in a public company so such a shareholder may not have negotiated articles which would protect him from the majority. One needs to also distinguish between a ‘for profit company’ from ‘not for profit company’. The latter is more in the nature of a public trust, giving the government a greater say in its oversight. While shareholders are broadly categorised as owners of the company, upon whom the risk, albeit a limited one, resides, there could be classes amongst them and there may be differences in apportioning of the risk among different classes. Those who bear the greatest risk also ought to have a major say in the affairs of the company. So generally, a preference shareholder cannot share the pedestal with an equity shareholder in managing the affairs of the company. Since preference shares provide the cushion to creditors, such shareholders will have a greater voice than the creditors, but only so much. He is still a quasi-creditor and his interests are not aligned with that of the equity shareholder.

SHAREHOLDERS AND BOARD OF DIRECTORS IN CORPORATE GOVERNANCE

Shareholders are the owners of the company. One of the reasons for them preferring a corporate structure to do business over a partnership is the facility that it affords to the idea of leaving the management of the business in the hands of someone most capable or well placed to do so. Like a principal nominating an agent to conduct his business, they would nominate someone to conduct the business of the company. The difference being that they nominate as the owners of the company and they themselves are not the company. Ipso facto, the principal is the company itself and the loyalty of director is primarily to it and not to the shareholders. The structure resembles a trust structure except that beneficiaries of a trust may have no role in the selection of a trustee. How the shareholders will choose the directors of a company will be dependent upon the provisions of the enabling statute i.e. Companies Act and the basic contract amongst the shareholders under it i.e. the Articles of Association. It is to the board of directors that the day to day working of the company and formulation of its policy is left to. It may comprise of share holders, but as members of board, their capacity is distinct.

The board of directors is constituted to manage the day to day affairs of the company, formulation of business plan etc. They have been chosen for their competence and for reflecting the different interests amongst the shareholders. But one must remember that they, the shareholders, are still the owners of the company, which has been bought into existence for the purpose of conduct of business, with most of them usually being businessmen. Unlike a trust, where the benefits to the beneficiaries are usually handed down, the initial shareholders are active participants in bringing about the company in existence. Perforce the enabling statute, i.e. Companies Act, has to recognize it and grant them a greater say in the affairs of the company. In fact in the very act of bringing the company into existence, the very constituting contract- i.e. Articles of Association, would reserve for shareholders some powers over and above that which the Companies Act provides for. Since the delegation of powers to the board of directors is a limited one and rest still remain vested in the shareholders as a body, it follows that the shareholders and the board are the two organs of the company which can speak for it and have the legal authority to act for it, as distinct from merely representing it. The company being an artificial person, there have to be organs comprising of natural persons (though shareholders may themselves he artificial persons) to which its acts may be ascribed.

Types of rights and powers vested in shareholders

RIGHTS OF SHAREHOLDERS IN CORPORATE GOVERNANCE

Shareholders are the primary stakeholders in a company, them bearing whatever little risk there is to be borne and the company being essentially for them. Other than protecting the creditors, the statute (Companies Act) would generally concern itself with what rights be vested in shareholders, which rights need to be protected in different circumstances, how the different rights need to be protected after taking into account from whom they need to be protected. There can be three sets of decision making rights which would vest in shareholders. The first set would relate to rights provided to shareholders by statute. The rights, as discussed above, would vary according to the nature of the company. These decision making rights have been devolved on shareholders for various reasons. Them being made aware of the nature of risk an activity involves and implications of an action taking into account conflict of interest between management and company and getting their consent where related party transaction may happen, general affirmation of the board’s all round work or any specific suggestion received from board, deciding on agents for effective oversight of board i.e. auditors etc. The second set relates to rights reserved for shareholders to decide by the basic contractual document amongst them i.e. Articles of Association. Articles may not only reserve certain rights for the shareholders but also provide for more onerous means of obtaining what may be called a shareholders resolution. This may be done by various means e.g. provide that certain resolutions in addition to fulfilling the requirements of Companies Act, will have to pass additional hurdles in form of approval of certain shareholder or block of shareholders, greater percentage of shareholders approving special requirements of quorum etc. Thirdly, the shareholders may by voting, reserve certain rights for themselves. They may relate to uncharted undefined areas which the Articles do not cover or it may relate to a matter which shareholders delegate to the board but need to maintain final control.

Rights reserved for shareholders by Companies Act-

LIMITATION ON SHAREHOLDERS GOVERNANCE RIGHTS

Respect for and adherence to division of powers by the Articles between the board and the shareholders is a contractual obligation upon the shareholders for the shareholders. Till it is there, unaltered, the division has to be respected by the shareholders even if the resolution had a majority support large enough to after the Articles. Further, the Articles are public document, and members of the public having dealings with the company ought to be certain what is within the domain of the board of directors or the shareholders to decide. If the power is conferred on the board, then only it can exercise it. In a private company, its extent can be very wide, given the nature of a private company. Howsoever large the majority of the shareholders, they cannot usurp the powers of the board without altering the Articles. In case the board acts in a manner contrary to what was decided by the shareholders, it would be difficult for the courts to decide which action to attribute to the company in the absence of such a rule. Ipso facto, from this it follows that where the general management of the company vests in the board, members cannot by ordinary resolution give directions to the board or overrule it. Board of directors is of the company and not just the majority shareholders. Shareholders as a body are its owner and not just the majority. In addition to difficulties it would pose for attribution of decision on the company, it would tantamount to overriding the special rights which may be reserved for certain shareholders by the Articles. To say that the minority shareholders may exercise other remedies given by the Companies Act means that the minority to protect its rights can only use the sledgehammer which may as well harm the company, affecting minorities whose only interest was having the company avoid acting as per the decision. However one has to remember that these limitations on the shareholders would be relevant only if the company does possess a board competent or able to exercise its powers. Articles may have been framed for an active board. A deadlock may render the board completely unable to act. Since it is the shareholders who will bear the brunt of this deadlock, action by shareholders to resolve the deadlock even in derogation of directors powers under Articles to an extent, may not be violative of the compact. But the action needs to be limited to doing what is necessary for the resolution of the deadlock i.e, nomination of additional directors etc. However for this, the deadlock has to be severe enough so as to render the company’s board ineffective. Mere disagreement on an issue between directors may not provide the shareholders an alibi to act.

ELICITING OF SHAREHOLDERS VIEW- SHAREHOLDER MEETINGS

The decision of the shareholders is taken in a meeting of them. The question arises as to what constitutes a meeting of the shareholders. There are two types of meetings of the shareholders, the annual general meeting and the extraordinary general meeting. The former, as the very term suggests, is a compulsory annual ritual to be observed by the company. For the smooth functioning of the company, certain housekeeping functions have to be voted upon by the shareholders annually at the least. Any meeting other than the annual general meeting has to be called if certain prerequisites have been fulfilled. An extraordinary general meeting may be called by the board of directors whenever they like, or by the Tribunal or by the board on a requisition by members having ten percent of the shares having voting power.

A meeting in the ordinary sense has two aspects, exchange of views and perspectives and determination of the majority view. For the purpose of formation of views so as to decide how to vote and what to speak if allowed, also solicit support of others for one’s own perspective, it is necessary that a shareholder is aware of the facts in sufficient detail sufficiently in advance. For this reason the notice of meeting should set all material facts in sufficient detail concerning an item for discussion, including the interest of managerial personnel, for the shareholder to understand the meaning, scope and implications of the item of business so that they may decide on it. In addition the notice ought to be sent to the shareholders at least twenty one days in advance, thus giving them sufficient time to decide, solicit support and participate. Requirement of minimum notice period can be dispensed with only if there is a majority which would make solicitation of support irrelevant, i.e shareholder comprising ninety five percent of the votes dispense with it in writing.

For a meeting to happen, there needs to be a minimum of two people. This is a bare minimum required in a company which is not a single member company for the quorum of meeting. But the required numbers would go up in the case of a public company, the requisite minimum for a quorum being dependent on the number of members the concerned public company has. However as referred to earlier, the Companies Act sets the floor for quorum. The Articles may prescribe a higher number and many a times for quorum attendance of a specific shareholder is necessary. In the absence of quorum, the meeting is adjourned to the same day next week, and if called by requisitioning shareholders, it is cancelled. Those unable to attend may nominate a proxy, with the limitation that the proxy cannot express any views in meeting.

If a resolution is not passed by show of hands, wherein only those entitled to express views participate, it shall be put to vote by the chairman (selected by the members for conducting the meeting). Members possessing one tenth of the voting power can demand the poll. Once a demand is made, the resolution has to be passed by the requisite majority for the matter. Matters which require the members consent may be of differing importance and so different majorities may be required of different matters put to vote. But what also matters is how widespread the participation in voting is. Public companies with widespread shareholding may require a wider participation, if not in the expression of views, then in the poll. Physical presence for voting, by self or proxy may be dampener, unless someone is highly motivated or votes are solicited by interested parties. To enable the participation of small shareholders, who are not necessarily passionate about the matter put to vote, postal ballots may be a worthwhile option. The Government may provide for matters which can be decided only by postal ballot. The company may go further. Other than matters in which it is necessary to hear the directors or auditors, it may provide for any matter to be decided by postal ballot.

VOTING VALUE OF SHARES

While in a public company there is equality in the value of votes of each equity share, them having same value subject to those which have not been paid for, in a private company this may not necessarily be true. There can be difference in the voting rights of different shares in a private company. Whether a resolution has been passed or not will therefore depend not just on the face value of the share but the voting power which it has. Further, as referred to earlier, different resolutions will need different majorities to be determined by the Act and the Articles. Articles of Association may raise the bar, not lower it. A general resolution only needs a simple majority of the members present and voting to vote for it. Most of the matters which require the general resolution usually relate to ordinary everyday matters. However there may be issues where it would be inequitable to let a matter be passed by the ordinary simple majority. Though the requirement may not be as onerous as in a trust where all beneficiaries have to agree, still a sufficiently large majority needs to agree for the special resolution. The Act provides for a three fourth majority of shareholders present and voting. The matters for which such a resolution is required are broadly of two categories. The first set of situations are those which go to the root of the contractual relationship between the shareholders i.e relating to the amendment of the constitutional documents (Memorandum and Articles of Association). The second set of circumstances relate to where the interests of shareholders may be affected by the decision of the board (which will be controlled by the majority) or majority shareholders. The issue does not relate to the company’s identity (constitutional documents etc) but has the potential to affect the shareholder value. While the majority would have taken care that its interests are not affected or taken care of, those who do not control have to have an effective say. Examples of such actions are new share issuance not on rights basis, merger or amalgamation with another company, actions affecting the earnings potential (sale of undertaking) or increase risk (leverage by taking debt above a particular level), or may benefit others(investment outside the company above a particular limit) or a related party transactions. It is recognised that in related party transactions, it is the shareholders controlling company who will be usually benefitting from such transactions or the transaction may be having their active consent, therefore in certain class of related party transactions (according to the size of company or size of transactions), the beneficiary of the transaction cannot vote for the special resolution as what is needed is the assent of the rest. While there is a division in the powers of the board of directors and shareholders as a body, until the company is hurtling towards bankruptcy, the board primarily acts for its shareholders. The shareholders can therefore as a body, affirm and ratify the acts of the directors or waive their rights against them subject to of course two qualifications, that the said acts should be within the powers of the company and if it is not an related party transaction at an arm’s length, then the directors shall not vote on it as shareholders.

DUOMATIC PRINCIPLES

While the shareholders’ will is reflected in the resolutions passed by them, insistence on it may be unjust to the third parties, especially in cases of private companies where the conduct of parties may show an informal and unanimous agreement among shareholders. However, there has to be a conduct of the shareholders which does evidence of unanimous agreement among themselves. This recognition of informal agreement, though not provided by stature, had to be inferred by the courts as tan amounting to a resolution passed by the shareholders provided it was intra vires.

ARE SHAREHOLDERS UNDER DUTY WHEN VOTING?

Shareholders, when voting for a resolution, are not under any legal obligation to take into account the company’s interests, contractual or moral obligations. Even a director of the company, when voting as a shareholder is not under any obligation to vote for the resolution affirming the decision of the board of which he was a party to as a member of the board. The vote is a property right of the shareholder which can be exercised as per the shareholder’s perception of its interest and it owes no fiduciary duty to the company. Being a property right, it can be the subject of contract. Shareholders can agree among themselves the manner and purpose for which they shall vote and such contractual obligations are legally enforceable.

VOTING RIGHTS OF PREFERENCE SHAREHOLDERS

Whilst we referred to shareholders voting for resolutions, we limited out reference to equity shareholders. It is they who take the maximum risk in the corporate venture and it is fair that they should have the right to decide the direction of the company. However when the issue in question is in the terms of any other class of securities, i.e. any series of preference shares, it is fair that they should have the vote on it and the amendment is carried out by the fourth vote. Also, when a company runs into financial trouble, the directors owe to the duty not just to equity shareholders but creditors too, who may have also protected their interest by having taken security. It is the quasi creditors, the preference shareholders who would be left unprotected. In recognition of their unprotected status, the statute confers certain powers in such an event. The non-payment of preferential dividend to preference shareholders for two consecutive years would be an indication of brewing financial troubles and therefore in such a circumstance they get a right to vote on any resolution put for the shareholders vote.

Summary:

In order to understand the Corporate Governance structure of a Company, two basic factors have been taken into account. The first factor is that wherever there is a divergence between ownership of an asset and control over it, certain duties will be imputed by law upon the person who is in control of the asset. Further new duties may be added or the implied duties may be diluted by contract, but there has to be a certainty as to who is bound and to what extent. The second factor which works in determining the contours of corporate governance structure is the fact that whenever the state imparts legal personality upon an entity which is not natural, it will generally provide for rules of ascription. The module has included brief discussion on role of board of directors and shareholders of a company. The rights of shareholders, specially their voting rights, value of their votes, meetings for exercising these rights have been discussed. Distinction between voting rights of equity and preference shareholders have been included in the module.

References:-

1. Avtar Singh, Company Law, 15th Edition 2013, Eastern Book Company , Lucknow

2. Davies, Gower and Davies’ Principles of Modern Company Law, 8th Edition 2008, Sweet and Maxwell, London

3. EilisFerran, Company Law and Corporate Finance, 1999, Oxford University Press, Oxford

4. Penington, Penington’s Company Law, 8th Edition 2001, Oxford University Press, Oxford