Reclassification of shares: How and why is this done?

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Last week an interesting move at the country's largest private sector company Reliance Industries came to light. Reliance informed investors that it had reclassified 9.41 crore shares moving them from the Promoter and Persons Acting in Concert (PAC) category to the public category. These shares part of treasury stock were owned by eight corporate bodies that became subsequently Reliance subsidiaries, the moves stripped the shares of voting rights leading to the reclassification. The move also reduced the Promoter and Persons Acting in Concert stake by about 6.4% to 44.79%.

There are two questions for this transaction, one is how do shares get reclassified and why would the promoters want to do this?

Vivek Gupta of BMR and Independent Lawyer Vishal Gandhi may provide some answers:

Q: Not just Reliance but a bunch of companies in this country have what is called treasury stock, slightly anomaly situation because the company law does not quite allow a company to hold its own stock. Do you want to comment to begin with on the greyness of this whole treasury stock situation?

Gupta: You are right in pointing out that yes Companies Act does not permit treasury stocks but what a lot of companies have done and done so validly is that under a scheme of merger they have created a pool of stock, which is for the benefit of the shareholders of the company. For example, this was a transaction that was done by ICICI when they merged ICICI Bank . This is also a transaction that was done by Reliance when Reliance Petroleum and other Reliance Group companies merged into it.

To the extent that the parent company held shares in its subsidiary upon the merger since the parent company could not hold its own stock a trust was created. This trust was duly approved by the jurisdiction of High Court which would approve a merger transaction and this trust was for the benefit of the shareholders of the company.

So effectively, treasury stock came to light but treasury stocks came to light completely validly and in accordance with approvals from the High Court, approvals from the stock exchanges to which the schemes were submitted.

Q: About 13-14% of Reliance's stocks has held its treasury, partly by a petroleum trust as Mr Vivek Gupta mentioned because of the merger of Reliance Petroleum with Reliance Industries and partly through eight corporate bodies. They have became Reliance subsidiaries again-we are told by the Reliance spokesperson-because Reliance converted the loans given to these corporate bodies in to equity and hence these companies became Reliance subsidiaries.

What I am trying to understand is how did we go from step A which involve those eight corporate bodies holding these 9.41 crore shares, which had voting rights and shares which were classified under the promoter and PAC category to step B where these corporate bodies became Reliance subsidiaries holding these 9.41 crore shares but stripped of voting rights and also reclassified as public shareholding and not promoter and PSU shareholding?
 
Gandhi: This is a statutory requirement that where a subsidiary holds shares in a parent, the subsidiary will not have any voting rights on those shares. There are certain exceptions in fact even for a subsidiary to hold shares in a parent there are very limited circumstances in which it can be possible. So the reclassification to the extent of the shares becoming non-voting is a legal requirement under the company's act.

As far as the second part whether this promoter holding has become public holding is more of a question of fact who actually holds these shares.

Q: How do you assess that? There are Reliance subsidiaries so what do you make of the reclassification?

Gupta: One does not know enough about individual shareholding patterns about how they got classified as Reliance subsidiaries etc to be able to unequivocally answer this question of fact as Mr Vishal Gandhi has put it. Promoter has a very clear definition under the takeover code that definition has two-three limbs; one is persons in control of the company, second is person's name in the offer document as promoters, third is entities forming part of the promoter group. If a reclassification is happened, I would imagine that this very objective definition must have been satisfied.

Q: So there was no longer any promoter interest or holding in these companies, they became Reliance subsidiaries and therefore they come under the public category, did I get it right?

Gupta: That is possibly one line of factual argument. I do not know what the facts are specifically to be able to say whether that line of factual argument is the one that Reliance has taken and therefore reclassify it but that is potentially one line of factual arguments.

Q: Why would anyone want to do this? So at some point we were mulling over, there was also a warrant conversion that came up last week that increase the promoter's stake in Reliance Industries. So the natural question or the natural curiosity was that was this done in order to avoid triggering off the 55% takeover clause limit because the promoter already had 51% before that warrant conversion.

But we understand that the promoters did sell about 12.5 lakh shares making sure that their stake post the warrant conversion was 54.9% and so hence by a slim margin safe of that takeover code trigger. So why do you think they did it if they were already safe of the takeover code?

Gandhi: If they were already safe of the takeover code, probably to formulate a strategy for any future restructurings or future plan in terms of how the shareholding should be of the company.

Q: Would you be in agreement that just to create more leg room for any future increase in promoter's stake?

Gupta: Possibly. Also I think it is in a sense a layered defense so today you may not reach the takeover code trigger but what they have done is very interesting. The moment Reliance holds these companies as subsidiaries, shares held by these subsidiaries cease to carry voting rights. The moment that voting right goes away then for the purpose of the takeover code where shares are defined as financial instruments which must carry voting rights, these cease to be shares for the purpose of takeover code.

So I think some leg room is being created from 55% trigger perspective if you can reclassify as you have said 6% into non-voting shares then potentially that gives promoters the flexibility to play around with their stakes or to increase promoter stakes and in these times of falling markets often that is a useful tool for the promoters to have because fundamentally the company is very strong. So this keeps the promoters some leg room to indicate strength if they were want to do that.

Q: Is it commonly used-this whole structuring of converting from corporate body to subsidiary thereby stripping the shares of voting rights etc?

Gandhi: I do not think it is very common.

Gupta: I think very creative, falls within the law completely and a very interesting transaction as you have put it. I have not come across any other case. Yes  people have created treasury stocks but this situation where people have started making shares non-voting so as to avoid takeover code triggers-actually trigger is in other debate-and we have seen people, we have seen companies now come out with bonus issues of non-voting shares, people are already talking about rights issues of non-voting shares. So I wonder if we are going to see now a trend whereby promoter has increased their economic stake once they have established control and they do not really care about voting rights beyond 51%. So I wonder if this is part of the same trend. I have not seen an identical transaction but yes this trend is discernable in the last six months.