Board permanency gives promoters leverage against investors

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Some promoters have long believed that their right to run a company that they or their ancestors founded is absolute. Several of these promoters have embedded themselves into the company permanently. There are two ways in which this is done.

The first is by naming themselves permanent directors in the company’s Articles of Association (AoA).

This issue took centre stage when Diageo plc (Diageo) wanted to remove Vijay Mallya from the board, after it had established control over United Spirits Limited (USL). Mallya refused, saying he had a legal right to stay on the board. The USL’s AoA had incorporated within it the right of Mallya to chairperson of the board, which he continued to assert even as he escaped India’s law enforcement.

It was only after a $75mn settlement with Diageo that Mallya agreed to remove himself. There were subsequent disputes on the settlement and other issues between Diageo and Mallya which took to the courts. The other instances of directors embedding themselves as permanent directors or chairpersons include; Sharad Parekh in Nilkamal Limited and Onkar Kanwar (Chairperson) and Neeraj Kanwar (Vice-Chairperson) in Apollo Tyres Limited.

The founders of startups too are using this route for them to stay in control independent of shareholding levels. In Zomato’s case, Deepinder Goel and a set of investors have embedded in the company’s AOA their right to nominate board members even if they are diluted by more 50 percent. Goel owned 4.69 percent equity in Zomato on June 30, and he gets to nominate one board member until he owns 27,573 shares (founder shares, adjusted for bonus and/or consolidation). This is 0.00035 percent of the paid-up share capital (as on June 30). If he divests or donates these, even then he can appoint a nominee as long as he holds an executive position in the company. This is premised on his right to build equity through stock options. Given the low shareholding threshold for him to have board nomination rights, he will likely remain on the board until he decides otherwise.

The other way to board permanency is for directors to get appointed, but not be liable to retire by rotation.

Recently, Jawahar Goel’s reappointment as Managing Director of Dish TV Limited was defeated by shareholders in the 2022 AGM — yet he continues on the board as a non-executive director. He has board permanency since he was appointed as a director not liable to retire by rotation. The Companies Act 2013 requires at least a third of the board to retire by rotation. But Independent Directors do not retire by rotation, they are appointed for a specific term. Emulating this, companies have appointed executive directors not liable to retire by rotation for a fixed term. The issue is greater when non-executive directors or promoters are appointed, but are not liable to retire by rotation. Effectively, this means that once such directors are appointed, they do not come up for reappointment subsequently, and, therefore, have board permanency.

The promoters tend to get their permanent positions when they have sufficient shareholding to vote themselves in. These are usually times when the company’s performance is not a concern, which leads  shareholders to overlook the longer-term consequences of the resolution. The concern over board permanency becomes central when the company’s performance deteriorates, or there are significant corporate governance concerns, especially with respect to related-party transactions. In instances where promoters lose their dominant shareholding, either through reduction in shareholding or a significant dilution after debt-restructuring, they continue to remain in control. With a compliant board, these promoters seldom face pressure from their peers. It is then left to investors to fight for a change in the board and management.

Under these circumstances, for investors to effect change, they need to seek the removal of the director. This is a far more difficult battle than simply voting against a director’s reappointment.

To remove a director, a special notice must be sent by shareholders owning at least 1 percent voting power, or shares valued at Rs 500,000 in paid-up capital, and then the management is obligated to put the request to a shareholder vote. Otherwise, shareholders owning 10 percent or more of the paid-up capital can ask for an EGM to be held, and the resolution to remove directors can be brought to shareholders for a vote. The resolution to remove a director needs a simple majority to pass (75 percent majority if it is the removal of an independent director). All of this can happen only if the board does not fight the investor in support of the entrenched promoters.

The battle between a lender and an institutional investor with a media and a cable company is evidence of both, how long drawn and uncertain this process of removal then is, and the costs of promoter entrenchment.

Even as regulations on shareholder rights (and activism) are being tested in the courts, investors are better off not appointing promoters permanently to the board in the first instance itself.

Hetal Dalal works at Institutional Investor Advisory Services India Limited (IiAS). Twitter: @hetal_dalal. Views are personal, and do not represent the stand of this publication.