(First published on Linkedin)
In a recent informal guidance, SEBI clarified that reclassification of promoters to the public category is permissible, provided the conditions under Regulation 31A of LODR Regulations are satisfied.
One of the key conditions is that the promoters seeking reclassification, along with their “related persons” must not hold more than 10% of the total voting rights. While the threshold appears numerical, it gives rise to several complexities. A few nuances around reclassification include:
1. Individuals with no role in management or control: Regulation 31A(3)(b)(i), when read with the definition of “related persons”, captures immediate relatives irrespective of any actual involvement in the company. For example, a married daughter with no board position, may still be treated as a “related person”. Consequently, even where a promoter is independently seeking reclassification, their combined shareholding counts toward the 10% cap, making reclassification ineligible.
2. Classification based on status, not substance: Recent SEBI FAQs provides that even if a person or entity does not hold any shares, such person is required to be classified as promoter group if related to the promoters. Therefore, once they are included as a part of promoter/ promoter group, their reclassification requires the same regulatory process, which would be difficult to adhere to “related person” condition.
3. Gifting of shares to employees by promoters: In the case of Prudent Corporate Advisory, shares were gifted by the promoters to employees. Due to Regulation 31A(6), these employees would, by default, be classified as promoter group. If the employee base is large enough, it would lead to distortion of promoter holding/ disclosure, and thereby triggering the need for reclassification. Therefore, we had advised on a formal exemption from SEBI had to be sought to ensure that employees are correctly treated as public shareholders, and SEBI had accorded the said exemption.
4. Lack of clarity for trusts settled for non-immediate relatives: Where shares are settled in a trust for the benefit of grandchildren or distant relatives (tax issues aside), ambiguity arises on whether such contribution qualifies for automatic promoter group tagging under Regulation 31A(6).
5. Public to Promoter – reclassification triggers open offer: A public shareholder seeking reclassification as a promoter is required to make an open offer under the Takeover Code, regardless of actual control or acquisition.
While Regulation 31A is a well-intentioned framework, there is merit in considering a case-by-case approach or a relaxation mechanism, which was so previously, and is absent in the current avatar of Regulation 31A.