The Hindu Business Line : On course to a majority mess-up

THE Reliance imbroglio has given rise to questions about corporate governance. Are corporates heading towards the management philosophy of the erstwhile system of managing agents?

Reliance Industries Ltd (RIL) holds substantial interest in Reliance Energy Ltd (REL). RIL's shareholding in REL does not give it majority voting power, yet RIL is in a position to `control' REL inasmuch as it is the single largest shareholder. Thankfully, this is acknowledged by the definition in the SEBI Takeover Code. The REL board has given a notice, pursuant to Section 192A of the Act read with the Companies (Passing of Resolution by Postal Ballot) Rules, 2001, to pass a special resolution amending its articles of association (AoA) by inserting Article 131(a) in place of Article 131(a) (i), 131(a)(ii) and 131(aa) in the AoA of the company. The newly proposed Article reads thus:

"131(a): Notwithstanding anything contained in any other provisions of Articles of this Articles of Association including the provisions of Article 104-A, so long as the Reliance group of Companies and/or its associates/affiliates and/or subsidiary companies hold 26 per cent or more of the paid-up voting equity share capital of the company and are the single largest shareholding group in the company, they shall have the right to appoint majority of the directors on the board of directors of the company, and shall be deemed to be the promoter of the company as defined in Regulation 2(h) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, and shall exercise control over the company, as defined in Regulation 2(c) of the said Regulations including amendments, modifications or re-enactment thereof, and Reliance Industries Ltd shall designate one of the directors to be the chairman of the board, and may also designate one of the directors to the vice-chairman of the board; and Reliance Industries Ltd shall determine the period for which each of them is to hold such office and the chairman and vice-chairman so designated shall not be liable to retire by rotation."

Hitherto litigations were fought to seek justice against the oppression of minority shareholders by majority shareholders, by resorting to the relief available under Sections 397, 398 and 399 of the Companies Act 1956. Does this not amount to oppression of the rights of the majority (74 per cent) shareholders?

From a plain reading of the newly introduced Article, it is apparent that REL has empowered RIL as a single largest shareholder with unfettered powers, the right to appoint majority of directors on the REL board. Such an empowerment is in direct conflict with Clause 49 of the Listing Agreement encompassing corporate governance and constitution of audit committee and Section 292A of the Act.

Section 292A mandates the constitution of an audit committee comprising not less than three directors and such number of other directors as the board may determine, of which, two-thirds of the total members shall be directors, other than managing or whole-time directors. The appointee by RIL can never qualify to be an independent director.

Clause 49 of the Listing Agreement defines the term independent director as a non- executive director of the company who: i) apart from receiving director's remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associates which may affect the independence of the director;

ii) is not related to promoters or persons occupying management positions at the board level or at one level below the board;

iii) has not been an executive of the company in the preceding three financial years;

iv) is not a partner or an executive or was not partner or an executive during the preceding three years, of any of the following: a) the statutory audit firm or the internal audit firm that is associated with the company, and b) the legal firm(s) and consulting firm(s) that have a material association with the company.

v) is not a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the director; and

vi) is not a substantial shareholder of the company, that is, owning 2 per cent or more of the block of voting shares.

If RIL reserves the right to appoint majority of directors, these provisions can never be satisfied. Will the chairman and vice-chairman be executive or non-executive? This will be vital for the composition of the audit committee of the Listing Agreement. Without any agreement between REL and RIL what effect this AoA will have is a moot point.

Another conflict that could arise is that the right to appoint majority of directors is given to a shareholder with 26 per cent of voting equity. The rest of the shareholders may over time acquire more than the holdings of RIL to control the composition of the board.

In the newly inserted Article, REL has depended on the definition of promoter as outlined in Regulation 2(h) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. This definition includes all persons acting in concert and also the direct and indirect interest. It is also significant that both RIL and REL are listed companies and their shares are compulsorily demated. So there can be no ground for refusal of transfers except where the acquirer has such an obligation under the Takeover Code.

Conversely, any person or persons acting in concert or otherwise can acquire holdings which can tilt the balance. Going by press reports, there are other issues relating to resignation of directors. It would appear from the explanatory statement that persons who are supposed to have resigned from the board are being still shown as directors. In law, when a person resigns, the resignation takes effect from the date thereof unless the letter specifies otherwise. If there is any reconsideration on this issue, it can only be by way of reappointment; there is no such thing as withdrawal or acceptance of resignation. Legally it is not necessary to obtain the board's permission or consent. The board has to merely note a resignation and file the necessary return. This is settled law.

It is hoped that the Reliance group, having received encomiums in different fields, which include the observance of best corporate governance practices, follows the spirit of corporate law.

(The author is a Pune-based company secretary.)

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