Class of shares and class of shareholders and applicability of section 48 of the Companies Act, 2013

1. Background

• We all know that section 43 of the Companies Act, 2013 (hereinafter referred to as “the Act”) states two kinds of capital (a) Equity share capital (b) Preference share capital.
  • These two kinds of shares capital have specific rights as stated in section 43 of the Act. It divides equity into two types
  • Equity share capital with voting rights or
  • Equity share capital with differential rights as to dividend, voting or otherwise in accordance with such rules as may be prescribed

• Preference share capital has some preferential right with respect to
  • Payment of dividend
  • Repayment in case of winding up or repayment of capital
  • Preferential right to the payment of any fixed premium or premium on any fixed scale specified in the memorandum or articles of the capital

• The basic two kinds of share capital when further dividend into different types are considered as “class” for the purpose of the Act. It can be seen from various sections viz 47, 48, 49.

• Sub-section (1) of section 48 states as follows:-
  • “Where a share capital of the company is divided into different classes of shares, the rights attached to the shares of any class may be varied with the consent in writing of the holders of not less than three-fourths of the issued shares of that class or by means of a special resolution passed at a separate meeting of the holders of the issued shares of that class,—
    • if provision with respect to such variation is contained in the memorandum or articles of the company; or
    • in the absence of any such provision in the memorandum or articles, if such variation is not prohibited by the terms of issue of the shares of that class:Provided that if variation by one class of shareholders affects the rights of any other class of shareholders, the consent of three-fourths of such other class of shareholders shall also be obtained and the provisions of this section shall apply to such variation.”

• From this is it clear that section 43 of the Act states two kinds of capital and section 48 of the Act makes it clear that there can be classes in each kind of capital.

• Sub-section (2) of Section 47 of the Act also mentions about classes in second proviso as follows
  • “Provided further that where the dividend in respect of a class of preference shares has not been paid for a period of two years or more, such class of preference shareholders shall have a right to vote on all the resolutions placed before the company.”

• Section 49 of the Act states as under:-
  • “Where any calls for further share capital are made on the shares of a class, such calls shall be made on a uniform basis on all shares falling under that class.
  • Explanation.—For the purposes of this section, shares of the same nominal value on which different amounts have been paid-up shall not be deemed to fall under the same class.”
• It is clear from section 43, 47, 48 and 49 that there are only two kinds of share capital i.e equity and preference. In each kind there can be different classes of share capital.

2 The question which this article deals with :-

• Whether the use of word “class” is restricted to “shares” or it extends to “shareholders” as well? In other words, whether the rights not attached to shares, but individual shareholder can be considered as “class” under section 48 of the Act and can it be varied?

• Consider a situation where particular rights are given to a shareholder viz.. right of pre-emption over other shareholders, right to prior consent on some matters, right to appoint director, right in case of unissued shares etc.   The rights are given to specific investor or shareholder in the articles of the company. The Company had not issued any shares having these rights. But by virtue of the articles one shareholder enjoys these rights.

• In above situation, whether we will consider him as a “class” or since the shares when issued not having these terms and conditions as part of issue and allotment, will it be considered as “class”

3 We need to analyse following to arrive at the conclusion for above questions

• Whether the title of the section gives any hint?

• Whether the section itself is clear about it?

• Whether any precedent available for addressing the question raised?

4 Lets analyse it one by one:-The first one is whether the title of the section is giving any hint?

• The title of section 48 is “variation of shareholders rights”  

• Heading in particular section lends, though not normally a part of the statutory provision, assistance in interpreting the statutory intent since the ‘heading’ always serves as a guide to depict the intention. It also makes it clear that the marginal note to a section cannot be referred to for the purpose of construing the section, but it can certainly be relied upon as indicating the drift of the section. It also shows that the heading/marginal notes prima facie furnish some clue as to the meaning and purpose of the section. [1]

• The title of a statute is an important part which may be referred to for the purpose of ascertaining its general scope and depicting its construction, although it cannot override the clear meaning of the enactment.[2]

• One cannot resort to the title of a Statute for the purpose of construing its provisions. Still, the title of an Act of parliament is no part of the law, but it may tend to show the object of the legislature.[3]

• The title of a statute does not traverse much in construing it; but it is not to be absolutely disregarded.[4]

• In our case, the title states that it is variation of shareholders rights. The title shows the object of the legislature, then here it is in indicating that the rights of shareholders too.

5 The Second aspect which we should analyse – Whether the section itself is clear about it?

• Sub-section (1) of section 48 of the Act uses both the terms “rights attached to the shares of any class” and “variation by one class of shareholders affects the rights of any other class of shareholders”

• Since sub-section (1) of section 48 of the Act states that rights attached to shares of any class may be varied with the consent in writing of the holders of not less than three-fourth of the issued shares of that class or by means of special resolution passed at a separate meeting of the holders of the issued shares of that class ….. … “variation by one class of shareholders affects the rights of any other class of shareholders”

• It is understood from the section that there can be two scenarios
  • One is where at the time of issuance of shares the company has created different classes of shares and now there is a situation to vary those terms and conditions
  • The other possibility mentioned in the proviso which is -variation of rights of one class of shareholders affecting other class of shareholders
  • The first rule of interpretation is literal interpretation. If we apply the simple meaning to the words used in the section then what it indicates to us. Why literal interpretation to be applied first? We can refer to the Hon’ble Supreme Court’s classic observation on ‘literal rule’ in Kanailal Sur V Paramnidhi Sadhu Khan, AIR 1957 SC 907, Gajendragadkar J., had explained the rule in these words:
  • “The first and primary rule of construction is that the intention of the legislature must be found in the words used y the legislature itself. If the words used are capable of one construction only then it would not be open to the Courts to adopt any other hypothetical construction on the ground that such construction is more consistent with the alleged object and policy of the Act. The words used in the material provisions of the statute must be interpreted in their plain grammatical meaning and it is only when such words are capable of two constructions one of which is likely to defeat or impair the policy of the Act whilst other construction is likely to assist the achievement of the said policy, then the Courts would prefer to adopt the latter constructions. It is only in such cases that it becomes relevant to consider the mischief and defect which the Act purports to remedy and correct.Maxwell in his book on the subject of statutory interpretation – ;the first and most elementary rule of construction the words of a statute must prima facie be given their ordinary meaning. Ordinary words must be given their ordinary meanings and technical words their technical meanings, unless absurdity would result. This is the golden rule
  • If we apply literal rule of interpretation, then the words in sub-section (1) of section 48 of the Act shall be given their ordinary meaning. Hence, the two terms used in section 48 covers both rights attached to the shares of any class and variation of one class of shareholders.

6 Now the last one is -Whether any precedent available for addressing the question raised?

• We can refer the judgement given in “Cumbrian Newspapers Group Ltd V Cumberland & Westmorland Herald Newspaper & Printing Co. Ltd [1986] BCLC 286 (Ch) 
• The Plaintiff, Cumbrain Newspapers Group Ltd and defendant Cumberland & Westmorland Herald Newspaper & Printing Co Ltd.
• The plaintiff and defendant were both publishers of newspapers. They negotiated a transaction whereby the defendant would acquire inter alia one of the plaintiff’s newspapers and the benefit of certain advertising arrangements and the plaintiff would acquire inter alia 10 per cent of the defendants share capital. The defendant duly issued 10 percent shareholding to the plaintiff and as part of the agreement under which the shares were issued amended its articles to grant to the plaintiff rights of pre-emption over other ordinary shares, rights in respect of unissued shares and the right to appoint a director. The purpose of such rights was to enable plaintiff, in its capacity as shareholder, to be in a position to be able to prevent a take-over of the defendant. After the arrangements so embarked on hd continued for several years the directors of the dependent proposed to convene an extraordinary general meeting and to pass a special resolution to cancel the articles which gave such special rights to the plaintiff. Plaintiff objected it stating that (a) the rights were class rights which could not be abrogated without its consent and (b) an injunction restraining the defendant from convening or holding the extraordinary general meeting. 
• In this case, the plaintiff contends that the special rights which it enjoys under the articles in question are “class rights” which cannot be varied or abrogated without is consent. Alternatively, the plaintiff contends that it is entitled to enjoy those special rights pursuant to an agreement made between itself and the defendant in 1968, and that it is , in consequence, entitled either to restrain the defendant from conveying the proposed general meeting , or at least to restrain the defendant from acting on any special resolution abrogating or varying the plaintiff’s special rights.
• The defendant on the other hand, denies the contractual entitlement of the plaintiff to enjoy those rights, and asserts that it is entitled to alter its articles in the manner prescribed by law.   
• We will focus on the discussion w.r.t. section 125 of the Companies Act, 1985 (UK) (Section 48 in our case). The judgement states that the rights and benefits which may be contained in articles can be divided into three categories:-
  • There are rights or benefits which are annexed to particular shares. Classic examples of rights of this character are dividend rights, rights to participate in surplus assets on a winding up.
  • Second category of rights or benefits which may be contained in articles, would cover rights or benefits conferred on individuals not in the capacity of members or shareholders of the company bit , for ulterior reasons connected with the administration of the company’s affairs or the conduct of its business.
  • The third category, the rights or benefits that, although not attached to any particular shares, were nonetheless conferred on the beneficiary in the capacity of member or shareholder of the company.
• The first category is very clear to us. When the rights are attached to shares at the time of issue it falls under Section 48 of the Act. The second category is not relevant for us.  The judgement elaborated the third category where the rights and benefits are not attached to any particular shares but conferred on the beneficiary in the capacity of member or shareholder of the company.
• The judgement also refers, Bushell V Faith , 1970 A.A. 1099 there were two classes of shareholders in the company. There were shareholders who were not for the time being directors, and shareholders who were for the time being directors. The former had rights against latter which the latter did not enjoy against the former. The two classes were identifiable not by reference to their respective ownership of particular shares, but by reference to the office held by the latter. But the rights of the former, and the obligations of the latter, required their respective ownership of shares in the company. Accordingly, as a matter of classification, the rights in question fall in third category.
• In Cumbrain case, it was the question for decision whether rights in this third category are within the meaning of the phrase in section 125 of the Companies Act, 1985 and in article 4 of table A. (in our case section 48 of the Act and article 6 of Table F)
• In this case defendant argued that third category of rights are not rights attached to a class of shares, for the purposes of section 125, it must follow that articles containing such rights can be altered by special resolution pursuant to section 9 of the Act of 1985 (Special resolution for alteration of articles of association).
• The judge stated it would, in my opinion, be surprising and unsatisfactory of class rights contained in articles were to be at the mercy of a special resolution majority in general meeting.
• This is very important paragraph from the said judgement “A number of considerations lead me to the conclusion that the purpose of sections 125 to 127 of the Act of 1985, and section 32 of the Act of 1980, was to deal comprehensively with the manner in which class rights in companies having a share capital could be varied or abrogated.
  • They are these : first, chapter II of Part V of the Act (Which includes section 125 to 129) is headed “class rights”. The side note to section 125 reads “Variation of class rights”. The language seems to treat “Class rights” as synonymous with “rights attached to any class of shares” at any rate so far as companies with a share capital are concerned.
  • Second, the use in section 17(2)(b) of the Act of 1985 of the expression rights of any class of members in connects both with companies having share capital and with companies having no share capital, underlines the point that the expression “rights attached to any class of shares” in section 125, must have been regarded by the legislature as synonymous with the former phase, so far as companies with a share capital were concerned.
  • Third, the evident intention of the legislature to protect rights attached to any class of shares against variation or abrogation by the mere alteration of articles, would if coupled with an intention to provide no such protection against variation or abrogation of class rights of the third category , be anomalous and arbitrary,
  • Fourth, if the variation or abrogation of third category right are not dealt with by section 123 the conclusion would see to follow that if the rights were contained in the memorandum, the rights could not be varied or abrogated at all. The enabling provisions of section 124 of the Act, of 1985 would obviously not apply, or would the enabling provisions of section 17 of the Act of 1985. The term of section 17, to my mind, strongly suggest a legislative belief that section 125 would deal with the variation or abrogation of any “special rights of any class of member” contained in the memorandum.
  • Fifth, the combination of considerations thirdly and fourthly above-mentioned leads to a further point. What sense could be there be in a result under which third category rights contained in articles were more freely alterable than rights attached to any class of shares contained therein, but under which third category rights contained in the memorandum were less freely alterable than rights attached to any class of shares contained in the memorandum ? the distinction would not be merely anomalous; it would, to my mind, be perverse.
  • The question, whether section 125 covers even rights conferred by articles to a specific member holding shares of the company was concluded in favour of plaintiff. The conclusion was as follows:“In my judgment, a company which, by its articles, confers special rights on one or more of its members in the capacity of member or shareholder thereby constitutes the shares for the time being held by that member or members, a class of shares for the purposes of section 125. The rights are class rights.”

7 Summary

• The title of section 48 of the Act is “variation of shareholders Rights” which though not forming part of law but does indicate the intent or objective behind the section. It indicates that the section contains the provisions relating to variation of shareholders rights too.

• Sub-section (1) of section 48 of the Act uses the terms “rights attached to the shares of any class and proviso to sub-section (1) of section 48 “variation by one class of shareholders affects the rights of any other class of shareholders…” It seems that the words “rights attached to class of shares” and “rights of any class of shareholders” are used interchangeably. Section 48 covers both the types of rights.

• As per the judgement citied in para 6, we could see that the it is in favour of view that section 48 also includes the rights of class of shareholders.

• It is very interesting to study the case laws on selective reduction of capital or reduction of capital where minority is wiped out. Whether such type of shareholders will be considered as “Class of shareholders”? if yes, whether consent of three-fourth shareholders will be required as per Section 48 of the Act?

8 Conclusion :-

As per the title which indicates variation of shareholders rights, section having used both the terms interchangeably and based on the judgement discussed above, it seems that a view can be taken that section 48 shall apply even in cases where there is variation of rights of shareholders too.  It will be Interesting to study minority as “class” under section 48 of the Act.

---

[1] Brihan Mumbai Electric Supply Transport Undertaking & Another V Laqshya Media P. Ltd 2009 AIR SCW 7528.

[2] Ashwini Kumar V Arabinda Bose AIR 1952 SC 369, Popatlal Shah AIR 1953 SC 274; Manoharlal AIR 1961 SC 918

[3] Per Wightman, J.. in Johnson V Upham (1859) 2 EcE 250, 263

[4] Kenrick & Co V Lawrence & Co (1890) 25 QBD 99, 104; Sunderaraman AIR 1958 SC 468, 485