A proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of the company
A company can be private or public. A public company is one that offers shares, debentures and interests to the public. Owners of a company are called shareholders.
A closely held corporation’s shareholders are usually divided into two groups: (i) shareholders that have a controlling interest in the corporation; and (ii) shareholders that do not have a controlling interest in the company. The corporate shareholders that do not have a controlling interest in the company are known as “minority shareholders”.
Majority shareholder is a single shareholder who controls more than half of a corporation’s outstanding shares.
Other hand, minority shareholders are shareholders who have minority stakes in a company that is controlled by a majority shareholder. The right and power of majority and minority shareholders is not same. Majority shareholders actually control the market. They enjoy a huge opportunities from share market. In other hand, minority shareholders do not get their proper right. Sometimes they suffer very much in the time of stock market crash.
A proper balance of the right of majority and minority shareholders is necessary for avoid those crisis. For the smooth functioning of the company, authority must ensure the proper balance of the rights of majority and minority shareholders of a company who does not have the voting control of the company, by virtue of owning below 50 percent of the firm’s equity capital.
In most of the company it is seen that the majority shareholders get together and elect such board of directors who will work mainly to serve their personal purpose rather than the company’s interest. They will only indulge in such kind of decision which will bring maximum benefit to the majority shareholders.
While disgruntled shareholders of public listed companies have the options of selling their shares in the open market, the same course of action is unfortunately not open to shareholders of unlisted companies, since there is no ready market for private company shares. In a world that recognizes ‘simple majority rules’, minority shareholders of companies are by default vulnerable to oppression, disregard and unfair treatment by majority shareholders who are in control of the company.
This may seem an obvious statement, but the greater the shareholding of an individual, the greater his/her rights and the greater is his/her power within the company. The law is clear enough that minority shareholders or investors can only take actions for “equitable considerations” when they feel that they have been sidelined, discriminated or treated unfairly.
Minority shareholder’s rights:
Minority shareholder rights consist of rights that are generally available to all shareholders and rights that may be available under state close corporation laws. Corporations are governed by state law and shareholder rights are set out in the corporate statute of the company’s state of incorporation.
As “equitable considerations”, often, they feel inferior as second class to the majority and because of this, they are afraid to take actions to seek remedies. The situation is made worse when minority shareholders or investors do not know each other or when they are disunited or totally disorganized among themselves.
The corporate governance framework should ensure the equitable treatment of all shareholders, including minority shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
Today’s minority shareholders come to the corporation with varied attitudes and agendas. Although their shareholder status results from a variety of circumstances, it is important in each case to make their relationship with the corporation and the other shareholders as productive as possible. This is best done by understanding their rights and striking the appropriate balance among all shareholders. Taking this action early will help avoid problems which at the very least can be distractive and, in many cases, leads to a substantial waste of time and money, a result few businesses can afford an even fewer wish to endure.
Shareholders have the right to vote for the election of directors and on certain extraordinary matters affecting the corporation.
The most fundamental right of every shareholder is the right to vote their shares. A shareholder may only vote in the election of directors and to approve certain extraordinary matters affecting the corporation. After the issuance of shares these actions include most charter amendments (other than mere housekeeping amendments) including those that give rise to dissenter’s rights (described below), most mergers or share exchanges, the sale of all or substantially all of the corporations assets other than in the ordinary course of business, voluntary dissolution and the issuance of shares for promissory notes or future services.
Shareholders generally have the right to one vote per share and, except under limited circumstances; a majority of the shares can govern. One of the shareholder’s basic rights is to participate in the election of directors. This right, however, is very limited in practice since the number of shares owned by minority shareholder is generally not sufficient to carry the vote for even one director. That approach permits a shareholder to vote the number of shares he/she owns, times the number of directors to be elected. Under certain circumstances, that can be mathematically calculated, shareholders owning less than a majority of shares can elect one or more directors. With cumulative voting, the more directors elected the fewer number of shares a minority shareholder needs to elect a director. A more dramatic right in connection with shareholder voting is a shareholder’s right to ‘dissent’ from certain extraordinary transactions.
Shareholders have the right to expect the officers and directors of their corporation to perform their duties in accordance with established standards of conduct.
Shareholders have the right to expect their officers and directors to act in good faith, with due diligence and in the best interest of the corporation. This right becomes even more important to minority shareholders who, as a result of their limited ownership in the corporation, have little if any practical control over corporate affairs. Shareholders can expect and demand, through derivative suits and otherwise, that officers and directors of corporations operate in the best interests of the corporation. These duties prevent officers and directors from competing against the corporation or developing opportunities for themselves without first providing that opportunity to the corporation.
Dissenter’s rights can also be conferred on shareholders by special provisions contained in the corporation’s charter, by laws or resolution of the board of directors. Upon dissent, a shareholder following the requirements of the statute may demand that is shares be redeemed for their fair value. Thus, a shareholder may force his way out of a corporation that is taking certain significant action with which the shareholder does not agree.
Shareholders also have the right to prevent directors from becoming personally involved in transactions with the corporation in which they have a conflict of interest or from lending money to themselves or guaranteeing their own debts. Although there are statutory means by which directors and shareholders may approve these transactions, these rules provide some structure and protection for minority shareholders.
Shareholders have the right to question the action of officers, directors and majority shareholders.
As noted above, shareholders may question the decisions of officers or directors and this can be done in the name of the corporation through derivative actions. These are civil lawsuits brought to recover damages under a right that belongs to the corporation. Under certain circumstances a shareholder may also sue in his/her own name to protect an individual right as shareholder. Majority shareholders also have certain obligations to minority shareholders in their capacity of controlling the corporation.
Basically, majority shareholders have the obligation to act in the best interests of the corporation and all its shareholders. In certain cases this minority shareholder right can be exercised directly against a shareholder, without having to go against a corporation or through the derivative action process.
Shareholders have the right to inspect certain records and to receive certain reports and other information from the corporation.
A company is required to maintain certain permanent records, including information on meetings and actions of the directors. Corporations must also keep appropriate accounting records and records of its shareholders. Once a shareholder has owned stock in the company for six months or owns at least 5 percent of the stock in the company (a “qualified shareholder”), he may inspect and copy any of the records a company is required to keep at its principal office after giving the company five days retain notice of his request. This would include records such as the corporation’s bylaws and minutes of shareholder meetings and records of all action taken by shareholders without a meeting, for the past three years.
To have access to these records, a qualified shareholder must make his demand in good faith and for a proper purpose, describe with reasonable particularity his purpose and the requested records, and he may only inspect the records that are directly connected with his purpose. Although the right to inspect these additional records is protected by certain safeguards, under the appropriate circumstances a shareholder should be able to inspect those records that will be important protecting his or her rights and seeing that the corporation is operated in the best interests of all shareholders.
Shareholders may also inspect and copy the corporation’s voting lists (e.g. name, address and number or shares). These records may be reviewed by any shareholder for a period beginning two days after notice of a shareholder meeting and continuing through the meeting.
Shareholders have the right to benefit from corporate operations.
Receipt of dividend distributions is the typical means by which shareholders benefit from company operations. The corporation may redeem a demanding shareholder’s stock for its fair value. If the corporation elects to redeem the shares, the demanding shareholder as the right to withdraw the request and keep his/her shares or completes the redemption.
In addition, qualified shareholders may inspect and copy additional records, including minutes and actions of directors and shareholders, accounting records and the records of shareholders.
Shareholders may have the right to maintain their percentage ownership of stock in the corporation.
Certain rights of a minority shareholder are based upon the percentage of shares he owns in the corporation. Thus, it is important for a shareholder to be able to continue to retain that percentage and protect his proportionate voting and financial interest. It provides that under circumstances a shareholder will have preemptive rights- rights to maintain his/her respective percentage interest in the corporation if additional shares are sold. These rights are effectuated by permitting the shareholder to purchase the number of shares necessary to retain that percentage interest.
The common law also provides protection from dilution of a shareholder’s interest. Case law precludes directors under certain circumstances from issuing or redeeming shares in a fashion that does not treat all shareholders equally. This right has evolved from the director’s statutory standards of conduct.
Shareholders have the right to force the dissolution of a corporation.
A shareholder may force the dissolution of a corporation if he/she can establish among other things, which certain deadlocks exist in the corporate management, which liquidation is reasonably necessary to protect the rights or interests of shareholders or that corporate assets are being misapplied or wasted. If a shareholder can establish that one of the required conditions exists, a superior court has the authority to dissolve the corporation and to issue injunctions, appoint a receiver and take other actions it deems appropriate to preserve corporate assets and carry on the business of the corporation.
Case law in also provides minority shareholders with some rights that evolve from their “reasonable expectations”. These case have established that the protect able rights or interests of minority shareholders can include expectations that may have developed from the actions and relationship of the shareholders. The exercise of analyzing and documenting these expectations will also help avoid misunderstandings which often lead to shareholder controversies.
Shareholders have the right to participate in distributions from the corporation upon its dissolution.
The other fundamental shareholder right is to participate in distributions from the corporation upon its dissolution. A shareholder is entitled to receive his/her share of liquidating distributions from the corporation. Generally, all shares participate equally in the distribution. The actual distribution, however, will be subject to the statutory priorities and to preferences, if any, set forth in the corporations’ articles of incorporation.
Shareholders may further develop their relationship through the use of a shareholder’s agreement.
No review of the rights of a minority shareholder would be complete without considering the use of shareholder agreements. Without a doubt, the best means of dealing with the rights of minority shareholders, from both majority and minority shareholder perspective, is through the use of an effective and well drafted shareholder’s agreement.
The shareholders of a corporation can name specific individuals or grant certain shareholders the right to designate individuals to serve on the board of directors. This would assure minority representation on the board.
In appropriate circumstances, “reasonable expectations” could include the expectations to participate in the management of the business, as well as continued employment. These cases make it even more important to establish periodically review and document the expectations of the parties (e.g. shareholder agreement provision).
High vote and high quorum requirements can also provide some minority protection, as would the use of a veto power over selected corporate activities. By using this approach, minority shareholder can remain involved with corporate activities. This is also a method by which majority prevent misunderstandings and feelings of exclusion, which can be the basis of shareholder controversies.
Shareholders have certain statutory and equitable rights which may be expanded or restricted by agreement, by the articles of incorporation, by laws, and by the course of dealing among shareholders. Understanding these rights is important to keeping the relationship among shareholders well structured and meeting the expectations of all involved.
Minority shareholder rights- the necessities and the limitations
Sometimes economic policy made a radical shift by dismantling the entire edifice of micro management and controls. Industrial licensing could be abolished and foreign investment allowed in most sectors. f. Foreign institutional investors would allowed to enter the capital markets which substantially increased its size and depth. The business conglomerates could so far been shaped by the industrial licensing policy and their success in lobbying for these licenses. Many units are lacked global economies of scale as well as technology. The financial sector reforms and the changing nature of banking and capital markets generated pressures that could a direct bearing on corporate governance and policies.
A shareholder’s agreement can also address restrictions of the transfer of shares which can help protect all shareholders from having “outsiders” become shareholders in the corporation. This is important to both minority and the majority shareholders. The designation of the directors of the corporation may also be matter minority shareholders would want to address in a shareholder’s agreement.
Credit ratings and access to markets required more transparent disclosures and financial scale to tap the new segments opening up. The capital markets also generated pressures to reduce intra group’s investment as financial analysts and disapproved of such cross investments and diversion of funds. This was accompanied an aggressive entry by foreign firms into the Indian market. The foreign firms, almost without exception ejected their joint venture partners to more closely integrate their affiliates in their global operations.
Those foreign firms could enter country for the first time became aggressive buyers of local firms with entrenched positions, distribution networks and capacity to speed their entry into corporation. Divestitures of weaker or poorly performing units are necessary to protect many firms from hostile takeovers. The advantage to foreign firms with integrated global operations needed to be neutralized and the most successful houses embarked on a strategy of takeover and expansion in other countries.
A much talked about regulatory dilemma is that of balancing the rights of minority shareholders against the principle of shareholder democracy. On closer inspection, this regulatory dilemma is not as serious as it might appear at first sight. In many ways, the very term shareholder democracy represents a misguided analogy between political governance and corporate governance. Unlike political governance, corporate governance is primarily contractual in nature, and corporate governance is at bottom a matter of enforcing the spirit of this contractual relationship.
It is important to bear in mind that the relation between the company and its shareholders and the relation between the shareholders inter-se is primarily contractual in nature. The memorandum and articles of association of the company constitute the core of this contract and the corporate law provides the framework within which the contracts operate. The essence of this contractual relationship is that each shareholder is entitled to a share in the profits and assets of the company in proportion to his shareholding. Flowing from this is the fact that the Board and the management of the company have a fiduciary responsibility towards each and every shareholder and not just towards the majority or dominant shareholder.
Shareholder democracy is not the essence of the corporate form of business at all. Shares are first and foremost ownership rights – rights to profits and assets. In some cases (non-voting shares for example) that is all there is to it. In other cases, shares also carry some secondary rights including the control rights – rights to appoint the Board and approve certain major decisions. The term shareholder democracy focuses on the secondary and less important part of shareholder rights. Corporate governance ought to be concerned more about ownership rights. If a shareholder’s ownership rights have been trampled upon, it is no answer to say that his control rights have been fully respected.
THE RISE OF THE MINORITY
The past few years have witnessed a silent revolution in Indian corporate governance where managements have woken up to the power of minority shareholders who vote with their wallets. In response to this power, the more progressive companies are voluntarily accepting tougher accounting standards and more stringent disclosure norms than are mandated by law. The reasons due to which corporate governance has seen improvements are as follows
1. Deregulation: Economic reforms have not only increased growth prospects, but they have also made markets more competitive. This means that in order to survive companies will need to invest continuously on a large scale.
2. Disintermediation: Meanwhile, financial sector reforms have made it imperative for firms to rely on capital markets to a greater degree for their needs of additional capital.
3. Institutionalization: Simultaneously, the increasing institutionalization of the capital markets has tremendously enhanced the disciplining power of the market.
4. Globalization: Globalization of our financial markets has exposed issuers, investors and intermediaries to the higher standards of disclosure and corporate governance that prevail in more developed capital markets.
5. Tax reforms: Tax reforms coupled with deregulation and competition have tilted the balance away from black money transactions. This makes the worst forms of misgovernance less attractive than in the past.
The primary protection to minority shareholders is laid down in the company’s law. Some of these provisions are the regulatory equivalent of an atom bomb – they are drastic remedies suitable only for the gravest cases of misgovernance.
Protection of minority shareholders
Company law provides that a company can be wound up if the Court is of the opinion that it is just and equitable to do so. This is, of course, the ultimate resort for a shareholder to enforce his ownership rights. Rather than let the value of his shareholding be frittered away by the enrichment of the dominant shareholder, he approaches the court to wind up the company and give him his share of the assets of the company. In most realistic situations, this is hardly a meaningful remedy as the break-up value of a company when it is wound up is far less than its value as a “going concern”.
It is well known that winding up and other bankruptcy procedures usually lead only to the enrichment of the lawyers and other intermediaries involved.
Company law also provides for another remedy if the minority shareholders can show that the company’s affairs are being conducted in a manner prejudicial to the interests of the company or its shareholders to such an extent as to make it just and equitable to wind it up. Instead of approaching the Court, they can approach the Company Law Tribunal). The Company Law Tribunal which is a quasi-judicial body can make suitable orders if it is satisfied that it is just and equitable to wind up the company on these grounds, but that such winding up would unfairly prejudice the members.
In particular, the Tribunal may regulate the conduct of the company’s affairs in future, order the buyout of the minority shareholders by the other shareholders or by the company itself, set aside or modify certain contracts entered into by the company, or appoint a receiver. The Tribunal could also provide for some directors of the company to be appointed by the Central Government, or by proportional representation. The Tribunal normally entertains such complaints only from a group of shareholders who are at least one hundred in number or constitute 10% of the shareholders by number or by value.
A board which is accountable to the owners would only be one which is accountable to the dominant shareholder; it would not make the governance problem any easier to solve. Clearly, the problem of corporate governance abuses by the dominant shareholder can be solved only by forces outside the company itself.
As the legal treatment of shareholder protection finds its balance between enabling logical majority rule and safeguarding minority interests, it lands itself in a sticky situation of perpetual grey area where the laws and regulation could no longer afford straightforward legal resolution but requires judiciary intervention for even the most trivial cases. While the need for minority shareholder protection was earlier established, this should not be taken to the extreme.
In fact, excessive lawsuits by minority shareholders in the name of ‘minority protection’ can bog down the legal court system and deter investments when cases drag. Over-protection may also lead to abuse by minority players to deliberately utilize their rights to create obstacles for company directors in running the day-to-day operation and harass management. There is therefore a need to maintain a balance by providing adequate avenues for redress while deterring litigious shareholders from gaming to benefit from lawsuits.
In my view, although company laws does, in theory, provide minority shareholders an avenue for redress, its inherent bias towards majority interests and the difficulty of minority complainant in proving fraud offer little assurance of an adequate shield for minority investors. Finally, we have noticed that the bad effects of exploiting minors’ rights and harming company’s policies to benefit individual can be very dangerous. It can even bring a company to dissolution. That is why it is said that, a proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of the company.
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