Governing unlisted firms

Proposed norms are in the right direction

The government is reportedly working on a Takeover Code for unlisted companies. Unlike listed ones, transfer of shares in unlisted firms in India now happen on the basis of other contracts and agreements between shareholders. Although the provisions were added in the Companies Act, they have not been implemented so far due to the lack of a Takeover Code. The Code will allow entities owning 75 per cent equity in an unlisted company to trigger a takeover of the rest of the shareholding by approaching the National Company Law Tribunal. Provisions in the Companies Act give an option to minority shareholders to exit the company with a process prescribed for valuation as well. In this context of takeover, the Act notes: “An aggrieved party may make an application to the Tribunal in the event of any grievances with respect to the takeover … as may be prescribed and the Tribunal may, on application, pass such order as it may deem fit.”

 
The proposed Code will help fill a critical gap if it is designed well. It should protect the interest of minority shareholders in unlisted companies by providing them an exit route at a fair valuation. There have been instances of governance failure in unlisted firms, which hurt the interest of minority shareholders. Therefore, it would be critical that the Code does not become a tool in the hands of the majority shareholders to push the minority shareholders out of the firm. Put differently, minority shareholders should have the option of selling their shares and not forced to do so. At the same time, there should be a level playing field. Legal experts say if a minority shareholder wants to sell his stake to a third party, the majority shareholder must have the first right to buy the shares at a valuation that matches that of the third party.

 
At a broader level, the government’s work on the Takeover Code for unlisted firms can be seen in the context of increasing disclosure norms and streamlining processes for companies in this space. While the focus normally is on the listed universe, it is also important to improve governance and transparency in the large universe of unlisted companies. In this context, the government recently introduced several compliance measures for unlisted companies, including compulsory dematerialisation of shares, and is thinking of mandating unlisted companies to file quarterly or half-yearly financial statements. This will help improve transparency in this segment and keep minority shareholders better-informed as they do not get to know how the firms are being run until the annual financial statements are filed. Currently, listed companies disclose their financial results every quarter, which helps minority shareholders track their functioning.

 

To begin with, the government should implement better disclosure and governance norms in large unlisted companies above a threshold, say, in terms of revenue. This is required because an across-the-broad enforcement can lead to both oversight and implementation challenges. The government’s intent to put processes in place and improve disclosure norms for unlisted firms is in the right direction. But its success will depend on how the new norms are designed and implemented.