05/10/2020 The Tata-Mistry Dispute: Quo Vadis, HR News, ETHRWorld NEWS SITES Sign in/Sign up Follow us: NEWS TRENDS WORKPLACE 4.0 HRTECH HR TV ENGAGE ADVISORY BOARD BRAND SOLUTIONS INTERVIEWS INDUSTRY EXPERT SPEAK CXO MOVEMENT INTERNATIONAL CAREERS FOR TOMORROW WHITEPAPER MORE HR News / Latest HR News / Industry The Tata-Mistry Subscribe to our Newsletters 100000+ Industry Leaders Dispute: Quo Vadis have already joined If the reported eorts of the two groups to settle their Your Email JOIN NO dispute before the next hearing were to succeed, it would mean a lost opportunity to not have the Supreme Court of India weigh in on the foundational principles of corporate governance—that of voice and exit for INDUSTRY shareholders—that this dispute is about. 28 mins ago ETHRWorld Contributor October 01, 2020, 20:40 IST Mumbai: Bidi workers struggle amid COVID-19 lockdown 2 hrs ago Over 1 lakh local shops, kiranas to facilitate Amazon India's delivery this festive season Ratan Tata (L) and Cyrus Mistry (R) https://hr.economictimes.indiatimes.com/news/industry/the-tata-mistry-dispute-quo-vadis/78431843 1/11 05/10/2020 The Tata-Mistry Dispute: Quo Vadis, HR News, ETHRWorld By J Ramachandran, Savithran Ramesh, K S 2 hrs ago Paytm, Manikandan other startups vow to Last week, the Shapoorji Pallonji Group (SP Group) ght announced its intention to exit the Tata Group after Google's clout: the Supreme Court restrained it from further pledging Report its shares in Tata Sons until the next hearing. The SP Group’s decision signals a rather bitter end to the 2 hrs ago seven-decades-long relationship that turned publicly Tourism businesses sour in 2016 with the abrupt dismissal of Cyrus Mistry hit as sta as Chairman of Tata Sons. If the reported eorts of the can’t return two groups to settle their dispute before the next hearing were to succeed, it would mean a lost View More opportunity to not have the Supreme Court of India weigh in on the foundational principles of corporate governance—that of voice and exit for shareholders— EDITOR'S PICK that this dispute is about. The division between ownership and control lies at the heart of corporate governance. The primary objective of most individuals who invest their money in a company (investors) is to receive economic benets — a proportionate share in the prots of the company, for instance — though they cede eective control over how their money is deployed, which rests with those in Women Leaders for Industry, control of the corporation. Apart from the protection Organisation granted by the legal framework in limiting their exposure to the money invested, investors protect View More themselves further by reserving the right to sell their stake (right to exit) and by seeking a say (right to voice) in the management of the company. The judicial decisions in the Tata-Mistry dispute to date have implications for both these rights. Let us begin by considering the right to voice. The right to an eective voice is preserved through two mechanisms. First, by requiring those in control to https://hr.economictimes.indiatimes.com/news/industry/the-tata-mistry-dispute-quo-vadis/78431843 2/11 05/10/2020 The Tata-Mistry Dispute: Quo Vadis, HR News, ETHRWorld seek shareholder approval for certain critical matters such as changes to share capital, transfer of business, etc. Second, by having the right to elect the members of the board of directors. The board, empowered by the articles of association of the company, monitors decision making by managers. The ecacy of these two mechanisms in giving voice to the shareholders is determined by the shareholding structure. In situations where there is a controlling shareholder, who has a large or dominant stake — the case with much of corporate India, including Tata Sons — the voice of this controlling shareholder carries signicant weight. This means that the voice of the other (minority) shareholders inevitably gets muted. The minority shareholders’ hopes of being heard, especially when their interests vary from that of the controlling shareholder, will primarily depend on the board of directors — specically, on what principles govern the board’s existence and functioning. Does the board have an existence independent of those who elected the directors so that it might do what it considers to be right/appropriate? Or is it expected to privilege the interests of the controlling shareholders, who eectively have the power to elect and remove the directors? These questions lie at the heart of the diering judgements of the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) in the Tata-Mistry dispute. The articles of association of Tata Sons allow Tata Trusts, the controlling shareholder with 67% of Tata Sons’ shares, to nominate up to a third of the directors on the board of Tata Sons so long as the Trusts held at least 40% of the shares. The articles also require the armative vote of a majority of the nominee directors to decide any matter requiring the board’s approval https://hr.economictimes.indiatimes.com/news/industry/the-tata-mistry-dispute-quo-vadis/78431843 3/11 05/10/2020 The Tata-Mistry Dispute: Quo Vadis, HR News, ETHRWorld and specied a list of matters that required the board’s approval. The SP Group argued that the armative vote compromised the independent functioning of the directors and made the board of Tata Sons redundant at best. The NCLT viewed the board of directors as an extension of the shareholders electing them. Invoking the principle of “corporate democracy”, NCLT held that the article requiring armative vote of nominated directors is justied since the Tata Trusts could have elected all the directors on the board by virtue of their majority and controlled the company through such a mechanism. The NCLAT disagreed. It concluded that the armative vote had an overriding eect that renders the majority decision of the board subservient to it. This implies that the board of a company has an independent existence and its authority to take decisions is delinked from that of the controlling shareholder. Eectively, the board is not bound by the dictates of the controlling shareholders who may have the power to elect and remove them. This means that the duciary duty of the directors is not to any particular shareholder but to the corporation itself. The matter is now pending before the Supreme Court. A ruling in the case will help determine the eectiveness of voice as a lever of governance available to shareholders. The Supreme Court’s interpretation is also likely to critically inform the scope of the right to exit for shareholders, as demonstrated by recent developments in the Tata- Mistry dispute. The exercise of the right to exit is relatively straightforward in public companies whose shares are traded in the stock markets. The prevailing share price https://hr.economictimes.indiatimes.com/news/industry/the-tata-mistry-dispute-quo-vadis/78431843 4/11 05/10/2020 The Tata-Mistry Dispute: Quo Vadis, HR News, ETHRWorld acts as a signal of value and thus the shareholders can exit at any time, especially if the shares are traded actively. However, in the case of private companies (or even deemed public companies) which are permitted to restrict transferability of shares, the terms of exit (when, to whom and at what price) are specied in the articles of association and/or shareholder contracts. For instance, in Tata Sons’ case, when an existing shareholder seeks to exit, the board of directors has the power to nd potential buyers, determine the fair value for the shares, and even block potential investors suggested by the exiting shareholder on certain grounds. In such cases where the articles bestow the responsibility of determining the terms of exit to the board of directors, the question of whom they are responsible to becomes even more critical. Let us consider the implication of this in the present dispute between SP Group and Tata Sons. In determining fair value, should the board of Tata Sons privilege the interests of Tata Trusts, the dominant shareholder (as the NCLT interpretation implies)? Or should the board do what it independently thinks is right/appropriate for Tata Sons (as the NCLAT interpretation implies)? The counsel for Tata Sons reportedly termed the SP Group’s decision to pledge its shareholdings in Tata Sons ‘mischievous’ since it allowed the possibility of an outside investor such as Warren Buet coming forward to oer a 30% premium price which forces Tata Sons to match that higher oer. What if the board of directors believes that the ‘premium’ price oered by Warren Buet is the fair value even if lower valuations could be arrived at which were more favourable to the controlling shareholder? Or what if the board of directors were to have an independent standing and believe that having someone like Warren Buet as an investor is good for https://hr.economictimes.indiatimes.com/news/industry/the-tata-mistry-dispute-quo-vadis/78431843 5/11 05/10/2020 The Tata-Mistry Dispute: Quo Vadis, HR News, ETHRWorld the corporation, though it may not align with the interests of the controlling shareholder? The Supreme Court’s guidance on the role of the board will help address these questions which have far-reaching implications for the evolution of corporate governance in India. J Ramachandran is Professor of Strategy at IIM Bangalore; Savithran Ramesh is Research Associate at IIM Bangalore; and K S Manikandan is Associate Professor of Strategy at IIM Trichy. DISCLAIMER: The views expressed are solely of the authors and ETHRWorld does not necessarily subscribe to it.