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  • Gunjan Modi

Promoters v/s Persons in Control and its Effect on ESOP Regulations

[Gunjan is a student at National Law School of India University, Bengaluru.]

An employee stock ownership plan (ESOP) is a scheme which is formulated by a company to provide employees with the option to buy its shares at a pre-determined price, which isolates the benefits that the employee can gain from such shares from any increase in purchasing price of shares during public issue. In doing so, a company has to carefully formulate a plan keeping in mind that the interests of its employees, on one hand, and its investors, on the other, are not in conflict.

Previously, there were two regulations that dealt with ESOPs; the Securities and Exchange Board of India (Issue of Sweat Equity) Regulations 2002 and the Securities and Exchange Board of India (Share Based Employee Benefits) Regulations 2014. These two regulations have recently been amalgamated into one regulation which is called the SEBI (Share Based Employee Benefit and Sweat Equity) Regulations 2021 (New Regulations). The objective behind this amalgamation is to streamline the procedure to grant ESOPs and rationalize the provisions of the regulations in accordance to global practices which will result in ease of doing business. Securities and Exchange Board of India (SEBI) also acknowledged that since both the regulations essentially deal with providing employee benefits through issuance of equity shares, an amalgamation of the regulations is a possibility.

This blog restricts itself to the research question of analysing the implications of SEBI's proposal to shift from the concept of ‘promoters’ to 'persons in control', in the New Regulations. The author analyses the arguments against Paytm’s move to issue ESOP to its founder, Mr Vijay Shekhar Sharma in order to understand the reasoning behind SEBI’s move and contrast its effect on the applicability of these regulations.

The New Regulations expressly prohibited grant of ESOPs to promoter or promoter groups as when we read the definition of 'promoter' under Section 92 of the Companies Act, 2013, promoters cannot be considered as ‘employees’. Recently in 2023, Paytm was criticized for granting ESOPs to its founder and Chief Executive Officer, Mr Vijay Shekhar Sharma, on grounds that even if Mr Sharma was not classified as a promoter of Paytm, he nevertheless was a person in control who had similar rights and obligations as that of a promoter. Such criticism comes from the recently proposed shift by SEBI from the concept of promoters to persons in control as proposed in a consultation paper dated 1 May 2021.

In this consultation paper, SEBI justifies the need for this change due to the increasing change in the ownership patterns in the companies. Such change is seen in the form of private and institutional investors having substantial control and voting rights in the company, in comparison to its promoters. Such a shift also indicates the intention of the regulator to move towards qualitative enhancement of corporate governance by focusing more on the role of Board of Directors of a company. In such cases, the promoter, even without having substantial control, might be responsible for the company which creates a gap in the systematic functioning of the company as well as leaves a gray area in the “accountability” aspect of management. Looking at this shift from the perspective of the investors, the falling control in the hands of a promoter might be detrimental to the interests of investors as when only identified promoters/promoter groups are known to the investors, people who are actually in control of the company might be unknown, causing a break in the chain of effective information and decision-making considerations for them.

Considering these aspects to the Paytm’s case, Mr Sharma being the founder, CEO and non-retiring director on the Board of Directors, has significant control over Paytm’s operations and management bringing him under the ambit of 'persons in control'.

With no mention of 'persons in control' in the New Regulations, it seems to opt for the concept of 'promoters' instead. This section of the paper argues that this is untrue as on a reading on the definition of 'control' under the New Regulations, along with the definition of 'promoter' under Section 69(6)(a) of the Companies Act 2013 and the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations), it can be interpreted that both the concepts can be applied for the purposes of these regulations.

Without diving deep into the question of which of the two, promoters or persons in control, is better, the author argues that for the purposes of these regulations, instead of a complete shift in the promoters to persons in control, there should be a streamlining of the two concepts; It should include promoters who were the founders and initial brains behind the incorporation of the company, as well as new private and institutional equity shareholders with substantial shareholding to ensure that in no case the interests of employees are compromised. The rationale behind this argument is that there can be scenarios where even if a promoter no longer has substantial shareholding in the company, he / she might have a strong influence over the management of the company, whereas a private / institutional equity shareholder might have a substantial control over the company by the way of voting rights. Section 62(6)(a) of the Companies Act 2013 defines a 'promoter' and it provides that a promoter is “who was a party to the preparation of the prospectus or of the portion thereof containing the untrue statement”. This expresses the intention of the drafters of the act to hold those liable who were initially involved in the incorporation or major decisions such as an IPO of the company. However, it is pertinent to note that this definition doesn’t recognize the act of promoting a company as a criterion for being classified as a promoter.

The inclusion of both the concepts ensures that the benefits of the employees are not sidelined due to influential persons and substantial shareholders of the company who might have a say in how stock options are granted to the employees. This rationale is reflected in the definition of a 'promoter' under the ICDR Regulations, Regulation 2(1)(oo) of which provides that 'promoter shall include a person who has control over the affairs of the issuer'. Such an aspect of 'control' being included in the definition can help in finding a middle ground for the two clashing concepts. Further, the New Regulations provide that 'control' shall have the same meaning as that given under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Acquisition Regulations). Under the Acquisition Regulations, in Regulation 2 (1)(e), 'control' is defined as 'right to appoint majority of the directors or to control the management or policy decisions' which can be done by 'virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner'. This broad definition which includes the aspects of control by shareholding or control by way of management rights further shows that promoters and persons in control are both considered to have substantial control for the purposes of the Acquisition Regulations. It is suggested by the author that through analysis and interpretation, a clarification by the regulator on this point will be ideal to ensure that there are no discrepancies and confusion when a stock option scheme is being formulated by a company. This is essential because it will clarify the stance of the law on whether ESOPs can be granted to persons in control or not.

The regulator, by the way of amendment to the applicability and procedure of issuing stock options to its employees, has brought in several desirable changes that enable a more efficient and easy grants of stock options to its employees. This article looked into some of the notable changes brought in by way of the New Regulations. It analyzed the provisions of the New Regulations and argued that even though there is no mention of persons in control in the New Regulations, it can be read into the law due the language and scope thereof.

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