For various reasons, Real Estate Investment Trust (“REITs”) and Infrastructure Investment Trust (“InvITs”) have emerged as the favorable class of investments for public investors over the past few years. Acknowledging the increasing popularity of REITs and InvITs, the Securities and Exchange Board of India (“SEBI”) has been initiating several measures to democratize these investment vehicles and, thereby, enhance the quality of corporate governance within their management structure by amending SEBI (Real Estate Investment Trust) Regulations, 2014 (“REIT Regulations”) and the SEBI (Infrastructure Investment Trust) Regulations, 2014 (“InvIT Regulations”).
REIT is an investment vehicle which allows investors to enjoy fractional ownership in real estate assets and it is structured in the form of a Trust formed through a Trust Deed registered under the Registration Act, 1908. Real estate assets may be held by the REIT directly or through a Holding Company or a Special Purpose Vehicle (“SPV”) constituted exclusively for that purpose. A REIT would issue securities known as ‘Units’ to the investors, which would signify the share of ownership of the investor in the real estate asset held by the REIT. The investors are referred to as ‘unitholders.’
Apart from the unitholders, parties to a REIT include the Sponsor, the Trustee, and the Manager:
Sponsor is the person or the entity which floats the REIT. Sponsor is the promoter of the REIT and complies with the initial registration requirements under the SEBI (Real Estate Investment Trusts) Regulations, 2014. Sponsor constitutes a Trust, transfers the real state assets held in its name to the new trust and appoints a Trustee to hold the real estate assets of the REIT in trust for the benefit of the unitholders.
The Trustee should be registered with SEBI under the SEBI (Debenture Trustee) Regulations, 1993. The Trustee enters into an investment management agreement with a Manager.
The Manager is responsible to make the investment decisions and perform operational activities with respect to the underlying real estate assets of the REIT. Only a company or LLP or a body corporate can be appointed as Manager.
InvIT is also an investment vehicle which has a structure like REIT. However, the underlying assets in an InvIT investment would be infrastructure projects such as roads, bridges, dams, ports, and such other projects specified by the Government of India through the Harmonised Master List of Infrastructure Sub-sectors. Also, the entity responsible for the investment decisions and to perform operational activities with respect to the underlying assets of the InvIT is know as Investment Manager.
Parity of Rights of Unitholders
As a rule, Reg. 4(2)(g) of the REIT Regulations and Reg. 4(2)(h) of the InvIT Regulations lay down that no unitholder enjoys any superior rights over another unitholder. This rule is ensured by restricting issuance of multiple classes of units by REITs and InvITs. Recently, to protect the interest of the minority unitholders, SEBI amended the REIT Regulations and the InvIT Regulations.
Amendments allow a unitholder(s) (“eligible unitholders”) holding minimum ten percent of the total outstanding units of the REIT/InvIT, either individually or collectively, to nominate one director on the board of directors of the Manager/ Investment Manager.
An eligible unitholder shall be entitled to nominate only one nominee director. Furthermore, if the eligible unitholder or any of its associate entity has a right to appoint a director on the Board of directors of the Manager in any other capacity such as shareholder of the Manager or lender to the Manager or the REIT or its Holding Company or SPV, then such unitholder, shall not be entitled to nominate any director under the amended provisions.
A detailed framework for appointment of nominee directors by the eligible unitholders has also been introduced by SEBI through a Circular (“Circular/Framework”) dated September 11, 2023.
Obligations of the Manager
Under the new framework, the Manager have continuous obligations to monitor and facilitate the exercise of the right to appoint nominee directors by the eligible unitholders.
The Board of Directors of the Manager shall formulate and adopt a policy which would specify the qualifications and criteria for appointment and evaluation parameters of individuals nominated by the eligible unitholder.
The Manager shall send a written intimation to all unitholders on their email address within ten days from the end of each financial year, requesting them to inform if any of the eligible unitholders wish to exercise the right to nominate a director to its Board.
Every month, the Manager has to review whether the eligible unitholders who have exercised the board nomination right, continue to have or hold the required number of units of REIT/InvIT and make a report of the same to the Trustee.
The Manager has to confirm the eligibility of the nominees put forth by the unitholders based on the evaluation done by the Nomination and Remuneration Committee and/or the Board of Directors of the Manager, in line with the policy formulated. If the nominee is found to be eligible, the Manager has to complete the formalities for appointment of the nominee director in a time bound manner. In case the nominee is ineligible to be appointed as director, the same has to be intimated to the nominating unitholder, after recording reasons as to why the nominee was considered not eligible to hold the post.
Expanding Role of Unitholders
Apart from granting rights to appoint nominee directors, the new regulations cast a duty on the eligible unitholders to play a proactive role in laying down culture of good governance in the Trust structures.
The eligible unitholders who wish to exercise the right to nominate a director has to intimate, in writing, the name and other specified details of the nominee within 10 days from receipt of the intimation from the Manager. If the Manager intimates that the nominee is ineligible to be appointed as director, the eligible unitholders can propose another candidate within a period of ten days from the receipt of such communication from the Manager.
The eligible unitholders should immediately inform the Manager if their unitholding falls below the threshold of ten percent due to issuance of fresh units or due to any other reason. The unitholders have to ensure that the nominee director has to step down from the Board of the Manager within two days from the change of such holding.
The eligible unitholders has been mandated to comply with the Stewardship Code introduced in the Regulations which calls for safeguarding the interest of all the unitholders. It mandates the eligible unitholders to formulate a comprehensive policy on the discharge of their stewardship responsibilities. They should also periodically review and monitor the REIT or InvIT, distinct from the functions exercised by the Trustee. The stewardship code ensures that eligible unitholders are made a significant stakeholder in ensuring adequate corporate governance safeguards in the REIT and InvIT structure.
Nominee Directors: Knight in the Game
The policies and interests of the minority unitholders would be implemented and safeguarded by the nominee directors. They have to ensure that the Board of Directors of the Manager defines the scope of the governance principles that would guide their investment and operational decisions.
The nominee director should be a person who is eligible and otherwise not disqualified to be appointed as a director in a company under the Companies Act, 2013.
He/she should be a “fit and proper” person as specified by SEBI in its SEBI (Intermediaries) Guidelines, 2008.
He/she should not be barred by SEBI from accessing the securities market.
He/she should not be a promoter, director or person in control of a company or entity which has been barred from accessing the securities market by SEBI or any other authority.
Nominee Directors shall recuse themselves from voting on any transaction where either such director, such director’s associates or the eligible unitholders who nominated him or associate of such eligible unitholders is a party.
Deemed Amendment
The Circular provides that in view of the amendments made to the REIT Regulations and the InvIT Regulations, the trust deed and investment management agreement of existing REITs and InvITs shall stand amended or be deemed to incorporate provisions to provide board nomination rights to eligible unitholders. Furthermore, the Trustees and Managers have to ensure within six months from the date of the Circular that the trust deeds and the investment management agreements are amended to incorporate the framework provided in the circular to facilitate nomination of directors by eligible unitholders.
How do the New Rules Improve Governance of REIT and InvIT?
SEBI has ushered in changes to the governance structure of the REIT and InvIT with the primary objective of equipping the minority unitholders to influence the investment decisions of the Manager and to safeguard their rights and investment. However, the change in rules would also have incidental impact on the corporate governance front for REIT and InvIT.
Recognises the Rights of Unitholders: As the new rules have come into force, the unitholders, individually or collectively, who hold not less than ten percent of the issued units in a REIT and InvIT can nominate a director to the Board of the Manager. This new framework introduced by SEBI to safeguard the interests of minority shareholders in REITs and InvITs would recognise and complement the existing market practice. Earlier, differential rights for nominating directors were being granted to investors by REITs and InvITs through Trust Deeds and Information Memorandums though the Regulations did not overtly provide for such rights. This was considered essential to exercise a degree of control over the operations of the REIT or InvIT but was considered to be a grey area in regulatory compliance. After the Amendments, now the Regulations explicitly acknowledge the extant practice and ensures that such practices can be aligned with the legal regime.
Governance structure to tilt in favour of unitholders: The Board composition already prescribed under both the Regulations requires that one half of the strength of Board of Directors of the Manager should comprise of independent directors. A combination of the right to nominate directors by the minority unitholders and the presence of significant number of independent directors would indeed augment the protection afforded to the investments and interests of minority shareholders in REITs and InvITs.
Unitholders to have an expansive role: The stewardship code made applicable to the eligible unitholders would make them a significant contributor to the governance of the REITs and InvITs. The provisions of the stewardship code indicates that the eligible unitholders need to perform as an additional layer of scrutiny over the Manager, in addition to the Trustee. This approach has been successfully tested by SEBI earlier with the Mutual Funds. Introduction of stewardship code for mutual funds had urged the Boards of directors of the Asset Management Companies to be mindful of its voting decisions in the decision making forums of listed companies and thereby led to better governance in those listed entities. Now in the case of REITs and InvITs too, the regulator has passed the baton to the eligible unitholders to monitor the Manager, in addition to the role played by the Trustees. The eligible unitholders have to frame a comprehensive policy which should lay down the principles for monitoring the Manager through the nominee directors, methods to deal with any conflict of interests that may arise and the voting policy to be adopted with regard to the governance and investment matters of the REIT or InvIT. Apart from laying down the principles for the unitholders, the stewardship code would provide guidance to the nominee directors while performing their duties.