Corporate Analysis – Restrictions on Transfer of Shares – Private Equity, India
In terms of
Sections 2(68) and 2(71) of the Companies Act, 2013 (“CA13”), a public
company is defined as a company which inter
alia, does not restrict the right to transfer its shares. These
provisions of the CA13 have already been notified and have come into force in
supersession of the corresponding provisions of the Companies Act, 1956.
Further, as
stipulated under Section 58(2) of the CA13, the shares of a public company
are freely transferrable. However, the proviso to Section 58(2) further
states that “any contract or arrangement between two or more persons in
respect of transfer of securities shall be enforceable as a contract”.
The aforesaid
provisions of the CA13 appear to be an attempt to codify the principles laid
down in a recent judgment of the Bombay High Court in the case of Messer
Holdings Limited vs.Shyam Madanmohan Ruia and Ors., [2010]104SCL293 (Bom),
noted below:
“…an
agreement by a particular shareholder or between two shareholders relating
only to their own shares (by way of pledge, sale or for preemption) is a
consensual arrangement entered into by them, in exercise of their right of
free transferability and it consequently imposes no restriction on
transferability…The concept of free transferability of shares of a public
company is not affected in any manner if the shareholder expresses his willingness
to sell the shares held by him to another party with right of first purchase
(preemption) at the prevailing market price at the relevant time. So long as
the member agrees to pay such prevailing market price and abides by other
stipulations in the Act, Rules and Articles of Association there can be no
violation. For the sake of free transferability both the seller and purchaser
must agree to the terms of sale…. The fact that shares of public company can
be subscribed and there is no prohibition for invitation to the public to
subscribe to shares, unlike in the case of private company, does not whittle
down the right of the shareholder of a public company to arrive at consensual
agreement which is otherwise in conformity with the extant regulations and
the governing laws… it is open to the
shareholders to enter into consensual agreements which are not in conflict
with the Articles of Association, the Act and the Rules, in relation to the
specific shares held by them; and such agreement can be enforced like any
other agreement. That does not impede the free transferability of shares at
all…”
Interestingly, the nature of a shareholders’ agreement was
considered by a 2 (two) Judges Bench of the Supreme Court of India in the
case of V.B. Rangaraj v. V.B. Gopalakrishnan and Ors.,(1992)1SCC160.
In that case, an agreement was entered into between shareholders of a private
company wherein a restriction was imposed on a living member of the company
to transfer his shares only to a member of his own branch of the family. Such
restrictions were, however, not envisaged or provided for within the articles
of association of the company. The Apex Court took the view that provisions
of the shareholders agreement imposing restrictions even when consistent with
company legislation, are to be authorized
only when they are incorporated in the articles of association.
This view was
however not subscribed to by the Apex Court in a recent matter of Vodafone
International Holdings B.V. vs. Union of India and Anr., (2012)6SCC613,
wherein the Court has taken a view that freedom of contract can be restricted
by law only in cases where it is for some good of
the community. The Companies Act, 1956, or the other legislations do not explicitly or
impliedly forbid shareholders of a company to enter into agreements as to how
they should exercise voting rights attached to their shares.
Legal Analysis
In light of the
revised definitions under CA13 and the recent judgments, the legal position
with respect to validity of restrictions on transfer of shares of a public
company can be summarized as under:
- An agreement between shareholders restricting
the transfer of shares in a public company does not violate the legal mandate
of free transferability of shares of a public company;
- Restrictions on transfer of shares as
aforesaid, must not be in violation of the articles of association of the
public company or the governing law (i.e. the CA13);
Such agreement restricting transfer of shares, can be enforced as a contract amongst and
against the shareholders who are party thereto; - However, such
contractual restrictions on transfer of shares of a public company are not
enforceable against the company, in case the company is not a party to the
agreement containing such restrictions.
By: Ms. Seema Jhingan, Partner ([email protected]) and Mr. Himanshu Chahar,
Senior Associate ([email protected]).