Sunday, February 28, 2010

Public Company shares cannot be fettered at all, says Bombay HC

The Bombay High Court has ruled that any pre-emptive rights over shares in public limited companies are patently illegal in view of the principle of “free transferability” enshrined in Section 111A of the Companies Act, 1956 (“the Act”). This revives the debate on enforceability of shareholder agreements and joint venture agreements governing public limited companies.

In the case of Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd. (MANU/MH/0109/2010), in an emphatic decision, the Bombay High Court has said that a pre-emptive right would impose a fetter on transferability of shares – a requirement, in the view of the court, envisaged only for private companies and in fact prohibited for public companies, in the scheme of the Act – and therefore “patently illegal”. Setting aside an arbitral award resolving a dispute over price for transfer of shares under a right of first refusal clause between the litigating parties, the court has said that arbitrator ought to have held that the pre-emptive right was completely contrary to law and therefore unenforceable and consequently, the award deserved to be set aside.

The Court ruled thus:-

“53. The provision contained in the law for the free transferability of shares in a public Company is founded on the principle that members of the public must have the freedom to purchase and, every shareholder, the freedom to transfer. The incorporation of a Company in the public, as distinguished from the private, realm leads to specific consequences and the imposition of obligations envisaged in law. Those who promote and manage public companies assume those obligations. Corresponding to those obligations are rights, which the law recognizes as inhering in the members of the public who subscribe to shares. The principle of free transferability must be given a broad dimension in order to fulfill the object of the law. Imposing restrictions on the principle of free transferability, is a legislative function, simply because the postulate of free transferability was enunciated as a matter of legislative policy when Parliament introduced Section 111A into the Companies' Act, 1956. That is a binding precept which governs the discourse on transferability of shares. The word "transferable" is of the widest possible import and Parliament by using the expression "freely transferable", has reinforced the legislative intent of allowing transfers of shares of public companies in a free and efficient domain.

54. The effect of Clause 7 of the Protocol Agreement is to create a right of pre emption between the Petitioner and the Respondent in the event that either of them seeks to part with or transfer its shareholding in MSL. In that event, the party desirous to transfer its shareholding is obligated to furnish a first option to the other for the purchase of the shares at such rate, as may be agreed to between the parties or decided upon by arbitration. The consequence of Clause 7 of the Protocol Agreement, which has been incorporated in the Articles of Association, is to preclude sale to or purchase by the members of the public of the shares, which are offered for sale if the offer is accepted by the Petitioner, or as the case may be, by the Respondent within thirty days of the receipt of the notice. The effect of a clause of preemption is to impose a restriction on the free transferability of the shares by subjecting the norms of transferability laid down in Section 111A to a preemptive right created by the agreement between the parties. This is impermissible. Section 9 of the Companies' Act, 1956 gives overriding force and effect to the provisions of the Act, notwithstanding anything to the contrary contained in the Memorandum or Articles of a Company or in any agreement executed by it or for that matter in any resolution of the Company in general meeting or of its Board of Directors. A provision contained in the Memorandum, Articles, Agreement or Resolution is to the extent to which it is repugnant to the provisions of the Act, regarded as void.”

The decision can have far-reaching and perhaps unintended consequences, not just for joint venture partners and private equity investors, but also for banks, financial institutions and even for regulators and stock exchanges. If a holder of shares of a public company is prohibited from agreeing not to transfer his shares except subject to certain conditions (indeed, in consideration for a reciprocal promise) no fetter or encumbrance of any nature can be permitted.

A pledge of shares by a shareholder would create a fetter on transfer. So would be a non-disposal undertaking given by shareholders to banks to raise funds either for themselves or for the public companies in which they hold shares. The Securities and Exchange Board of India, by subordinate legislation, imposes a “lock-in” on shares held in public companies in certain situations. So do stock exchanges routinely ask substantial shareholders not to transfer their shares for specified periods of time. These measures would be per se illegal too since subordinate law has to necessarily give way to Parliament-made law and cannot impose restrictions higher than the principles laid down by Parliament.

Indeed, the Delhi High Court has held a similar view, refusing to overturn a decision of the Company Law Board, and the Supreme Court did not grant leave to appeal against the Delhi High Court decision. The Bombay High Court has noted thus:

“55. The Delhi High Court had occasion to consider the issue in its decision in Smt. Pushpa Katoch v. Manu Maharani Hotels Ltd. MANU/DE/0867/2005 : 121 (2005) DLT 333 In the case before the Delhi High Court, in a Petition under Sections 397 and 398 of the Companies' Act, 1956, one of the grievances was that three sisters of the Appellant had transferred their shareholding in a Public Limited Company, in violation of a right of preemption contained in a family settlement. The Company Law Board held that the Articles of Association of the Company, which was a Public Limited Company, did not recognize a right of preemption. Since the Company was a Public Limited Company, no fetter could be imposed on the right of the shareholder to transfer his shares, by virtue of the provisions of Section 111A. The CLB rested its decision both on the basis that the preemptive right was not recognized by the Articles of Association and on the foundation that a Public Company could not have a provision recognizing preemptive rights to its members. The Delhi High Court in an appeal arising out of the judgment of the CLB relied upon the judgment of the Supreme Court in Rangaraj (supra) to hold that a restriction which is not specified in the Articles, would not bind either the Company or its shareholders. The Delhi High Court also held that by virtue of the provisions of Section 111A, the right of a shareholder to transfer his/her shares could not be fettered. Mr. Justice A.K. Sikri held thus:

‘The CLB further rightly mentioned that as per the provisions of Section 111A of the Act, there could not be any fetters on the right of a
shareholder to transfer his/her shares. It may be noted that the Legislature has made different provisions for transfer of shares in case of private limited company and public limited company. Section 111, which deals with "Power to refuse registration and appeal against refusal", relates to the private limited companies. On the other hand, provisions of Section 111A dealing with "Rectification of register on transfer" are attracted in the case of public limited companies. While
restrictions can be stipulated in the Articles of Association so far as transfer of shares of a private limited company is concerned, sub section (2) of Section 111A of the Act specifically provides that the shares or debentures and any interest therein of a company shall be freely transferable. Proviso to this Sub-section further stipulates that if a company without sufficient cause refuses to transfer the shares within two months, the transferee may file an appeal to the Company Law Board and "it shall direct company to register the transfer of shares". Since the respondent No. 1 company is a public limited company, the CLB rightly opined that there could be no fetters on the right of a
shareholder to transfer his/her shares. We have already noted that there is no such provision giving pre emptory right to other promoters in the Articles of Association. Even if there was such a provision in the Articles of Association, it would have been ultra vires the provisions of the Act, as no company can provide in the Articles of Association any matter which offends the specific provision of an act (see Re. Denver Hotel Co., 1893(1) Chancery Division 495). No doubt, the four sisters promoted the company and their intention was to make the family property as a hotel and run the same. No doubt, in the Board meeting
held on 16th March 1994 and the Memorandum of Family Agreement it was recorded that any promoter wanting to sell the shares would first offer the same to other promoters. However, at the same time, while incorporating this company, the promoters decided to have a public company limited by shares rather than a private company. They should have understood the implication and consequences of getting a public company incorporated. If they wanted such an arrangement, as recorded in the minutes of the meeting dated 16th March 1994 and the Memorandum of Family Settlement, they should have been wise enough to incorporate a private company and further to provide such a clause in the Articles of Association. After incorporating a public company, it was too late in the day to think of such an arrangement and recording the same in the Board meeting or the family settlement, which could not have any legal basis.’
A Special Leave Petition against the judgment of the Delhi High Court was dismissed by the Supreme Court on 7th April 2006. I am in respectful agreement with the view of the Delhi High Court which reflects the correct position in law.”

The key question that has emerged is whether a person entitled to free and marketable title to a property (the property being shares held in a public company) is necessarily fettered from dealing with such property freely in any manner other than transfer of shares. The court’s opinion underlines a fetter on the owner of such property. A holder of shares in a public company is therefore fettered from enjoying such property to the fullest – a contract to refrain from disposing of the shares in any manner for receipt of a reciprocal promise, has been held to be illegal and unenforceable.

The issue of whether at all a fetter on share ownership in a public company can be contracted has not been considered in detail by the Supreme Court so far – all debate has been around whether an agreement not enshrined in the Articles of Association would be enforceable. One would have to keenly wait and watch this space.


vswaminathan said...

“The Securities and Exchange Board of India, by subordinate legislation, imposes a “lock-in” on shares held in public companies in certain situations. So do stock exchanges routinely ask substantial shareholders not to transfer their shares for specified periods of time. These measures would be per se illegal too since subordinate law has to necessarily give way to Parliament-made law and cannot impose restrictions higher than the principles laid down by Parliament.”

According to one’s understanding and perception, the above cited clinching observations of the Bombay High Court seem to throw a grave doubt on the illegality / impropriety of the powers of the SEBI/ Stock Exchanges in re. delisting - especially, out of the 3 types, compulsory delisting.

One may refer also to the points focused on in the write-up, under -Conclusion - @

Comments from those who may be better equipped could be of useful guidance from the point of view of public interest.


Siddharth Raja said...

Has an appeal been filed against this decision? If so, any idea of what's its status? Thank you. Siddharth Raja

debashree said...

The broad premise of the said judgment is that S. 111A (2) provides that the shares or debentures and any interest therein of a company shall be freely transferable. However, a careful reading of Proviso to Section 111 A (2) deals with the power to order registration of a transfer where it has been refused by the company “without sufficient cause”. In view of this proviso read along with s. 111A (2), it can be clearly construed that in case of pledges the refusal by the company to register transfer of pledged shares shall be based upon a “sufficient cause”. Hence, pledge of shares and regulatory provisions for statutory non-transfer of shares in consideration shall not be affected by this judgment as they shall amount to a “sufficient cause”. Further, pledge creates an equitable interest in the shares in favor of the lender.
However, I do agree that Non-Disposal of Shareholding Undertaking, taken by the Lenders from major Shareholders / Promoters, , are in danger of unenforceability because of this Judgment. Further, the concept of "Contracting Out", which is well known as regards all personal rights and which appears to have been pleaded by the Respondents, does not appear to have been sufficiently dealt with and answered by the Court.

Jay said...

Interestingly, while both Section 9 and the relevant proviso to Section 111A are proposed to be dropped in the Companies Bill, 2009, Chandrachud, J has not referred to Section 82 which clearly says that shares and debentures of a company are transferable in the manner provided by the articles.

Anupam Prasad said...

@ Siddharth Raja : An appeal has been filed against this decision, before the Division Bench of the Bombay High Court, and the same is scheduled to come up in April, 2010.

Umakanth V. said...

@Anupam. Thanks for the update.

Vinod Kothari said...

We have written an article on this ruling; with respect, the ruling does not correctly define the position of law. See our article at

we will like to write on this site more about this ruling - the moderator may let us know an email to which we can write

Anonymous said...

Nice try, sir. That's like saying the abolition of slavery in the US or begar in India restricted the slaves' or bonded workers' freedom to bind themselves to bondage. Clever argument: freedom includes the freedom to bind yourself not to be free. But such arguments don't fly in contemporary thought. Such arguments have systemic implications. If people have the right to bind themselves to bonded labor, then they might - but how beneficial will this be for the system? Similarly, shareholders that have the "freedom" to hinder their own freedom may systemically destroy the principle of free transferability!

Nete said...

this decision has been over ruled by Bombay HC in Bombay Oxygen case.
It upheld the validity of this Agreements and redefined the meaning of "freely transferrable"