The question of whether transfer restrictions imposed by agreement on shares of a listed company are enforceable has been a vexed one. Numerous decisions of the Supreme Court as well as High Courts had expressed somewhat different views on the nuances of the issue. However, some stability was brought about in 2010 by a decision of a division bench of the Bombay High Court in Messer Holdings v. Shyam Madanmohan Ruia, which effectively ruled that restrictions expressed in an agreement between shareholders are not violative of the Companies Act, 1956 (the “1956 Act”) and that they can be enforced inter se among shareholders. In doing so, the Court diverged from the ruling of a single judge in Western Maharashtra Development Corpn. Ltd. v. Bajaj Auto Limited, which had held such transfer restrictions to be unenforceable.
Both the decisions have been the subject-matter of appeals. While the Messer Holdings decision was appealed to the Supreme Court, where hearings are underway, the Bajaj Auto decision was appealed to a division bench of the Bombay High Court. By way of a judgement dated May 8, 2015, the division bench of the Bombay High Court in Bajaj Auto Ltd. v. Western Maharashtra Development Corporation Ltd. pronounced its judgment by overturning the judgment of the single judge and essentially concurring with the division bench in Messer Holdings. It is this decision that is the subject matter of the post. The relevance of this decision is that it further establishes the prominence of Messer Holdings and adds some robustness to the enforceability of share transfer restrictions in agreements as between shareholders.
The brief facts are that Bajaj Auto Ltd. and Western Maharashtra Development Corporation Ltd. (“WMDC”) had set up a joint venture in the form of Maharashtra Scooters Ltd., in which Bajaj Auto held 24%, WMDC 27% and the public 49%. The dispute arose out of a share transfer restriction contained in clause 7 of a Protocol Agreement between Bajaj Auto and WMDC, which is in the nature of a right of first refusal. A dispute related to the price at which Bajaj Auto could exercise the right to acquire WMDC’s stake. The matter resulted in arbitration for determination of the price, wherein an award was issued. The single judge set aside the arbitration award on the ground that clause 7 was in violation of section 111A of the 1956 Act, which provided for free transferability of shares in a public company. It is against this order that Bajaj Auto preferred an appeal. The division bench allowed the appeal.
A large part of the division bench’s reasoning resonates with Messer Holdings, which explores the historical origins of section 111A that substituted section 22A of the Securities Contracts (Regulation) Act, 1956 (SCRA). Given the similarity of reasoning with Messer Holding, I do not propose to discuss the division bench judgment in detail. However, some key excerpts are set out below:
24. On a reading of section 22A as it stood then, it is clear that the provisions therein applied only to public companies whose shares were listed on the recognised Stock Exchanges. The provision in section 22A(2) that securities of public companies shall be freely transferable, was made only as the basis for the consequential provisions in sections 22A(3) to (9) to provide for free transferability by restricting the entitlement of public companies (through their Board of Directors) to refuse registration of transfers only in four stipulated circumstances [section 22A sub-section (3)]. This is also borne out by the statement of objects and reasons discussed above. In other words, section 22A(2) provided for free transferability and the actual steps taken to provide for the same were set out in sections 22A(3) to (9).
25. The wordings of section 22A as well as the objects and reasons discussed above make it clear that section 22A was introduced to ensure that the Board of Directors of public companies exercising powers under its Articles of Association, do not place an undue burden on small investors by refusing to transfer shares without assigning any reason. In light of the language of section 22A as well as the statement of objects and reasons, we do not read section 22A(2) to mean that it would affect the right of individual shareholders to deal with their own shares on such terms and conditions as they deem fit or to enter into any consensual arrangement / agreement regarding their own shares by way of sale, pledge, pre-emption or otherwise.
26. Once the context in which section 22A had been inserted is understood, it cannot be said that two individual shareholders entering into a consensual agreement to deal with their shares in a particular manner, either in presenti or at a future date, would impinge or violate the concept of free transferability as contemplated under section 22A(2). The purpose of the said provision, as we understand it, was to ensure that the Board of Directors of the company cannot refuse transfer of shares except on the grounds specified in the said section. This does not mean that if an individual shareholder enters into a separate agreement with another shareholder to deal with his specified shares in a particular manner, the same would violate the concept of free transferability as envisaged under section 22A.
27. We have come to this conclusion because we find that shares of a company are movable property and the right of the shareholder to deal with his shares and / or to enter into contracts in relation thereto (either by way of sale, pledge, pre-emption etc.), is nothing but a shareholder exercising his property rights. Such contracts voluntarily entered into by a shareholder for his own shares giving rights of pre-emption to a third party / another shareholder, cannot constitute a restriction on free transferability as contemplated under section 22A. In fact, such contracts (either by way of sale, pledge or pre-emption) are entered into by a shareholder in exercise of his right to freely deal with and / or transfer his own shares.
Furthermore, the court concluded that even through the terms of the Protocol Agreement were incorporated into the articles of association of the company, that would not alter the enforceability of the agreement inter se between the parties.
An extended contribution of the division bench judgment is its analysis of the factual situation in the context of the new legislation, i.e. Companies Act, 2013 (the “2013 Act”). Although the case itself was decided under the 1956 Act, the court expressed its views on the 2013 Act (which can at best be considered obiter dicta). It examined section 58(2) of the 2013, which “specifically provides that without prejudice to sub-section (1), the securities or other interest of any member in a public company shall be freely transferable. However, the proviso to the said section stipulates that any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract”. After briefly considering the parliamentary process behind the enactment of this provision, the Court appears to suggest that the new provisions will resolve the matter:
40. On reading section 58 …, we are of the view that section 58 merely clarifies and codifies the existing legal position regarding such pre-emption agreements. In other words, what was implicit in the provisions of section 111A of the Companies Act, 1956 has now been made explicit in section 58 of the Companies Act, 2013.
However, in an earlier paper, Niranjan and I find (on pages 29 to 32) that section 58 may not have resolved the matter entirely, and that some open issues remain.
In all, the recent decision of the Bombay High Court further entrenches the Messer Holdings position and enhances the enforceability of transfer restrictions in public companies. Although this judgment relates to the 1956 Act, some observations have been made regarding the position under the 2013 Act as well. However, the limitations of this approach are that this and the Messer Holdings are both Bombay High Court decisions, without other High Court having expressly concurring with this view. In fact, other High Courts such as Gujarat High Court (Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd.,  97 Comp. Cas. 301) and Delhi High Court (Smt. Pushpa Katoch v. Manu Maharani Hotels Ltd.,  131 Comp. Cas. 42) have adopted a different view. Moreover, since Messer Holdings is on appeal (and the present judgment might very well be appealed against as well), the true resolution of the issue will have to await a pronouncement from the Supreme Court.
[I would like to thank Nikhil Suresh Pareek for bringing the judgment discussed in this post to our attention]