April 27 2010
In Western Maharashtra Development Corp Ltd v Bajaj Auto Limited(1) the Bombay High Court upheld the principle of free transferability of a public limited company's shares, while also holding pre-emptive rights over such shares to be patently illegal.
In 1974 Western Maharashtra Development Corp Ltd entered into a protocol agreement with Bajaj Auto Limited pursuant to which a new manufacturing company, Maharashtra Scooters Ltd (MSL), was incorporated and registered as a public limited company under the Companies Act 1956. MSL's shares were listed on the Bombay Stock Exchange and the National Stock Exchange. The purpose of the protocol agreement was to set up a new manufacturing entity (MSL) to manufacture scooters using the respondent's experience and know-how. Therefore, the respondent agreed to participate in the equity capital of MSL. In terms of the protocol agreement, 27% of the shares in MSL were held by the petitioner, 24% by the respondent and the remaining 49% by the public at large. This percentage of shareholding was to be sacrosanct and neither party to the protocol agreement was permitted to alter the structure of MSL (ie, the number of shares or the rights, privileges, restrictions or qualifications of any class of share). Any further issue of capital was to be made in a manner so as to ensure that participation by the parties to the protocol agreement in total issued equity share capital would remain in the proportion set out above. Neither party was allowed or entitled to deal in its shareholding in such a manner as to lose its absolute control over voting rights. The intent of the parties was to control at least 51% of the equity capital of MSL.
Clause 7 of the protocol agreement was the focus of the dispute between the parties. Clause 7 imposed a mandatory obligation on any party to the protocol agreement that wished to transfer or part with its shareholding to offer such shares first to the other party by way of a written notice specifying the number of shares, as well as the rate at which it was willing to sell. A simple acceptance of such offer within 30 days would end the matter and the offeror would be bound to sell the shares. However, any dispute over the rate or price of the shares would have to be determined by reference to arbitration, after the offeree had, within 30 days, confirmed its intention to purchase. Failure to accept the proposal or offer within 30 days of receipt would free the offeror of any obligation and it would be free to sell the shares to any other party, but only at a rate that was no less than that specified in the notice or offer.
In 2003, upon repeated requests from the respondent to divest its shareholding in MSL, the petitioner communicated its willingness to sell its shares in MSL. However, since the parties could not arrive at a consensus regarding the price of the shares, the dispute was referred to arbitration before a sole arbitrator. The petitioner lodged a challenge questioning the jurisdiction of the arbitrator, primarily on the grounds that the protocol agreement was illegal and void, as it restrained free transferability of the shares held in a public limited company (MSL), which was therefore violative of Section 111A(2) read with Section 9(3) of the Companies Act. The arbitrator rejected the plea of lack of jurisdiction and went on to list a particular date as the date for valuation. The arbitrator, while dealing with the issue, referred to VB Rangarajan v VB Gopalkrishnan(4) and MS Madhusoodhan v Kerala Kaumudi Pvt Ltd,(5) observing that the protocol agreement was a private agreement and thus would not fall within the ambit of Section 111A of the Companies Act. The petitioner challenged this arbitral award under Section 34 of the Arbitration and Conciliation Act 1996.
The primary issue before the Bombay High Court concerned the arbitrator's jurisdiction and his determination of the valuation of the shares. The petitioner contended that the arbitrator had exceeded his jurisdiction in deciding the date on which the valuation had to be determined.
Going into the scope of the challenge under Section 34 of the Arbitration and Conciliation Act, the Bombay High Court observed that the 'illegality' of the arbitral award must go to the root of the matter. Such illegality was to be judged in respect of Section 111A of the Companies Act. In this regard, the court observed that, subject to Section 111A, "the shares or debentures and any interest therein of a Company are freely transferable". Furthermore, read in light of Section 9, Section 111A would take precedence over any agreement between the parties and not vice versa. Thus, a private agreement between shareholders which creates a right of pre-emption or imposes a restriction on the free transferability of the shares of a public limited company will not be permitted under the Companies Act.
The court took this opportunity to elucidate the nature and scope of 'free transferability' under Section 111A of the Companies Act. Giving the term 'transfer' a broad tenor, the court went on to observe that:
"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."
Hence, the Bombay High Court held that the effect of a pre-emption clause was to restrict the free transferability of shares. This, it was held, was impermissible in light of Section 111A read with Section 9. The court also distinguished between the decisions relied on by the arbitrator (ie, VB Rangarajan and MS Madhusoodhan) on the facts, observing that the position of law with regard to a public limited company is materially different from that of a private company. Hence, the restrictions on the transferability of shares which can be contemplated by a 'private company' (under Section 3 of the Companies Act) are expressly made impermissible in the case of a public limited company by way of Section 111A. The court went on to hold that the arbitral award was "completely contrary to substantive provisions of law and was patently illegal". It was held that the arbitrator had ignored the express and specific provisions of the Companies Act and lost sight of the very concept of free transferability of shares of a public limited company.
The court has held the principle of transferability of a public limited company's shares to be overarching, giving the public the freedom to purchase transfer shares at its discretion. The implications of this decision are far reaching. Apart from pre-emptive rights, other conditions could come up for scrutiny in light of the decision. This would also restrict the pledging of a shareholding in a public limited company for the purposes of raising a loan, as there would be covenants restricting the transferability of such shares. Another question that the courts now need to look into is whether Section 111A prohibits a right of disposition.
While free transferability of a public limited company's shares is a significant right, discretion should be vested with the shareholder to impose fetters on the same if it so desires. However, this issue is yet to be decided by the Supreme Court.
For further information on this topic please contact Ruchi A Mahajan or Jai Mohan at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 2692 0500), fax (+ 91 11 2692 4900) or email (firstname.lastname@example.org or email@example.com).
(2) Subject to the provisions of this section, the shares or debentures and any interest therein of a company shall be freely transferable:
[Provided that if a company without sufficient cause refuses to register transfer of shares within two months from the date on which the instrument of transfer or the intimation of transfer, as the case may be, is delivered to the company, the transferee may appeal to the [Tribunal] and it shall direct such company to register the transfer of shares.]"
Save as otherwise expressly provided in the Act-
(a) the provisions of this Act shall have effect notwithstanding anything to the contrary contained in the memorandum or articles of a company, or in any agreement executed by it, or in any resolution passed by the company in general meeting or by its Board of directors, whether the same be registered, executed or passed, as the case may be, before or after the commencement of this Act; and
(b) any provision contained in the memorandum, articles, agreement or resolution aforesaid shall, to the extent to which it is repugnant to the provisions of this Act, become or be void, as the case may be."
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