A recent judgment by the Bombay High Court on impermissibility of restrictions on transferability of shares in public companies has stirred a colossal pandemonium within the corporate and financial fraternity.
The dispute between Western Maharashtra Development Corporation Limited (WMDCL) and Bajaj Auto Limited (BAL) involved assessment of enforceability of a particular clause of a Protocol Agreement that was executed between them with the objective that these shareholders would control the majority of the equity capital of the joint venture entity, Maharashtra Scooters Limited (MSL). The subject clause accorded pre-emptive rights to both parties to purchase one another’s shareholding before any offer could be made to any third party. The transfer was stipulated at the rate specified by the seller, or else was to be decided by an arbitral tribunal. Similar stipulation was also included in the Articles of Association (AOA) of MSL.
Disagreement ensued between the parties on price of shares to be transferred from WMDCL to BAL, and was referred for adjudication by arbitration.
The arbitral award determined the transfer price, and was subsequently challenged before the Bombay High Court (BHC) on various grounds, including inter alia, that the Protocol Agreement was illegal, and any determination under the agreement was void, since its effect was to create a right of pre-emption in MSL, a public company, against the mandate of “free transferability” contained in section 111A of the Companies Act, 1956 (the Act).
The BHC considered the arguments and the counter arguments at length, and in its judgment delivered recently, made some vital observations on the scope of appellate jurisdiction in arbitration matters, before dealing with the crux issue of the ongoing debate, i.e. restrictions on transferability of shares in public companies.
On the key issue, the BHC observed, “By the provisions of the Companies Act, 1956, restrictions on the transferability of shares which are contemplated by the definition of a ‘private company’ under section 3(1)(iii) are expressly made impermissible in the case of a public company by the provisions of section 111A… a restriction to that effect cannot be read into the provision of section 111A… because, such a restriction is not mentioned in the statutory provision… the word ‘transferable’ is of the widest possible import….where the language of the statute is plain and unambiguous, neither the consequence nor the conduct of parties would be of relevance… ”.
The BHC, on the issue of restriction on free transferability of shares in a pubic company by way of its AOA, declared the challenged arbitral award, which upheld the validity of the said pre-emptive clause, as “…patently illegal…contrary to substantive provisions of law…and contrary to public policy”, and that the arbitrator had,”…ignored the express and specific provisions of the Companies Act, 1956; lost sight of the very concept of free transferability of the shares of a Public Limited Company and failed to apply the provisions of section 9 under which overriding force is given to the Act notwithstanding anything to the contrary contained in the Memorandum, Articles or agreement”.
The BHC also upheld applicability of section 111A to contracts for the transfer of particular shares between particular shareholders of public companies, agreeing with the observations made by the Delhi High Court earlier in the case of Smt. Pushpa Katoch vs. Manu Maharani Hotels Limited. In that case, the Delhi High Court while dealing with a family arrangement restricting transfer of shares in a public company held that by virtue of section 111A, the right of a shareholder to transfer his or her shares cannot be fettered. The Court noted that the transfer restriction was not contained in the Articles of Association of the Company, and observed, “…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”.
Upon a recent challenge by BAL against the BHC judgment before the division bench of the BHC, a ‘status quo’ order has been passed with respect to the disputed shares, restricting any dealings thereof by either of the parties until a subsequent interim order is passed.
Though the judgment of the BHC is not the first of its kind on the issue, it has sent tremors running into the corporate and financial community. The implications of the judgment are being widely debated and discussed, and apprehensions are being raised over its applicability to a number of transactions and contractual stipulations, in addition to the right of pre-emption that was the central issue therein.
An obvious concern is over enforceability of drag-along and tag-along rights, put and call options and similar stipulations in the joint venture and shareholder agreements which also, in a way, could be said to restrict transferability of shares. If a restrictive provision inter se the shareholders itself is held bad in law, liquidated or reasonable damages for its breach may also, arguably, not ensue.
The financial sector is also concerned as to whether applicability of the judgment can be limited to arrangements inter se shareholders and/or company. Since section 111A does not stipulate such a qualification, the transfer restrictions imposed as part of financial transactions between the banks and the promoter shareholders could also be questioned.
Some clarity is needed on the inter play between the stipulations of section 111A and the lock-in restrictions imposed by regulators, such as SEBI, as also the contractual restrictions on change of shareholding regularly imposed by development authorities across various States onto the allottees of land.
In addition, the judgment has left public companies, especially those unlisted, with a handful of practical issues, such as how to avoid takeovers by competitors, or to attract investments based on promoters’ credibility. The private equity investors would also share the concerns while investing in public companies.
Lastly, for academic debate purposes, does the judgment cement the right of the shareholders to free transferability, or in effect, hampers their opportunity to enter into quid pro quo arrangements. Does the right to transfer then include a right not to transfer. Well, the right to life surely does not include a right to the contrary.
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