Preemptive right is not a restriction on free transferability under Section 111A
Introduction
1. The concept of free transferability of shares in a public company under section 111A of the Companies Act 1956 is perhaps the most important unresolved controversy in contemporary Indian corporate law. Time and again the question has arisen as to whether the pre-emptive right (pre-emptive rights) in the shareholder agreement and the joint venture agreement constitute a restriction on the free transferability of the shares. The preemptive right is a device commonly used in the corporate world. Under the right of first refusal, a second party planning to exit the company is obligated to give the first party (promoter) the opportunity to purchase the shares before the shares can be sold to a third party who is an outside party. This is basically to prevent easy third party entry into the company by buying shares of the party that wants to get out of the company. Many companies, both unlisted and publicly traded, have these types of agreements with large shareholders.
Right of first refusal if you violate section 111A
2. In the recent judgment of a Chamber of the Bombay High Court in the case of Messer Holdings Ltd. v. Shyam Madanmohan Ruia decided on September 1, 2010 and reported in [2010] 98 CLA 325 has ruled that the stock transfer restriction with the “right of first refusal” (preemptive) clause in the agreement does not violate the provisions of section 111A. In paragraph 55, Khanwilkar, J, held as follows:
‘[T]The expression “freely transferable” in section 111A does not mean that the shareholder cannot enter into an agreed arrangement/agreement with the third party (proposed transferee) in relation to its specific shares. If the company even wants to prohibit this right of the shareholders, it may have to provide an express condition in the bylaws or in the Law and Regulations, as the case may be, to that effect. The statutory provision obtained in the form of section 111A of the Companies Act does not expressly restrict or eliminate the right of shareholders to enter into consensual arrangements/agreements in respect of the shares they hold.
This is a reversal of a previous ruling by the single judge in the case of Western Maharashtra Development Corporation v. Bajaj Auto Ltd. [2010] CLA 131 (Bom.) decided on February 15, 2010 which held that section 111A mandates that there can be no restriction on the transfer of shares in a public company. Accordingly, an agreement granting a pre-emptive right in respect of such shares has been found to be manifestly illegal. Judge DY Chandrachud in that case held as follows:
‘The principle of free transfer must be given a broad dimension to fulfill the purpose of the law. Placing restrictions on the principle of free transferability is a legislative function, simply because the postulate of free transferability was stated as a matter of legislative policy when Parliament introduced section 111A. This is a binding precept that governs the discourse on the transferability of shares. The word “transferable” has the widest possible meaning and Parliament, by using the expression “freely transferable”, has reinforced the legislative intention to allow the transfer of shares of public companies in a free and efficient domain. The effect of a preference clause is to impose a restriction on the free transferability of the shares by subjecting the transferability rules established in article 111A to a right of preference created by the agreement between the parties. This is inadmissible.
This judgment in the Western Maharashtra case (supra) had indeed put Corporate India in a bind, with many companies facing the prospect of having to rework their share agreements with outside investors. However, the recent ruling by Messer Holdings Ltd. (supra) has been a great relief to both the companies and the private equity funds that invest in these firms. The judgment also suggests that it is not mandatory for the company to be a party to such an agreement related to share transfer restrictions and that it is not necessary to incorporate share transfer restrictions into the company’s bylaws.
Section 111A does not apply to a private business
3. The restriction of the transferability of the shares of a private company must be contrasted with the cases of public companies in which the law provides for free transferability. The free transferability of shares is the norm in the case of shares of a public company. With regard to private companies, the statutes restrict the rights of shareholders to transfer shares and prohibit the invitation to the public to subscribe for shares or bonds of the company. In the case VB Rangaraj v. VB Gopalakrishnan [1991] 6 CLA 211, the Supreme Court has indicated that the transfer of shares in the case of a private company is regulated by the company’s bylaws and that any restriction that is not specified in the bylaws is not binding on the company or on the shareholders. . Regarding the public company in the case of Pushpa Katoch v. Manu Maharani Hotels Ltd.
[2005] 69 CLA 151 (Del.) ruled that even if the right of first refusal has been incorporated into the bylaws, a shareholder cannot be restricted from transferring the shares since section 111A which applies to public companies provides for free transfer of actions.
Concept of free transferability as held in Messers Holdings Ltd. box
4. The question before Messer Holdings Ltd. (supra) was whether it can be said that the pre-emptive subscription right violates the free transfer of shares provided for in article 111A. Reference may be made in this context to the provisions of subsection (2) of section 111A which begins with the expression “subject to the provisions of this section, the shares or debentures and any interest therein of a company shall be freely transferable.” . In other words, it is a provision that reaffirms that the shares or obligations and any interest in them of a company will be freely transferable subject, however, to the provisions of the other part of article 111A. The proviso of subsection (2) reinforces the position that section 111A is to regulate the powers of the Board of Directors of the company with respect to the transfer of shares or debentures and any interest therein of a company. The Board of Directors cannot refuse to register the transfer of shares unless there is sufficient cause to do so.
4.1 The concept of free transferability of the shares of a public company is not affected in any way if the shareholder expresses his willingness to sell the shares he owns to a third party with a preferential subscription right at the current market price at the time. relevant. As long as the member agrees to pay the prevailing market price and complies with other provisions of the Law, the Rules and the statutes, there can be no violation. For the sake of free transfer, both the seller and the buyer must accept the conditions of sale. The freedom of purchase cannot mean the shareholder’s obligation to sell his shares. The shareholder is free to transfer his shares under the terms defined by him, such as the pre-emptive subscription right, provided that the terms are compatible with other regulations, including the repurchase of the shares at the prevailing market price when said offer is made.
The fact that the shares of a public company can be subscribed and that there is no prohibition on inviting the public to subscribe for shares, unlike the case of a private company, does not reduce the right of the shareholder of a public company to reach consensual agreements . agreement that is otherwise in compliance with existing regulations and applicable laws.
Conclusion
5. While the recent ruling by Messers Holdings (supra) offers strategic investors much-needed respite, legal experts believe that some companies are likely to knock on the doors of the Supreme Court for clarity, as it has a big impact on various joint ventures. deal across corporate india. Some experts believe that the stock transfer restriction should be present in all agreements. The debate over the enforceability of the terms of shareholder agreements governing corporations is definitely not over yet.
