[Anshika is a student at Jindal Global Law School.]
In contrast to private companies, shares of public companies are freely transferable in accordance with Section 2(71) and Section 58(2) of the Companies Act 2013 (CA 2013). However, despite the fact that a free transferable nature of share enables investors to acquire stakes in multiple companies and thus enhance market liquidity, a question that arises is whether this restriction is absolutely free or not.
Legal Framework in India: Deciphering the Regulatory Landscape of Share Transferability
According to Section 58(2) of the CA 2013, the shares within a public company must be of such nature that they can be easily transferred, with no intervention from the board of directors or the concerned depository. The primary objective of enabling unrestricted share transferability is to safeguard the interests of the shareholders from the arbitrary decisions of the company. The shares owned by an individual within a company is considered as their personal property, and as an essential aspect of their ownership, these shareholders possess an inherent right to freely transfer their shares at their discretion.
However, the inclusion of a pre-emptive clause, established through mutual agreement between two or more shareholders to regulate share transfers does not contravene the legal mandate of free transferability of shares. Such an agreement only binds the contracting parties and does not impose restrictions on all the shareholders of the company, mandating them to exclusively sell its shares only to other existing members.
Are There Any Exceptions to the Free Transferable Nature of Such Shares in a Public Company?
Indeed, there are restrictions imposed on such free nature of share transferability. Restrictions on share transfer within companies are commonly outlined in Shareholders Agreements including provisions like right of first refusal, tag along or restrictions of a more absolute nature such as a lock‐in or ban on selling shares to any competitor etc.
Section 58(4) of the CA 2013 permits public companies to restrict share transfer registrations for "sufficient cause", and thus is a restriction on unrestricted share transferability allowed under Section 58(2) of CA 2013.
Why are Such Restrictions Being Imposed?
The objective behind such a provision is to empower the directors with the authority to restrict transfers in cases of exceptional circumstances, where sufficient cause is found, that is, where the transfer of shares is found to be undesirable in the company's interests. Even if the scenario were such that most shareholders were in favor of the transferees, it would not alter the situation either way. However, because of the fact that the CA 2013 does not specify what constitutes as "sufficient cause", it places absolute discretion on the company for its determination.
Navigating Legal Precedents on Such Restrictions: A Comparative Study of Mackintosh and Synthite
The interpretation of the term "sufficient cause" has evolved from the Companies Act 1956 (as previously mentioned under Section 111 of Companies Act 1956) and has thus received a wider meaning under Section 58 of CA 2013, through various cases such as that of Mackintosh Burn Limited v. Sarkar and Chowdhury Enterprises Private Limited (Mackintosh) and Synthite Industries Limited v. Plant Lipids Private Limited and Others (Synthite). In Mackintosh, the Supreme Court of India held that the registration of a share transfer may not only be refused on the ground of it resulting in a violation of any law but also for any other “sufficient cause”. The Supreme Court of India ruled that the denial of share transfer registration may not only be warranted due to its contravention with the law but also for any other “sufficient cause”. Significantly enlarges the scope of the expression “sufficient cause” used in Section 58(4) of CA 2013. The ruling in Mackintosh notably broadens the purview of the term "sufficient cause" as referenced in Section 58(4) of the CA 2013 and thus, implies that sufficient cause encompasses factors that are not conducive to the best interests of the company, and thus recognizes a limited right of a public company to restrict transfer of shares with sufficient reasons, including instances where any conflicts of interest may arise.
Then the case of Synthite delineates a comprehensive criteria, based on the approach that there is a correlation between the fiduciary responsibilities of a director to act in the interest of the company and the shareholders, for the determination of the parameters of the term “sufficient cause”. Directors are obligated to act in good faith and promote the interests of the company and the shareholder, in accordance with Section 166(2) of CA 2013. Therefore, the determination of sufficient cause under Section 58(4) of CA 2013 necessitates examining whether the obligations under Section 166(2) of CA 2013 have been fulfilled or not, that is, adjudging whether the restriction was with the intention of advancing the company’s and the shareholders interest or not.
Implication on Corporate Governance
Regardless of the fact that free transferability of shares provides an opportunity for the potential challenger to buy shares from an existing shareholder wishing to exit the company, imposing a restriction on such transfers help enhance corporate governance to a certain extent. Through this approach, the potential challenger willing to enter the company as a shareholder is prevented from gaining any control due to reasonable justifications in favour of the company’s interest. These justifications by the board of directors thereby ensure transparency and accountability as the board of directors are required to provide justifications on the ‘"sufficient cause" that led to the decision to the refusal of the transfer of shares.
The refusal of share transfer with sufficient cause enables the court to mitigate the agency cost stemming from the lack of clarity among the shareholders (principle) as to whether the board of directors (agent) is acting in their interest or not, which therefore can be proved by way of Section 166(2) of CA 2013. For instance, in Mackintosh, despite there being no formal resolution, the board was required to present its justification in order to defend itself before the court. By bringing these justifications to the forefront, it would offer shareholders insights into the functioning of the boards, thereby bridging the information gap. This process thus provides clarity, allowing the court to evaluate whether the decisions made were beneficial for both the company and the shareholders or not. Hence, even in the absence of formal resolutions, parties are obligated to offer justifications during court proceedings, and therefore, restriction backed by sufficient cause would effectively help reduce the information asymmetry between the board and the shareholders.
Conclusion – Can Share Transfers be Restricted in a Public Company?
Therefore, based on the above analysis, it can be deduced that the free transferability of shares under Section 58 of CA 2013 is not absolute. After the cases of Mackintosh and Synthite, the board of directors can restrict the transfer of shares to enhance corporate accountability, however only in case there is a sufficient cause to do so.
 3 REINER KRAAKMAN ET. AL., THE ANATOMY OF CORPORATE LAW 37-38 (OUP Oxford 2017).