• Nishant Sharma, Vaishnavi Bansal

PNB Housing Finance Case: Whether Statutory Compliance Justifies AoA Violation?

[Nishant and Vaishnavi are students at National Law University, Jodhpur.]

Punjab National Bank Housing Finance (PNB Housing Finance), a company incorporated in 1988 and registered under National Housing Bank has come under the scrutiny of the Securities and Exchange Board of India (SEBI) for its recent preferential issue of shares.

On 31 May 2021, the board of directors of PNB Housing Finance approved preferential allotment of equity shares and warrants to four companies: Carlyle Group, General Atlantic, Salisbury Investments and Alpha Investments. Post this allotment, Carlyle Group, a US-based private equity company, would have become the majority owner and the stake of the original promoter, Punjab National Bank, would have been reduced to 20% from the existing stake of 32.64%. Unfortunately, before the deal could get executed, it fell into various controversies which invited the attention to the details of the deal.

The deal caught public attention when the proxy advisor firm Stakeholders Empowerment Services (SES) claimed the deal to be unfair and asked the minority shareholders to vote against the deal. They claimed the deal to be unfair majorly because the price determined for the shares is not fair and is not indicative of the true value of the shares. To make the matter worse for PNB Housing Finance, SEBI issued an order to halt the Extraordinary General Meeting (EGM) of the company. It stated the EGM notice to be ultra vires the company’s Articles of Associations (AoA) as the procedure opted to determine the price of the shares was not in accordance to the procedure mentioned in their AoA.

AoA Violation

For PNB Housing Finance, the most contentious of all the allegations is with respect to the procedure opted for the pricing of the shares. The allotment price of these shares was fixed at INR 390 per share as compared to the prevailing market price of INR 540 per share. The PNB Housing Finance’s AoA explicitly provides that in such a case of preferential allotment, the price of shares shall be calculated on the basis of a valuation report from a registered valuer. However, PNB decided to have the valuation as per the statutory requirements while giving no regard to the procedure prescribed in its own AoA. This, according to SEBI, is ultra-vires the AoA and hence not permissible.

According to the existing legal framework, the pricing of the shares in preferential allotment invites the application of Section 62(1)(c) of the Companies Act 2013 (Act), Rule 13(1) of the Companies (Share Capital and Debentures) Rules 2014 (Share Capital Rules) and Regulation 164 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR). Section 62(1)(c) of the Act provides for further issue of the share capital through preferential allotment and refers to Rule 13 of the Share Capital Rules for the procedure. The proviso to Rule 13 of the Share Capital Rules says that in case of the issue of shares on a preferential basis by a listed company, the price of shares shall not be required to be determined by the valuation report of a registered valuer. Here, where there is no mandatory requirement of a valuation report of a registered valuer, Regulation 164 of the ICDR provides the procedure for the determination of price through an average method. PNB Housing Finance contends that they followed this procedure in arriving at the price of INR 390 per share and was right in doing so since they have complied with the statutory requirements even if they did not consider the report of a registered valuer as required by their AoA. They claim that the AoA is merely a contract between the members of the company and once they have satisfied the statutory requirements, it is up to them whether they wish to fulfil the requirements made between the members in the AoA. SEBI found the explanation offered by PNB Housing Finance for its non-compliance with its AoA to be unsatisfactory.

Therefore, SEBI issued the letter halting the EGM, against which the company filed an appeal to Securities Appellate Tribunal (SAT). The company was allowed to conduct the EGM but the results could not be disclosed until the matter was decided. On 9 August 2021, a 2-judge bench of the SAT delivered an inconclusive judgement owing to a difference in opinion between the two judges. The interim order of not disclosing the results remained operational. The matter now will most likely be adjudged by the Supreme Court.

The question for consideration before the Supreme Court here is whether the valuation report from the registered valuer as per the AoA is required for the correct pricing. In other words, the question is with respect to the applicability of the AoA of the company in case the statutory requirements for the same have already been satisfied.

Analysis of the AoA Violation

It is an established principle that the AoA of a company constitutes a binding contract among the shareholders and directors, and the same was affirmed by the Supreme Court recently in the case of Tata Consultancy Services Limited v. Cyrus Investments Private Limited and Others. The AoA constitutes the common understanding for all the stakeholders of the company and is the very “bedrock” of the company according to which the decisions must be taken. Therefore, it cannot be discarded without being given due consideration.

At the same time, in case the AoA is found to be ultra-vires the Act itself, Section 6 of the Act provides that the Act overrides the AoA and the memorandum of association. Therefore, if any provision of the AoA is ultra-vires the Act itself, the Act will override the provision and there shall be no need to confine to that provision.

In the present case, PNB Housing Finance has advanced the following two arguments in order to justify its act of non-compliance with its AoA:

1. That the AoA provision concerning the calculation for further preferential allotment of shares by a registered valuer is in conflict with the Act and hence the Act will override the AoA as per Section 6 of the Act; and

2. That the AoA is merely a contract, and it is the Board’s discretion to follow it, and it may or may not be followed in case statutory requirements are satisfied.

We argue that both these arguments are unsatisfactory and lack legal support.

With regards to the argument that the AoA provision is in conflict with the Act, we argue that such an interpretation is incorrect, and they have to be harmoniously construed. The proviso to Rule 13 of the Share Capital Rules (which provides the procedure for further allotment of shares) merely states that it shall not be mandatory for the listed company to get a valuation report from a registered valuer. Hence, it doesn’t categorically prohibit, rather leaves it to the option of the listed company to choose for its desired mode of valuation in conformity with ICDR Regulations. In such a case, when the company chooses to mention in its AoA that the mode to be chosen by the company shall be valuation through a registered valuer, it means that the company has taken the obligation in its AoA to have the valuation through a registered valuer only. This conclusion also resonates with the application of the principle of harmonious construction which provides that as far as possible two apparently conflicting provisions should be interpreted in a manner such that effect can be given to both. Therefore, the AoA provision and Rule 13 can be interpreted to mean that the AoA imposes an additional obligation regarding the valuation procedure, rather that interpreting that the two different procedures contradict each other. In 1992, V.B. Rangaraj v. V.B. Gopalkrishnan and others, the Supreme Court while dealing with a matter pertaining to transfer of shares held that AoA is binding on the company and its shareholders. Therefore, AoA form a common understanding amongst the shareholders as to the transfer or allotment of shares that is binding to all. In order to respect this common understanding as well as the autonomy of a company to operate where option has been provided to it, it is necessary to harmoniously construe the AoA and the statute wherever there is a possibility of conflict.

Secondly, PNB’s contention that AoA is merely a contract that is at the option of the board and may or may not be followed in case the statutory requirements are satisfied, is flawed. It has been laid down in numerous cases and recently reaffirmed in Tata Consultancy Services Limited v. Cyrus Investments Private Limited and Others that the AoA forms the “bedrock” of the company and cannot be disregarded in a manner which negatively affects the rights and status of the shareholders.

Here the board of PNB Housing Finance has approved valuation of the preferential issue of shares 30% below the book price. More importantly, such an issue would ultimately lead to Carlyle acquiring the controlling stake in the affairs of the company. This clearly indicates that this preferential issue directly impacts interests and status of the shareholders, and therefore mere statutory compliance without compliance with the AoA would be a grave violation of the duty of the board.


Therefore, we can conclude that both contentions made by PNB Housing Finance are unsubstantiated: neither is the AoA in violation of the statute, nor does compliance with the statutory requirements (read “options” in the present case) absolve it from the obligation to comply with its own AoA.


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