[Aditya is a student at Jindal Global Law School.]
The legal position of contractual restrictions on the transfer of shares has differed in several judgments, leading to an unsatisfactory position in Indian law. This contention has arisen due to the interpretation of whether the same is violative of the phrase “freely transferable” in case of public and private companies under the erstwhile Section 111A (2) of the Companies Act 1956 (CA 1956) and Section 58(2) of the current Companies Act 2013 (CA 2013), and whether such a transfer must be in consonance with the company’s articles.
The Rangaraj Judgment
Justice Sawant observed in VB Rangaraj v VB Gopalakrishnan (Rangaraj) that a private agreement that imposes a restriction on the transfer of shares that is not in consonance with the Articles of Association is “neither binding on the shareholders, nor on the company.” While the position that such agreements are not binding on the company is well established in English law, the court’s stance on the applicability of the same to shareholders is extremely peculiar. The only possible statutory provision that supported such a statement was Section 82 of CA 1956, which classified shares of a company to be moveable property, “transferable in the manner provided by the Articles of Association.”
The legislative history of this section can be traced back to Section 73(1) of the English Companies Act, which was extremely similar to that of its colonial predecessor in phraseology except for the phrase “moveable property” contained in place of “personal estate.”
During this time, the Board of Directors (BoD) of a company, by no statutory provision, had the ability to refuse the transfer of shares, and hence, the authority for such recourse by the BoD was to be found within the Articles of Association. Such a view was affirmed across English judgments, case in point being Re Cawley & Co, wherein the Lordships observed that the share transfer amongst shareholders is subject to the articles, indicating that “the board cannot, except in accordance with the articles, impose any restriction on the ability of a shareholder to transfer.” (emphasis supplied). Hence, the phrase “transferable in the manner” was only limited to the extent of the BoD and did not extend to contracting parties. J Radhakrishnan was hence of the view that the Rangaraj case may have been wrongly decided because it imposes a fetter on the freedom of the parties to enter into contract although no such fetter is found in CA 1956, in the Vodafone International Holdings v. Union of India case.
The consequences of such a decision had its bearing in the cases of Mafatlal Industries Limited v. Gujarat Gas (Mafatlal) and Pushpa Katoch v. Manu Maharani Hotels (Pushpa Katoch). By this time, Section 111 of CA 1956 had undergone a change by means of an amendment in 1996, wherein Section 111 was amended to be applicable only to private companies, and Section 111A was inserted in lieu of public companies. The key difference in this categorisation was that in the case of public companies, Section 111A(2) went to the extent of stating that their shares were “freely transferable”, while the principle established in Rangaraj remained the same with respect to Section 82 of CA 1956. However, this had no bearing on the courts in the cases of Pushpa Katoch and Mafatlal, where it was observed that “any restriction contained in the Articles that prohibits the transfer of shares would be null and void” (emphasis supplied) and that “The ratio in Rangaraj must be accepted with greater force in the case of a public limited company.” '
The decision by the division bench in Messer Holdings v. Shyam Madanmohan Ruia (Messer) was finally a welcome change, as Khanwilkar J rightly observed that the phrase “freely transferable” in Section 111A(2) only meant that “the seller and buyer both, must agree to the terms of sale” and did not imply that a shareholder cannot enter into a contractual agreement with another shareholder, or a third party, in relation to his specific shares. Furthermore, if a company wanted to prohibit such a right of the shareholders, it could only do so through means of an express condition barring the same in the Articles of Association. Hence, while the case did not expressly overrule the Rangaraj judgment, it made a distinction from it in the sense that the former stated that a restriction on the transfer of shares is "enforceable unless contained" in the articles, while the latter held that the same is "enforceable unless barred" by the articles.
Section 58(2): An Imperfect Solution?
Since there certainly exists a legal grey area between the positions in Rangaraj and Messer, there is a dire need for a legislative solution that addresses the two issues. Firstly, an agreement between two shareholders cannot be deemed to be ineffective just because it is not contained in the articles, and secondly, the phrase “freely transferable” does not bar the validity of contractual agreements.
The current legislative framework under Section 58(2) of CA 2013 fails to address the former and only partially achieves the latter. Sub-section (1) of Section 58 of CA 2013 expressly pertains to only private companies, while sub-section (2) begins with the phrase "without prejudice to sub-section (1)" and goes on to state that the securities in a public company are freely transferrable. Hence, although the proviso in Section 58(2) may result in safeguarding contractual arrangements in public companies pertaining to the transferability of shares, such a scenario has still not been clarified in case of private companies. The legislature has still left room for ambiguity by retaining the principle of Section 82 of CA 1956, now Section 44 of CA 2013, and has refrained from reversing the principle laid down in the Rangaraj case.
In future cases, there may be uncertainty as to whether a contractual restriction on the shares of any company is ineffective unless it is included in the articles of association, or whether such a restriction on the shares of a public company is enforceable "as a contract" under the proviso to Section 58(2), but the same restriction on the shares of a private company is unenforceable even as a matter of contract. If the former view is adopted, as done so in Pushpa Katoch and Mafatlal, the proviso to Section 58(2) would serve as a dead letter. However, if the latter is adopted, a constitutional challenge would arise because of the proviso, in the sense that an inherent discrimination would exist between a public company and a private company, and that there exists no rational nexus between the categorisation resulting from Section 58(2) and the object of the legislation.
Currently, a Special Leave Petition challenging the Bombay High Court's ruling in Messer is ongoing before the Supreme Court of India. Coupled with this, the Division Bench of the Bombay High Court’s decision in Bajaj Auto Limited v. Western Maharashtra Development reaffirming that “preemptive rights cannot be interpreted to be a violation of the phrase ‘freely transferrable’" is a right step in this direction.
Given the fact that the solution proposed by the legislature in CA 2013 is not substantial and takes the law to another thicket, it is left to the courts to perhaps modify the Rangaraj rule once and for all.