The right of first refusal 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 right of first refusal (right of first refusal) in the shareholders agreement and the joint venture agreement constitutes a restriction on the free transferability of shares. The right of first refusal is a commonly used device in the business world. Under the right of first refusal, a second party planning to exit the company is required to give the first party (promoter) the opportunity to buy the shares before the shares can be sold to a third party that is an outside party. This is basically to avoid an easy entry of third parties into the company by buying shares of the party that wants to exit the company. Many companies, both unlisted and some listed, have such agreements with large shareholders.
Right of first refusal if you violate section 111A
2. In the recent judgment of a Division 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 restriction on the transfer of shares with the “right of first refusal” clause in the agreement does not violate the provisions of section 111A. In paragraph 55, Khanwilkar, J, held the following:
‘[T]The expression “freely transferable” in section 111A does not mean that the shareholder cannot enter into an agreement / consensual agreement with the third party (proposed transferable) in relation to its specific shares. If the company even wants to prohibit this right to shareholders, it may have to provide an express condition in the bylaws or in the Law and Regulations, as the case may be, in that name. The legal provision obtained in the form of section 111A of the Corporations Law does not expressly restrict or eliminate the right of the shareholders to enter into agreements / consensual agreements with respect to the shares held.
This is a reversal of an earlier judgment of 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 article 111A orders that there can be no restriction on the transferability of shares in a public company. Consequently, an agreement granting a right of first refusal with respect to such actions has been clearly considered illegal. Judge DY Chandrachud in said case ruled as follows:
«The principle of free transferability must be given a broad dimension to fulfill the object of the law. The imposition of restrictions on the principle of free transferability is a legislative function, simply because the postulate of free transferability was enunciated as a matter of legislative policy when Parliament introduced Article 111A. This is a binding precept that governs the discourse on the transferability of shares. The word “transferable” is of the highest possible importance and Parliament, by using the term “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 pre-trial clause is to impose a restriction on the free transferability of the shares, subjecting the transferability rules provided for in article 111A to a pre-emptive right created by the agreement between the parties. This is inadmissible. ‘
This ruling in the Western Maharashtra case (supra) had indeed put Corporate India in a bind, and many companies faced the prospect of having to rework their equity agreements with outside investors. However, the recent ruling by Messer Holdings Ltd. (supra) has brought great relief to both companies and private equity funds investing in these companies. The ruling also suggests that it is not mandatory for the company to be a party to such an agreement related to share transfer restrictions and it is not necessary to incorporate share transfer restrictions into the company’s bylaws.
Section 111A does not apply to a private company
3. The restriction of the transferability of shares in a private company must be contrasted with cases involving public companies where the law provides for free transferability. The free transferability of the shares is the norm in the case of the shares of a public company. As regards private companies, the statutes restrict the rights of shareholders to transfer shares and prohibit inviting the public to subscribe for shares or obligations of the company. In the case of 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 not specified in the bylaws is not binding on either the company or the shareholders. . . As regards the public company in the Pushpa Katoch v. Manu Maharani Hotels Ltd.
[2005] 69 CLA 151 (Del.) It was resolved that even if the right of first refusal has been incorporated into the bylaws, the transfer of the shares cannot be restricted to a shareholder, since Article 111A, which applies to public companies, provides for the free transferability of the shares.
Free transferability concept as held in Messers Holdings Ltd. cash
4. The question posed to Messer Holdings Ltd. (supra) was whether it can be said that the pre-emptive subscription right violates the free transferability of shares provided for in section 111A. In this context, reference may be made to the provisions of subsection (2) of section 111A that begins with the expression “subject to the provisions of this section, the shares or obligations 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 participation in them of a company will be freely transferable, subject, however, to the provisions of the other part of Article 111A. The caveat in subsection (2) reinforces the position that section 111A regulates the powers of the company’s Board of Directors with respect to the transfer of shares or obligations 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 shares of a public company is not affected in any way if the shareholder expresses his willingness to sell the shares he owns to another party with the right of first purchase (preference) at the market price in force at the time. relevant. As long as the member agrees to pay the prevailing market price and complies with other stipulations of the Law, the Rules and the articles of association, there can be no violation. For the sake of free transfer, both the seller and the buyer must agree to the terms of sale. The freedom to buy cannot mean the obligation of the shareholder to sell his shares. The shareholder is free to transfer his shares on the terms defined by him, such as the right of first refusal, provided that the terms are consistent with other regulations, including the repurchase of the shares at the current market price when said offer is made.
The fact that public company shares can be subscribed and there is no prohibition of inviting the public to subscribe shares, unlike in the case of private companies, does not reduce the right of the shareholder of a public company to reach consensual agreements. agreement that is otherwise in compliance with current regulations and laws in force.
Conclution
5. While the recent Messers Holdings ruling (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. all India corporate deal. Some experts believe that the share transfer restriction should be present in all agreements. The debate on the enforceability of the terms of the shareholders’ agreements that govern corporations is definitely not over yet.