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THE UNRESOLVED CONTROVERSY IN INDIAN CORPORATE LAW, "RIGHT OF FIRST REFUSAL"

January 2011

In a welcome judgement delivered by the Division Bench of the Bombay High Court on 1 September 2010, in Messers Holdings Limited v. Shyam Madanmohan Ruia[1] it was pronounced that a consensual private arrangement between shareholders of a public limited company on a voluntary basis for putting restrictions in share transfer is not violative of Section 111A of the Companies Act 1956, which states "Subject to the provisions of this section, the shares or debentures and any interest therein of a company shall be freely transferable" and does not violate the principal "free transferability of shares". This latest judgement will have a very profound impact on corporate law, primarily over Section 111A, in the wake of various judgments having been passed earlier with opposing standpoints. The Division Bench further opined that neither is it a mandatory provision for the company to be a party in such a share transfer agreement, relating to share transfer restrictions nor is it necessary to incorporate share transfer restrictions in the Articles of Association ("AOA") of the company. 

BACKGROUND & ANALYSIS 

By filing four Appeals[2], Messers Holdings, the Appellant challenged the common judgement and order passed by the Single Learned Judge, Hon'ble Bombay High Court. In the Appeals, more or less, the same issues have been raised; however what we shall analyse here is how this case has thrown light on the crucial controversial subject of "free transferability of shares" which have had various interpretations in the past. 

To understand the dispute fully, it is pertinent to run through the important points of the case in brief. The dispute is with regards to the control of the major shareholding of one Bombay Oxygen Ltd. for control over 75001 shares. Through a Share Purchase Agreement ("SPA") dated 23rd June, 1997, the Ruia's agreed to divest their major control in Bombay Oxygen Ltd. in favour of M/s. Griesheim Gmbh, a German company looking for collaborations in India. By the said SPA the Ruia's agreed to sell their 45001 shares of to M/s. Griesheim Gmbh and in addition allowing them to purchase 30,000 shares from the public making an aggregate of 75001 shares equivalent to 50% + 1 share of Bombay Oxygen Ltd. 

However, as a matter of fact before executing the said SPA, M/s. Griesheim Gmbh had already entered into Share Purchase and Cooperation Agreement with Goyal MG Gases Pvt. Ltd. on 12th May, 1995, which fact was never disclosed to the Ruia's. The Ruia's on coming to know of the said arrangement filed suit before a Single Bench of the Bombay High Court. The plaintiffs therein were granted ad interim relief/ injunction against the defendant no.1 from transferring the shares in question in breach of clause 6.1 (Right to first refusal) of the said SPA. 

In terms of the clause for right of first refusal, only in the event of the other party not agreeing to purchase the shares so offered for the price and other terms and conditions, it would be open to sell the said shares to any person other than the competitors of the offeree. 

Soon after being granted injunction, the defendant no.1 and 3 formed defendant no.4 company (Messer Holdings Limited). When this came to the notice of the Ruia's, they filed another suit before a Single Bench of the Bombay High Court. The Learned Single Judge held in favour of Ruia's.

On appeal, the Division Bench observed that this was done with a clear attempt and motive to transfer the shares of defendant No.2 Company purchased bythe defendant no.1 company from the plaintiffs and from the public finally in favour of defendant No.4 Company , so as to bring the said transfer within the scope of clause 6.1 of the said SPA. 

In support of the Appellants submissions, reliance was placed by the Appellants on the previous decisions of the Apex Court in the case ofV.B.Rangaraj v/s. V.B.Gopal Krishnan & ors.[3] and Western Maharashtra Development Corporation Ltd. v/s. Bajaj Auto Ltd.[4] (WMDC).  

The principle in Rangaraj's case was that a restriction on the transfer of shares is unenforceable unless contained in AOA, meaning that such restrictions have to be embodied in the AOA. Hence, a private agreement whereunder there is a restriction on transfer of shareholding which is not stipulated in the Articles is not enforceable. If Messer's is good law, then the rule is that a restriction on the transfer of shares is "enforceable unless barred" by the AOA, meaning to prohibit the right of shareholders to transfer shares through a private arrangement, may have to be provided as an express condition in the AOA. 

To understand the controversial position taken by Division Bench on the burning issue, it is important to understand how the stand is different in the wake of the judgment of the single bench Bombay High Court in the WMDC case which ruled that any pre-emptive rights over shares in public limited companies was illegal in view of the principle of "free transferability" enshrined in Section 111A. 

In Messers Holding case, while delivering the judgment, Mr. Justice Khanwilkar, very clearly differed in opinion from WMDC, to make certain observations in response to the core dispute which were that the intention of the legislature behind the making of Section 111A was to restrain the actions of the Board of Directors, not individual shareholders. 111A only means that "both parties must agree to the terms of the sale". It was further held that this need not be embodied in the AOA. 

The Judges further opined that the right to enter into consensual arrangement must prevail so long as it is in conformity with the terms of AOA and other provisions of the Companies Act. The expression "freely transferable" under Section 111A, is in the context of the mandate against the Board of Directors to register the transfer of specified shares of the members in the name of the transferee, unless there is ample cause for not doing so. The said provision cannot be construed to mean that it also intends to take away the right of the shareholder to enter into consensual arrangement/agreement with the purchaser of their specific shares. The concept of free transferability of shares of a can not be said to violate in any manner Section 111A if the shareholder expresses his willingness to sell the shares held by him to another party with right of first purchase (preemption) by means of a consensual agreement. 

Referring to various cases and after prolonged arguments, the Division Bench thus upheld the decision by the Learned Single Judge stating that the Appellants 3 & 4 are not entitled for any relief, whereas the Respondents are entitled for the interim relief as is granted to them by the Learned Single Judge, thereby dismissing the Appeals. 

CONCLUSION 

The judgement will have far reaching effects for investors/shareholders who, by incorporating clauses like right of first refusal, agree to sell their stake to promoters in case they are planning to exit the company. While delivering the judgement, the Division Bench made their intention clear that a shareholder has freedom to transfer his shares on terms defined by him, provided the terms are consistent with the governing laws and is a consensual agreement between both parties. It is pertinent to note that right of first refusal is very widely present in the world of joint-ventures. Giving legal validity to such clauses of "pre-emption" definitely promotes the interest of shareholders. In conclusion, the Bombay High Court judgment will be welcomed by investors as it makes transfer of shares much more viable however perhaps the Supreme Court clarifying the relationships between the various judgments in the past, which have held a different ground, will be welcomed. 

By - Priya Sarmah

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