23 August, 2016
The question of the enforceability of contractual restrictions on transfer of shares of Indian public limited companies (Companies) has been the subject matter of various decisions by Indian courts. The Indian legislature has also examined this aspect, which has resulted in a change in the relevant legislation. Through this post, we examine the position as it stands today.
The debate on the enforceability of shareholder agreements and joint venture agreements governing Companies garnered significant attention in early 2010 when a single judge of the Bombay High Court (Bombay HC) set aside an arbitral award in a 2010 decision in Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd. The judgment indicated that the shares of a Company could not be fettered, were freely transferable and as such, any restriction on free transferability would be a violation of section 111A of the erstwhile Companies Act, 1956 (1956 Act).
Interestingly after the judgment in Bajaj Auto, a division bench of the Bombay HC in Messer Holdings Limited v. Shyam Madanmohan Ruia in 2010 reconsidered this question and pronounced a judgement that was different from the ruling in the Bajaj Auto: it was held that a private arrangement between shareholders of a Company on a voluntary basis, relating to share transfer restrictions (in this case a right of first refusal), would not be violative of Section 111A of the 1956 Act and as such, would be enforceable between the shareholders. The judgement further stated that it was not mandatory for a Company to be a party to such an arrangement and further that that it was not essential to incorporate share transfer restrictions in the byelaws of the Company.
The division bench in Messer Holdings also stated that a restriction on the transfer of shares is “enforceable unless barred” by the byelaws of a company. Messer Holdings appealed against this decision before India’s apex court (Appeal).
At the same time, following the division bench decision in the Messer Holdings, an appeal was filed in the Bajaj Auto case before a division bench of the Bombay HC (Bajaj Auto Appeal). The division bench of the Bombay HC pronounced its judgment in the Bajaj Auto Appeal in May 2015 whereby it overturned the judgment of the single judge in this case and agreed with the decision of the division bench in Messer Holdings. The division bench in Bajaj Auto Appeal also held that even if the terms of a private arrangement between shareholders were not permissible under the byelaws of a Company, it would not in any way destroy the enforceability of the agreement between the shareholders.
Foreign investors have shown strong preference for robust contractual rights and certainty over the enforcement of such rights
The Supreme Court delivered its decision on the Appeal in April 2016. The parties, by this time, had entered into a settlement agreement and there was no surviving dispute. Accordingly, the Appeal was dismissed. The Supreme Court also made it clear that it was not deciding on the existence or otherwise of any right or its transferability in the shares in question. Whilst the Appeal was a welcome opportunity for the Supreme Court to finally decide this question which has been the subject matter of much judicial debate by Indian courts, it was not to be so.
As India looks to attract more foreign investment, foreign investors will want robust contractual rights and certainty over the enforcement of such rights. There has been a fair amount of confusion on the subject matter, given the divergent opinions of the single judge of the Gujarat High Court in Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd. in 1997 and the Delhi High Court in Smt. Pushpa Katoch v. Manu Maharani Hotels Ltd. in 2005 (where the courts adopted the view that there cannot be any fetters, contractually or otherwise, on the right of a shareholder to transfer shares in a company), which were later differed by the division bench decisions of the Bombay HC in Messer Holdings in 2010. The Appeal was also a welcome opportunity to finally decide on the differing views of various High Courts. However, in light of the outcome of the Appeal, this was not to be so. It would be prudent to assume that status-quo continues and the division bench decisions of the Bombay HC in Messer Holdings and the Bajaj Auto Appeal continue to hold good, at least for the time being and would have a persuasive value over the single judge decisions of the Gujarat and Delhi High Courts.
As things stand, foreign investors looking to make investments into companies in India can, despite the requirement of free transferability of shares, potentially still enter into valid private arrangements vis-a-vis other shareholders to restrict the transfer of shares, irrespective of whether such restrictions are incorporated in the byelaws of the Company. However, it would also be prudent to note that this position might change, as and when the issue of contractual restrictions on the transfer of shares comes up before the Supreme Court again.
For further information, please contact:
Cyril Shroff, Managing Partner, Cyril Amarchand Mangaldas