Pre-emptive rights of shareholders of Private Company

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Pre-emptive rights of shareholders of Private Company: Enforceable to what extent

Transferability of shares is the primary feature of the incorporation of a company. Section 3 (iii) and (iv) of Companies Act 1956 deals with the definition of private and public company which determines the freedom and restriction to transfer shares as exercised by the shareholders of private and public companies respectively.

If we go through some of the cases filed at the Supreme Court of India in relation to restriction on transferability of shares, then we may conclude that in some of the cases, appellants have objection on their brethren shareholder’s act of transferring shares not in according with the shareholders agreement. Although Section 82 of the Companies Act states that the shares or debentures or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company.

Lets have a view on some of the landmark Supreme Court decisions relevant to transferability of shares:

The questions raised in the case of V.B Rangaraj v. V.B Gopalkrishnan and ors [1992] 73 is whether the shareholders can among themselves enter into agreement which is contrary to or inconsistent with the Articles of Association of the Company.

In this case the shares of a company are held by two brothers. There was an agreement between brothers that each branch of the company would hold equal number of shares. Hence if any member of the branch wished to sell its share, first option was to be given to member of that branch. The agreement was not incorporated in AOA and one of the member sold the shares in contravention of agreement.

The defendant contended the following contentions in defense:

• The restriction was not envisaged by AOA, thus it is not binding on shareholders or a vendee of the shares.

• It was unenforceable in law and thus not binding on the company.

The Supreme Court held that the Companies Act 1956 makes it clear that AOA is binding on company and shareholders and transfer of shares is regulated by AOA. The only restriction on transfer of shares binding on the company is one contained in AOA. Restrictions not specified in AOA is neither binding on company nor on the shareholders. Vendee cannot be denied registration except for grounds in AOA.

 

In the case of Madhusoodhanan v. Kerala Kaumudi the issue raised was whether a suit for specific performance would lie upon contravention of pre-emptive right in family settlement (Karar). In this case there were 9 shareholders (family members) in a private company. 5 shareholders enetered into a Karar (family settlement) that on the death of the Chairman (also a shareholder) her shareholders would divide in ratio of the 50:25:25 between the three shareholders. 50% was to be held by Madhu. The Karar was embodied in AOA.

 

On the death of Chairman, the 50% shares were not transferred to Madhu in terms of Karar. Hence Madhu filed a suit for specific performance.

The defendant contended that this restriction on transfer of share is in contravention of AOA, therefore unenforceable both against company and shareholders and no suit for specific performance would lie.

The Supreme Court held that holders of shares in a private company may agree to sell his shares to a person of his choice. Such agreements are specifically enforceable under Specific Relief Act.

Generally, Specific Relief does not lie for contract to transfer movable property unless covered by exception to Section 10. One such exception is if the property is not easily obtainable in the market. Shares of private limited company are not easily obtainable in the market. Thus Suit for specific performance would lie.

In this case the decision given in Rangaraj case was overruled making it clear that the Court never held that an agreement for transfer of shares among particular shareholders cannot be enforced like any other agreement.

In the case of Rolta India Ltd and Another v. Venre Industries Ltd and Others the appellants asked for the following relieves

• Restraining the defendants from taking any steps pursuant to or in implementation or in furtherance of the resolution passed in respect of the allotment of rights shares.

• Restraining the appointment of any additional directors on the board of directors of defendant Company.

This case was filed on the basis of a pooling agreement on curtailing the statutory rights given to the Board of directors to manage the company.

The defendant contended that a pooling agreement may be utilized in connection with the election of directors and shareholders’ resolutions where shareholders have a right to vote. However, a pooling agreement cannot be used to supersede the statutory rights given to the Board of directors to manage the company, the underlying reason being that the shareholders cannot achieve by pooling agreement that which is prohibited to them, if they are voting individually. Therefore, the power of shareholders to unite is not extended to contracts, whereby restrictions are placed on the powers of directors to manage the business of the Corporation. It is for this reason that a pooling agreement cannot be between directors regarding their powers as directors.

The Supreme Court held that since the company was in need to increase the capital, there was need for professionalization, but it would be deprived of it despite the fact that there is no such restriction in the articles of association. The objection was raised on the basis of Clause 8 of MoU. In our view, the curtailment of the powers of director by enforcement of such a clause would not be permissible. Clause 8 would result in curtailment of the fiduciary rights and duties of the directors. The shareholders cannot infringe upon the directors fiduciary rights and duties. Even directors cannot enter into an agreement, thereby agreeing not to increase the number of directors when there is no such restriction in the articles of association. The shareholders cannot dictate the terms to the directors, except by amendment of articles of association or by removal of directors. The agreement infringes upon the right of the first defendant to have more number of directors, in the interest of the company. The grant of interim injunction would amount to stultifying management of the company.

In Satyanarayana Rathi v. Anna Maliar Textiles Pvt. Ltd., (1999) 32 CLA 56, the articles of as-sociation of a private company contained that no share of the company shall be transferred to any person who is not a member of the company so long as any member of the company is willing to purchase the same at a fair price which shall be determined by directors from time to time. The appellant, in whose favour certain shares were pledged for dues for supply of cotton, asked the company to register the transfer of shares in his favour as the dues were remaining. The company refused to register the transfer as it would have been against the Article of Association. The Company Law Board (CLB) upheld the decision of the Board. It observed that a close scrutiny of the above articles will show that no share shall be transferred to an outsider if any member of the company is willing to purchase the same at a fair price which shall be determined by the directors. Further, transfer to an outsider is permissible only when the Board is unable to find a willing member to purchase the shares within a stipulated period.

In Tarlok Chand Khanna v. Raj Kumar Kapoor, (1983) 54 Com. Cas. 12 (Delhi), one of the regulations in the articles of the company was that all transfers of shares shall be sanctioned only with the unanimous decision of the directors. The Delhi High Court held that such provision which is preserved by S. 111(1) [now S. 111(13)] of the Act and being not inconsistent with any provision of the Act would be outside the reach of S. 9 of the Act. In the absence of any words of limitation such as the expression ‘Present and voting’ in the phraseology of the article, the same should be construed to mean that the sanction should be with the unanimous decision of all the directors of the company and a transfer which is otherwise valid, cannot be given effect to when it is based on the decision of the board in a meeting at which one of the directors was absent.

If we consider what Section 111 says then we will construe that the company has the power to refuse to register the transfer of shares if it is in contravention of AOA or otherwise. Also there is a remedy lying with the transferor or transferee to appeal against the refusal to register in CLB.

Likewise Section 111A says that the shares or debentures and interest therein of a company shall be freely transferable. In case the company without sufficient cause refuses to register the transfer, the transferee may appeal to CLB against refusal to register the transfer.

Thus it may be concluded that the power to refuse the transfer of shares cannot be exercised arbitrarily or for any other collateral purpose and can only be exercised for a bonafide reason in the interest of the company and general interest of the shareholders. However in cases where by its articles of association a company reserves the right to refuse the transfer of shares, the burden of proving that such refusal was not bonafide is on the person who so alleges.

This may also be noted that there may be restriction on transferability of the shares, there cannot be an absolute prohibition on the right to transfer shares. A pre-emption right has been held to not amount to a prohibition upon transfer.

3 COMMENTS

  1. our company, a private limited company was established in1913 and on 31.5.67 there were 50 shareholders of company. on 31.5.1967, company in therir EGM passed an resulation that there will be 50 shareholdrers of company but to run the club smoothly we will make co-opted members without voting right against a entry fee and after the death of one shareholder the senior most co-opted member will be eleveted to shareholder postwith out payment of any share money. this procedure is in force for the last 40+ years . no share certificate was ever issued to any shareholder nor transfer of shgare as per company laws took place. Can now we all shareholder sign an shareholder’s certificate specifiying that in the even of death of shareholder/resignation/expulsion the share in his name should be cancelled and re-alloted to senior co-opted member and his legal heir has no intrest in these shares as he has not paid the cost of shares and all shares belong to company. or let me know any other was we can keep same procedure of our club as per resulation of 1967..our company is non profit undertaking since 1913

  2. Shares of a pvt ltd co. is not given to shareholders.nor the balance sheet. Regular meeting of shareholder not taking place.what should the shareholder(minority )do now.)

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