SHARE TRANSFER RESTRICTIONS

A private company can restrict transfer of shares in terms of the provisions of section 2(68)
and section 58(1) of the companies act 2013. Therefore if there is any restriction on the
transfer of shares, which was agreed upon under a consensual agreement, it shall be binding
on such private companies and it has been the position of law that such restricitons be duly
appropriated in the AOA and shall be enforceable against the shareholders in a private
company. However, certain changes have been brought about by legislative actions such as
deletion of section 22 of the Securities Contract Regulation Act and by judicial
pronouncements. This opinion paper looks at these changes in detail.

RIGHT OF FIRST REFUSAL

Right of First Refusal (RoFR) forms an integral part of investor protection in a shareholder’s
contract as a pre-emptive option of a non-selling shareholder to purchase the shares of a
company that a selling shareholder seeks to liquidate.

RIGHT OF FIRST OFFER

It gives the non-selling shareholder a right to be offered the shares of the investor before they
are sold to a third party. ROFO is easily distinguished from ROFR as the seller is not bound
to sell his shares to the promoter, only to make an offer.

DEED OF ADHERENCE
All share transfers are required to be accompanied by a deed of adherence signed by the
transferee. This deed binds the new transferee to all the covenants and terms of the original
Shareholders Agreement.

PUT OPTION
The SHA provides for put option to the investor in the case of a default event. It seeks to
force the promoter to buy the put securities or effect a buyback of the same.

LOCK-IN RESTRICTION IN THE TISPRO REGULATIONS UNDER FEMA

Persons residing outside India are eligible to transfer securities in Indian companies’ subject
to the pricing guidelines under regulation 11 of the TISPROI Regulations. This transfer is,
however, limited by a lock-in period of 1 year of as prescribed under the regulations,
whichever is higher.
PRECEDENTS
1. V.B Rangaraj Vs V.B. Gopalakrishnan.1: in this case there was an oral agreement
between the heads of two families that both these families would hold equal shares in
the private company and in the event of one family wishing to liquidate its position,
such shares would be offered to the other family. The supreme court held that for a
restriction on transferability of share to be enforceable, such clause should be there in
the AOA and thus the oral agreement was not enforceable
2. M.S. Madhusoodhanan V Kerala Kaumudi Pvt Ltd2: in an agreement between the
members of the family it was stated that the existing share structure would not
change. The agreement also provided that after the death of two specific people in the
family their shares would pass on to Madhusoodhanan. The court distinguished this
case on the basis that the restriction placed was not upon share as a class but between
specific identified members for their specific identified shares, to which the company
need not be a party.
3. Western Maharaja Development Corporation Ltd. Vs Bajaj Auto Limited3: the
Bombay high court in this case had concluded that section 59 read with section 6
gives the picture that pre- emptive rights which are present in the shareholders
agreement are inhibitors to the “free transferability”, holding them to be
unenforceable as the word “transferable” is of the widest import and the legislative
intent behind the use of expression “freely transferable” is of allowing the free and
efficient transfer of shares. Section 6 which has an overriding effect on the
MOA/AOA and other resolutions of the company applies only to scenarios wherein a
document has been executed by the company and does not deal with matters wherein
the agreement is between the shareholders.
4. Vodafone India Holdings vs UOI4
Discussed restrictions such as put and call options and ROFR, and held that they are
legal and binding as between the shareholders and third party covenantors but the
company as a separate entity will not be bound by these restrictions.
5. Sancorp Confectionary pvt ltd vs Gumlink5

1
V.B Rangaraj Vs V.B. Gopalakrishnan AIR 19992 SC 453 Supreme Court of India
2
M.S. Madhusoodhanan V Kerala Kaumudi Pvt Ltd 2003 INSC 0592 Supreme Court of India
3
Western Maharaja Development Corporation Ltd. Vs Bajaj Auto Limited (2009) 13 STR 259
4
Vodafone International Holdings B.V. Vs. Union of India (UOI) and Ors. MANU/SC/0051/2012
5
2012(4)ARBLR240(Delhi)
 Deed of adherence requirement for trasferees of shares was upheld and enforced,
clarifying that the same will not bind the company itself.

PRESENT POSITION
The RoFR and RoFO as pre-emptive rights go against the spirit of free transferability of
shares in the listed and unlisted public companies under the Section 59 of the Companies Act,
1956. Section 59 emphasises on the free transferability of shares in public listed companies.
Pre-emptive rights such as these act as a hindrance to free transferability of shares. The
validity of these clauses has been debated at length in multitude of judgments. The division
bench of the High Court of Bombay in the case of Messrs Holdings limited v. Shyam
Madnmohan Ruia upheld the validity of these restrictions. In this case, the plaintiff was a
shareholder in Bombay Oxygen Corporation Limited (BOCL) a public company listed with
the Bombay stock exchange.6 The plaintiff entered into an agreement with a German
company to sell 45001 shares belonging to them and 30000 from the public. They later found
out that the German company had a Share Purchase and cooperation agreement with a
competitor of BOCL. The plaintiff filed a suit against the German Company to enforce their
RoFR. The Court observed that “the Shareholder has a right to transfer the shares on terms
defined by him (including pre-emptive rights) and that such agreements do not restrict free
transferability of shares. Further, the Court held that these agreements need not be
incorporated in the AoA and the requirement under Section 6 need not be fulfilled as Section
9 would not apply to contracts between shareholders and third parties not involving the
company. However, this judgment does come in contradiction to the law of land as
established by the case of V B Rangaraj v. V B Gopalakrishnan that agreements not stated in
the AoA are not binding either on the company or the shareholders. The Ruia judgment takes
a step forward and does away with the requirement of Section 9 itself. A similar view, in the
case of Western Maharashtra Development Corp. Ltd holding that Section 59 is not
applicable to consensual agreements between shareholders and third parties not involving the
company, is under appeal to the Supreme Court. The VB Rangaraj case holds good the
settled position of English law that a restriction on transfer of shares binds the shareholders
and not the company.

CONCLUSION
As a result of the Bombay high court judgement in Messer’s Holding Limited Vs S.M. Ruia
pre-emption clauses such as ROFO and ROFR are valid and enforceable, since these are
6
Messrs Holdings limited v. Shyam Madnmohan Ruia 2010 SCConline Bom 1284
agreements between shareholders or a shareholder and a third party, even though such
agreements may not be included in the articles of association and will not be hit by section 59
and section 6 of the companies act.