The Rangaraj-Madhusoodhanan Conflict and the "Reformulation" of Rangaraj in Para 55 of

Messer Holdings

Section 111A of the Companies Act, 1956, is perhaps the most significant unresolved
controversy in contemporary Indian corporate law. The blog noted today that a Division
Bench of the Bombay High Court (Messer Holdings) has held that a private arrangement
between shareholders conferring a right of first refusal is not contrary to s. 111A of the
Companies Act. In this post, I offer some thoughts on ascertaining the existing position of
law on the scope of s. 111A(2). A close analysis of five decisions is crucial for this exercise –
the oft-quoted judgment of the Supreme Court in VB Rangaraj v. VB Gopalakrishnan
[“Rangaraj”], the 1997 judgment of the Gujarat High Court in Mafatlal Industries
[“Mafatlal”], the 2002 judgment of the Supreme Court in M.S. Madhusoodhanan
[“Madhusoodhanan”], and the twin Bombay High Court 2010 judgments in Bajaj Auto and
Messer Holdings. It is important to identify exactly what these decisions hold. In addition, it
is necessary to consider the legislative history of s. 111A, and the position on transferability
of shares in common law. Interested readers may also refer to Puspha Katoch, Bhadresh
Kantilal Shah (CLB) and re Morgard Shammar (CLB).

Like most accounts, we must begin with the decision in Rangaraj. The defendant in that case
was a private limited company, and in time, its sole shareholder came to be a family that
consisted of two branches. The principals of each branch orally agreed in 1951 that the
proportion of shareholding of their respective branches would not change, and provided, for
this purpose, that any member of a branch who wished to sell his shares must first offer the
shares to his own branch. After referring to the decision of the Supreme Court in Kalinga
Tubes, common law decisions and scholarly opinion, Sawant J. held that shares are “freely
transferable” and that “a private agreement that imposes … restrictions not stipulated in the
articles of association…” is “not binding either on the shareholders or on the company”. The
latter part of his decision – that it does not bind the company – is not new, and is an accepted
rule of English law. However, that it does not bind the shareholders is a requirement peculiar
to Indian law, and the only possible statutory provision that supports it is s. 82, which Sawant
J. cites. However, s. 82, which provides that shares in a company constitute movable property
“transferable in the manner provided by the articles of association”, is widely thought to in
fact refer to the procedure of transfer.

In 1996, the Depositories Act was enacted, which omitted s. 22-A of the Securities Contract
Regulation Act, and added s. 111A to the Companies Act.

In 1999, an eminent judge of (then) the Gujarat High Court heard Mafatlal, where the
defendant was a public limited company. The plaintiff had sold 3.87 % of the equity in that
company to an FII with a pre-emption right, who later disposed of a part of those shares in
the open market. The plaintiff relied on the right of pre-emption to invalidate the subsequent
sale by the FII, and argued, interestingly, that “free transferability of shares refers to absence
of restrictions which may be imposed by third parties, but it cannot exclude the right of a
shareholder to impose restrictions on himself in the matter of transfer of shares to another
person.” This argument was rejected by M.B. Shah J., who pointed out that the “ratio in the
case of V.B. Rangaraj will apply with much greater force to the case of a public company”.
As we shall see, the contention Justice Shah rejected is remarkably similar to the contention
the Bombay High Court accepted in Messer Holdings.

In 2002, the Supreme Court decided Madhusoodhanan. The case arose out of a complex
family dispute in Kerala, and specifically out of a karar (agreement) that provided in Clause 2
that “there would be no change in the existing share structure” (among the family) of a
private company. Clause 2 also provided that the shares of two members would pass to
Madhusoodhanan in a certain percentage on their death. Ruma Pal J. distinguished Rangaraj
and Kalinga Tubes on the basis that this restriction was not on a share as a class, but on
specific, identified shares between specific, identified members, to which the company need
not be a party. Whether the decision is consistent in its entirety with Rangaraj is a matter of
disagreement, especially as to the clause that there would be no change in the existing share
structure – a provision similar to the requirement in Rangaraj that the shareholding pattern of
the two branches would remain constant. However, it is clear that it is not authority for the
general proposition that a private arrangement is legal under existing Indian law, but at best
for the proposition that a transaction between identified members imposing a restriction on
identified shares is legal.

This brings us to the two High Court decisions. In Bajaj Auto, which we discussed here,
Chandrachud J. noted that the karar in Madhusoodhanan had dealt with specific, identified
shares between identified members, followed Rangaraj, and declared that a right of pre-
emption is contrary to s. 111A. That has now been overruled in Messer Holdings. In Messer,
Khanwilkar J. makes three points – first, that the legislative history of s. 111A shows that the
intention of the legislature was to fetter the actions of the Board of Directors, not individual
shareholders; secondly, that Madhusoodhanan is authority for the general proposition that
“consensual arrangements between particular shareholders relating to their specific shares do
not impose restriction on the transferability of shares”; and thirdly, that “freely transferable”
in s. 111A only means that “both seller and purchaser must agree to the terms of the sale”. It
was further held that this need not be embodied in the articles of association. It is submitted
that the first point may well be correct, but cannot in itself displace the plain language of the
provision. The second and the third points are considered below in the summary.

One last point remains on Messer Holdings. In paragraph 55, Khanwilkar J. held as follows:
…“freely transferable” in Section 111A does not mean that the shareholder cannot enter into
consensual arrangement/agreement with the third party (proposed transferee) in relation to his
specific shares If the company wants to even prohibit that right of the shareholders, may have
to provide for an express condition in the Articles of Association or in the Act and Rules, as
the case may be, in that behalf [emphasis mine].

The rule in Rangaraj was that a restriction on the transfer of shares is “unenforceable unless
contained” in the Articles of Association. If Messer Holdings is good law, the rule is that a
restriction on the transfer of shares is “enforceable unless barred” by the Articles.

The present position of law

The present position of law may be summarised in the following propositions - the case that
stands for the proposition is in bold:

Shares of a company are “freely transferable” both as matter of common law and under the
Indian Companies Act (s. 82) and a restriction is “unenforceable unless contained” in the
Articles – VB Rangaraj

“Freely transferable” refers not to the act of sale, but to the subject of the sale (the shares
themselves) – VB Rangaraj

The above principle applies with even greater force to a public company, and is reflected in s.
111A(2), inserted after Rangaraj – Mafatlal Industries

Rules (1) and (2) do not apply when – Madhusoodhanan

The “restriction” is on identified shares – meaning that further shares acquired by the same
person in the same class may not be subject to the restriction; and

Those shares are held by identified members;

A general right of pre-emption in relation to the shares of a public company is contrary to s.

111A – Bajaj Auto

Madhusoodhanan stands for the general proposition that private arrangements are legal, and
“freely transferable” refers to the freedom of the buyer and the seller – Messer Holdings

A private arrangement imposing a restriction is enforceable unless barred by the Articles –

Messer Holdings
It is submitted, with respect, that Messer Holdings is incorrect, for it is contrary to VB
Rangaraj and since Madhusoodhanan is not authority for the general proposition it relies on.
Further, the meaning of “freely transferable” has been settled by Rangaraj to refer to the
subject of sale.

The correct position of law

It is easy to appreciate the adverse commercial consequences of the rule in Rangaraj. It means
that a pre-emption right, ubiquitous in the world of joint ventures, is illegal and
unenforceable. Messer Holdings, by reformulating the Rangaraj rule, averts this consequence.

However, the better answer lies perhaps in the Supreme Court adopting the rule of English
law that while a restriction does not bind the company, it binds the shareholders. This, for
example, permits a shareholder to obtain an injunction against his fellow shareholders
preventing transfer. Until that happens, Rangaraj continues to be the law of the land, and it is
submitted, with respect, that Messer Holdings is inconsistent with it as a matter of law,
although the result it produces is no doubt commercially desirable. Much of this controversy,
in the ultimate analysis, is perhaps a result of the thin line between Rangaraj and
Madhusoodhanan, and a clarification by the Supreme Court on the relationship between these
judgments, perhaps in the process modifying the Rangaraj rule, will be welcome