Amity University, Lucknow campus.

Modern Company Law

Under the guidance

of
Dr. Jyoti Yadav, Professor

Submitted by:
Srijan Sinha
Enrolment No: A8101821017
LLM 2021-22

Right of first refusal: A contractual restriction on

transfer of shares
 ACKNOWLEDGEMENT

I am highly pleased to work on the assignment under my faculty of Modern

Company Law, Dr. Jyoti Yadav. I am very grateful to her for her moral guidance. I
want to enlighten my readers regarding this topic, and I hope I have tried my best to
pave the way for bringing more luminosity to this topic.

I also want to thank all of my friends, without whose cooperation this project was
not possible. Apart from all these, I want to give special thanks to the e-library of
my university who made every relevant material regarding my topic available to me
during my busy research work and assisted me.

Much Obelized,

Srijan Sinha.
Introduction
Among various provisions of incorporating documents such as shareholder’s agreement in a
corporation, an item will often appear labeled “ROFR” / “Right of First Refusal.” ROFR is a
contractual right that obliges the selling shareholder not to sell its shares in the company to a third
party without offering his shares to another party (usually the other existing shareholders). Suppose
the existing shareholder(s) does not accept the offer. In that case, the selling shareholder is free to
sell his stake to a third party, provided the sale is not on more favorable terms than those
offered to the existing shareholders. Meaning thereby, the ROFR requires the property owner to
provide the same to the right holder, on the same terms as those provided by the third party, before
the owner can sell the property to that third party. By adopting this provision, the corporation’s
shareholders promise that they only will sell their shares after negotiating a price with a third party
and offering the shares at that price to their fellow shareholders.

Right of First Refusal in a shareholder’s agreement provides the grantee with a contingent option
to purchase an asset if the grantor elects to sell the shares1. Before considering the legal position
about the aforesaid issue, it would be worthwhile to have a brief insight into some of the focal
concepts about the provisions incorporated in agreements such as ‘Joint Venture Agreements’ or
‘Shareholders Agreement.’

These agreements signed amongst the shareholders may include some provisions, which broadly
include the following:

i. The Right of first refusal;

ii. Drag-Along Right; and A right that enables a majority shareholder to force a minority
shareholder to join in the sale of a company. The majority owner doing the dragging must
give the minority shareholder the same price, terms, and conditions as any other seller.
iii. Tag-Along Right. If a majority shareholder sells their stake, then the minority shareholder
has the right to join the transaction and sell their minority stake in the company.

Among various provisions of incorporating documents such as shareholder’s agreement in a

corporation, an item will often appear labeled “ROFR” / “Right of First Refusal.” ROFR is a

1
David I. Walker, Rethinking the Right of First Refusal, 5th Stanford Journal of Law, 1999, Discussion Paper No. 261,
The Harvard Law School.
contractual right that obliges the selling shareholder not to sell its shares in the company to a third
party without offering his shares to another party (usually the other existing shareholders). Suppose
the existing shareholder(s) does not accept the offer. In that case, the selling shareholder is free to
sell his stake to a third party, provided the sale is not on more favourable terms than those
offered to the existing shareholders. Meaning thereby, the ROFR requires the property owner to
provide the same to the right holder, on the same terms as those offered by the third party, before
the owner can sell the property to that third party. By adopting this provision, the corporation’s
shareholders promise that they only will sell their shares after negotiating a price with a third party
and offering the shares at that price to their fellow shareholders.

Right of First Refusal in a shareholder’s agreement provides the grantee with a contingent option
to purchase an asset if the grantor elects to sell the shares2. Before taking into account the legal
position with regard to the aforesaid issue, it would be worthwhile to have a brief insight into some
of the focal concepts pertaining to the provisions incorporated in agreements such as ‘Joint Venture
Agreements’ or ‘Shareholders Agreement’.

These agreements signed amongst the shareholders may include some provisions, which broadly
include the following:

i. The Right of first refusal;

ii. Drag-Along Right; and A right that enables a majority shareholder to force a minority
shareholder to join in the sale of a company. The majority owner doing the dragging must
give the minority shareholder the same price, terms, and conditions as any other seller.
iii. Tag-Along Right. If a majority shareholder sells his or her stake, then the minority
shareholder has the right to join the transaction and sell his or her minority stake in the
company.
iv. a screenplay would give the holder the right, assumingly, to make that movie first. Only if
the holder turns it down may the owner, then shop it around to other parties.
v. Taking the above into consideration, it may be noted that the aforementioned right is
framed so as to enforce the interests of the investors and the promoters/ current

2
David I. Walker, Rethinking the Right of First Refusal, 5th Stanford Journal of Law, 1999, Discussion Paper No. 261,
The Harvard Law School.
 shareholders in a particular venture. Considering the same, it would be a futile exercise if
the enforceability of the said right is not known to the parties to such agreements.

Pre-Emptive Right
vi. As compared to ROFR, there is an almost similar right which is known as a pre-emptive
right. It may not be an easy proposition to differentiate between the ROFR and the pre-
emptive rights, as the two seem to be similar, if not identical. Contrary to a right of first
refusal, a pre-emptive right appears to be similar to a right of the first offer. A Right of
first offer is a close cousin to the right of the first refusal. Under the right of the first
offer, before an owner can sell property subject to a right of the first offer, the right
holder must be given the chance to make an offer for the property. The owner can
then either accept the offer, or the owner can sell the property to a third party, but
only at a price above the one offered by the right holder. For this right to be effective
and enforceable, in the case of private company, the same may be inserted in the Articles
of Association of the Company. As per the said right, the right to transfer shares to non-
members is restricted. Further, it is worthwhile to note that a private agreement between
two or more shareholders in which they impose restrictions upon each other as to their right
of transfer does not bind the company and, consequently, the same is likely to be a subject
matter of a civil suit between the parties to the agreement and the party committing breach
may have to answer in terms of damages to the other. To bind the company, the agreement
has to include the company as one of the parties, and it has to be a subject matter in the
Articles of Association.3
vii. The discussion on this subject began in the year 1992 when the Supreme Court in the case
of V.B.Rangaraj v. V.B.Gopalakrishnan4 held that in case of a private limited company
transfer restrictions, if any, agreed by the shareholders unless embodied into the articles of
association would not be valid and binding. On the other hand, the Delhi High Court and
the Company Law Board held that in the case of listed shares, there cannot be any
restrictions namely rights of first refusal or any such rights. This was because Section 111A

3
Supra note 1
4
V B Rangaraj v. V B Gopalakrishnan, [1991] 6 CLA 211
 (2)5 of the Companies Act 1956, provides that the shares and debentures and any interest
therein of a company shall be freely transferable. Justice Chandrachud of the Bombay High
Court also took the same view in 2010 in the case of Western Maharashtra Development
Corporation v. Bajaj Auto Ltd6 and observed that “the principle of free transferability must
be given a broad dimension in order to fulfil the object of the law. Imposing restrictions on
the principle of free transferability is a legislative function, simply because the postulate of
free transferability was enunciated as a matter of legislative policy when Parliament
introduced Section 111A into the Companies Act, 1956. That is a binding precept which
governs the discourse on transferability of shares. The word “transferable” is of the widest
possible import and Parliament by using the expression “freely transferable”, has
reinforced the legislative intent of allowing transfers of shares of public companies in a
free and efficient domain. The effect of a clause of pre-emption is to impose a restriction
on the free transferability of the shares by subjecting the norms of transferability laid down
in Section 111A to a pre-emptive right created by the agreement between the parties. This
is impermissible.”
viii. This interpretation was causing a lot of hardship on the PE investors / Strategic Partners in
negotiating the right of first refusal or tag / drag rights with the Promoters, which are
typically exit options negotiated to protect their commercial interest. Question therefore
was whether in a listed company one can validly offer right of first refusal or tag/drag-
along rights that would ultimately be legally enforceable?
ix. The aforesaid decisions came up for consideration before the Division bench of the
Bombay High Court in case of Messer Holdings Limited v. Shyam Madanmohan Ruia
and Ors7. The judgment is interesting as it comes in the wake of the Bombay High Court
judgment in Bajaj Auto case8; it changed the way to negotiate restrictions on transfer of
shares in a public company. That judgment had ruled that any pre-emptive rights over
shares in public limited companies were illegal in view of the principle of "free
transferability” enshrined in Section 111A of the Companies Act, 1956. The debate on

5
Section 111A (2) of Companies Act, 1956: Subject to the provisions of this section, the shares or debentures and any
interest therein of a company shall be freely transferable.
6
(2010) 154 CompCas 593 (BOM)
7
Messer Holdings Ltd. v. Shyam Madanmohan Ruia, [2010] 98 CLA 325
8
Western Maharashtra Development Corporation v. Bajaj Auto Ltd., (2010) 154 CompCas 593 (BOM)
 enforceability of terms of shareholder agreements governing public limited companies is
definitely not over yet.
x. The Court with respect rejected the earlier interpretation given to the words “free
transferable” used in section 111A by the single Judge in the Bajaj Auto case9. The Division
bench for the first time examined the true intent of section 111A, the reason for its insertion
in the Companies Act, 1956 and observed that earlier when the shares were in physical
form, board of directors used arbitrary powers to reject transfer of shares leading to lot of
complaints by the transferees. That situation was partially remedied by the insertion of
section 22A of the Securities Contract Regulation Act, which laid down only four grounds
on which any board could reject transfers. With the introduction of the concept of
dematerialized shares through the Depositories Act, 1996, section 22A got deleted, and
section 111A was introduced in the Companies Act to deal with rectification of register.
The Court observed that the whole purpose of section 111A is to regulate the right of
the board of directors to refuse transfer of shares. Under Section 111-A, the Company
Law Board has been empowered to direct any depository or company to rectify its register
or records on an application made to it by a depository, company, participant or investor
or SEBI.10

a. Judgments in favour of ROFRs

i. Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd.

Gujarat High Court has held in favour of ROFRs. The decision of Gujarat High Court in the case
of Mafatlal Industries in 1997 is an important precedent relating to subject matter. This was the
case relevant to a public limited company. In this case a shareholder disposes the 3.87%
shareholding in the open market in violation of the agreed terms. Very interestingly and according
to the author, rightly argued that "free transferability" refers to the absence of restriction which
may be imposed by the 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 the then Judge Mr. Shah, who pointed out that the ratio laid down in the case of V B

9
Ibid.
10
A Ramaiya, Guide to the Companies Act, 17th edn., 2010, Part 1, Lexis Nexis Butterworths, Wadhwa, Nagpur
Rangarajan by the Apex Court is having much greater force and can be applied to public company
also. This decision had changed the whole scenario for public company.11

ii. Messer Holdings Limited v. Shyam Madanmohan Ruia

Bombay High Court has also accepted the legality of ROFRs in 2010. This case upheld the validity
of such pre-emptive rights including ROFR and opined that such rights do not violate the
provisions of Section 111-A. It also observed that a shareholder has freedom to transfer his shares
on terms defined by him, including ROFR, and subject to compliance with existing laws, such
arrangements do not restrict free transferability of shares. It was also held by the Hon'ble Court
that pre-emptive rights arise out of a private contract between shareholders with a third party and
these need not be embodied in the articles of association of the company since the company is not
a party to such arrangements.12

b. Judgments not in favour of ROFRs

i. Pushpa Katoch v. Manu Maharani Hotels Limited

Delhi High Court has held that there could not be any fetters on the right of a shareholder to transfer
his/her shares in a public company. It was specifically held that pre-emptive rights are
unenforceable even if incorporated in the articles of association, since such rights would be ultra
vires to Section 111-A.13

ii. Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd

Bombay High Court relied on Pushpa Katoch and held ROFRs to be patently illegal. It held that
pre-emptive rights go against the spirit of Section 111-A, and therefore are not legally tenable.
Single Judge of the Bombay High Court held that the principle of free transferability must be given
a broad dimension in order to fulfil the object of the law. The word “transferable” is of the widest
possible import and Parliament by using the expression “freely transferable”, has reinforced the
legislative intent of allowing transfers of shares of public companies in a free and efficient domain.
The Court further held that the Agreement and provision in Articles of Association restricting the

11
Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd., 1999 (97) CompCas 301 Guj
12
Supra note 7
13
Pushpa Katoch v. Manu Maharani Hotels Limited, 2006 (131) CompCas 42 Del
transfer shares is violative of section 111A read with section 9 of the Companies Act and therefore
it is void and accordingly the award is contrary to substantive provisions of law and is patently
illegal.14

Supreme Courts view

a) V.B. Rangaraj v. V.B. Gopalakrishnan15

In this case, shareholders of a private limited company were two branches of the family and it was
agreed orally in 1951, it means in backdrop of Independence and partition, that the proportion of
the shareholding of respective branches would not change, and further agreed that for this purpose,
any member of a branch want to sell his shares must first offer the share to his own branch. The
crux in this case is the oral agreement about restriction was not incorporated in Articles. Referring
to its own earlier relevant decision in Kalinga Tubes, the Supreme Court held that the shares are
"freely transferable" and that a private agreement imposing restriction on transfer of shares which
is not stipulated in Articles of association is neither binding to the Company nor to shareholders.
It means such kind of agreement is void in toto. One thing very clearly established in this case is
any restriction on share transfer must be incorporated in the Articles of the Company; otherwise it
will not have any effect, and aggrieved shareholders can not have any legal remedy against
violation of such restrictive provisions of agreement or understanding.

The Supreme Court held that a restriction on the transfer of shares contrary to the articles of
association of a private company was not binding on the private company or its shareholders.
Although this judgment was in relation to a private company, its reasoning has also been applied
to public companies. Therefore, if restrictions on the transfer of shares are to be enforceable,
provisions in the articles of association of a company are needed. The Court had taken the view
that provisions of the SHA imposing restrictions even when consistent with company law are to
be authorized only when they are incorporated in the articles of association.

14
Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd, (2010) 154 Comp Cas 593 (BOM)
15
AIR 1992 SC 453
(b) Vodafone International Holdings B.V. v. Union of India and another16

The Court has taken a view that freedom of contract can be restricted by law only in cases where
it is for some good of the community. The Companies Act, 1956, or the other legislations do not
explicitly or impliedly forbid shareholders of a company to enter into agreements as to how they
should exercise voting rights attached to their shares.

In this case, the Supreme Court did not subscribe with the view taken in the Rangaraj case (as
stated above) and stated that SHA is a private contract between the shareholders compared to the
articles of association of the company, which is a public document. SHA is essentially a contract
between some or all other shareholders in a company, the purpose of which is to confer rights and
impose obligations over and above those provided by the company law.

Further, the Court stated that the provisions of the SHA incorporating ROFRs need not necessarily
be authorized by the articles of association of the concerned company. Accordingly, the Court has
implied that in the event the articles of association of a company are silent with regards to the
provision of ROFR's, they can be legally enforceable, subject to the same being incorporated in
the SHA.

Recently on the October 3, 2013 a Notification17 was issued by SEBI (Securities Exchange Board
of India), which said that Right of First Refusal was legally allowed and valid in the Shareholders
Agreement. It also allowed tag along and drag-along rights. Through this, SEBI has rescinded its
previous notification of March 1, 2000 that prohibited contracts other than spot delivery contracts
or those entered into through the stock exchange mechanism. Accordingly, SEBI now permits
various types of pre-emption rights and put and call options, but subject to certain conditions. The
new position is as follows:

1. Spot delivery contracts are permitted, consistent with the previous position;

2. Sale and purchase contracts on securities are permitted so long as they are in accordance with
securities regulations and stock exchange regulations and by-laws. These would include
transactions, including in derivatives, which are carried out through the stock exchange.

16
2012 (1) UJ 334
17
The Gazette of India Extraordinary, Part III, SEBI Notification (Mumbai), 3rd October, 2013
3. Contracts for pre-emption including right of first refusal (ROFR) or tag-along or drag-along
rights contained in shareholders agreements or articles of association are allowed. Note that this is
only an inclusive provision and is not exhaustive of all the types of provisions in the agreements
or articles that can be enforced. This enables investors to exercise their exit rights in companies
through the above mechanisms that are generally recognized. No conditions are attached for the
exercise of these rights.

4. Put and call options contained in shareholders agreements or articles of association are treated
somewhat differently from pre-emption rights discussed in item 3 above. The reason is that the
exercise of options is subject to certain conditions:

a) The underlying securities that are the subject matter of the options must have been held by
the relevant party for a minimum period of 1 year from the date of entering into the option
contract. This seems to be to ensure that options are not short-term in nature and are
permitted only when the holding of the securities is for a considerable period of time. The
genesis for the erstwhile prohibition on options was to prevent speculation insecurities, and
this approach is imposing a minimum 1-year term on the options is consistent with that
philosophy.
b) The pricing of the options and the exercise is to comply with applicable laws. More
specifically, the notification states that all contracts permitted through it must comply with
the provisions of the Foreign Exchange Management Act, 1999. This applies when options
and pre-emption rights are granted by or in favour of a non-resident investor. Where the
exercise of the option or pre-emption results in a transfer of securities between a resident
and a non-resident investor, then the idea is that the relevant pricing norms imposed by the
Reserve Bank of India (RBI) must be complied with. This is significant for foreign
investors to take into account. Merely because SEBI has now conditionally permitted
options, it does not mean that parties have complete freedom in exercising the options. The
pricing is still regulated by the relevant RBI norms, and hence the commercial
understanding between the parties regarding the exercise price will be subject to these
regulatory constraints.
c) The new permissible regime applies only to physically-settled options where there is an
actual delivery of the underlying securities. It does not cover cash-settled options, which
 are essentially contracts for differences. This is understandable given the philosophy of the
legal regime to curb speculation. Moreover, investment agreements (where investors seek
exit rights) usually relate to an actual sale or purchase of securities rather than a contract
for differences, and hence this should not pose difficulties for customary investment
transactions.
5. This new permissible legal regime applies only prospectively and does not "affect or validate
any contract which has been entered into" prior to the date of the notification. Hence, past
contracts with pre-emption rights or put and call options will not be "grandfathered". One
possibility to overcome this restriction would be for parties to existing contracts to re-execute
them as of a future date.
6. Finally, an explanation to the notification states that the contracts specified in the notification
would be valid without regard to anything contained in section 18A18 of the Securities
Contracts (Regulation) Act, 1956, which refers to exchange-traded contracts. In other words,
such pre-emption rights and option contracts would be permissible even though they are
entered into on an over-the-counter (OTC) basis and not traded on the stock exchange.
7. Overall, SEBI’s notification represents a momentous regulatory change. Companies,
investors and their advisors have been grappling with concerns regarding the enforceability
of pre-emption rights and options for nearly two decades now. The oddity of the situation
was the expansive application of SEBI’s previous regime that applied not only to listed
companies but also to unlisted public companies. Moreover, while speculation was the
concern, it seemed to encompass genuine transactions as well, making customary investment
transactions inefficient in terms of structuring (particularly of exit options).
8. The current move is welcome as it rectifies a previously ambivalent and restrictive legal
regime. This will augur well to investors as well as companies requiring capital. There may
very well be issues regarding the specifics of the recent notification and the conditions
imposed therein, but the overall development is positive in nature.19

18
Section 18A: Notwithstanding anything contained in any other law for the time being in force, contracts in derivative
shall be legal and valid if such contracts are- (a) traded on a recognised stock exchange; (b) settled on the clearinghouse
of the recognised stock exchange, in accordance with the rules and bye-laws of such stock exchange.
19
Supra note 17
Provision under the Companies Act, 1956
9. One of the most controversial questions raised and still being ambivalent is:
10. Whether ROFR agreements, Tag along and Drag along rights are enforceable under law and
in compliance with section 111A of the Companies Act, 1956?
11. It is pertinent to highlight that this point is no longer Res Integra (untouched), but is covered
by the decision of the Supreme Court in the celebrated case of V.B.Rangaraj v.
V.B.Gopalakrishnan20. In the said case, the Apex Court has held that a restriction which is
not specified in the Articles of Association is not binding either on the Company or on the
shareholders. The court further held that the arrangement (as in the said case) imposed
additional restrictions on the member’s right of transfer of his shares which were not
stipulated in the articles and, therefore, were not binding either on the shareholders or on the
company. It was also held that the shares are movable property and transfer thereof is
regulated by the articles of association of the Company. The Court held that even if the
Articles of Association provide for a ROFR, if the right is a restriction on the free
transferability of shares and not a mere process, then it is not likely to be enforceable.
12. Later the Judicial viewpoint decided in 2010 in the case of Messer Holdings Limited v.
Shyam Madanmohan Ruia and Ors.21, A Division Bench of the Bombay High Court had
ruled in this case that a private arrangement between shareholders of a public limited
company on a voluntary basis relating to share transfer restrictions (right of first refusal) is
not violative of Section 111A of the Companies Act, 1956. The judgment also goes on to
suggest that it is not mandatory for the Company to be a party to such an agreement relating
to share transfer restrictions and it is not necessary to incorporate share transfer restrictions
in the articles of association of the Company.
13. Shareholders can enter into a consensual agreement in case of shares of public companies,
can also freely negotiate and enter into agreement containing the ROFR or what is commonly
known as Pre-emption/ Tag Along/ Drag Along rights even in the case of listed shares, which
was recently confirmed by the Division bench of A.M. Khanwilkar and A.A. Sayed, JJ. of

20
Supra note 4
21
Supra note 7
 the Bombay High Courts. These Share Purchase Agreement (SPA) are usually assent between
the Promoters, PE Investors, Technical or Financial Collaborators.
14. The decision in the case of Messer Holding provided some relief to shareholders of a public
company; however not resolve issues and concerns of corporates and joint venture parties.
But some questions have yet to find their stands. Without a company is a party to the
agreement between the shareholders, its terms cannot be inserted into Articles and even in
case it is incorporated in the Articles, the validity of restriction on share transfer in a public
company would not be sustained and upheld looking the decisions delivered so far. In such
circumstances, since shareholders agreement is not biding to a Company, a shareholder
cannot restrict the company from transferring shares which is in violation of the agreement.
Unless and until the role of the company and such restrictions validly find the place in
Articles, Company Law Board would not have jurisdiction for civil breach. Therefore remedy
available for aggrieved shareholders is to approach the civil court, which is costly and lengthy
and many times parties reluctant to prefer it in the joint venture business22. An in-depth
analysis of the aforementioned case is required as it is the most recent decision on the point
in issue.

Messer Holdings Limited v. Shyam Madanmohan Ruia and Ors.

The facts, in brief, Bombay Oxygen Ltd is defendant no. 2 company was listed on BSE. Messer
holding was the major shareholder of the Company. It entered into an agreement dated June 23,
1997, where the German company was to acquire shares and management of the company and
provide some technology to the company. It was the condition in the agreement that either party
wants to sell its share then offer it first to the other party except in some situations as provided in
the agreement. In this case, the arguments were (a) the agreement was void because of fraud and
misrepresentation (b) the agreement was void because it was in violation of SEBI rules and
regulation, and (c) the agreement was void as it restrict free transferability in term of section 111A
of the Companies Act and recent decision of Bombay High Court in the case of Bajaj Auto.

22
Satyajit Gupta, A twist in the tale: Share transfer restrictions in a public limited company legal?, Available at:
http://indiacorplaw.blogspot.in/2010/09/twist-in-tale-share-transfer.html
Clause 6.1 of the SPA dated June 23, 1997 between the parties conferred a right of first refusal on
the Ruias in respect of the shares of Bombay Oxygen Ltd., unless the shares were to be sold to a
member of the Hoechst group of companies.

The controlling shareholders of Bombay Oxygen Ltd, a public listed company agreed to divest a
majority of their shareholding to Messer Griesheim Gmbh (MGG) pursuant to which the
controlling shareholders agreed to divest a majority of their shareholding in the Company to MGG.
As per Clause 6.1, in the event either party intended to sell the entire or any part of the shares
in the Company, the transferring party was required to first offer the shares being
transferred to the other party. Although this case dealt with various other issues, we analyze the
issue pertaining to the legality of Clause 6.1 of the SPA and whether the same is violative of free
transferability of shares in a public company provided by Section 111 A of the Act. MGG relied
on inter-alia the decision of the Single Bench in Bajaj Auto Ltd.23 where this Court held that pre-
emptive rights on shares of a public company are contrary to the provisions of Section 111A of
the Act, which requires that the shares of a public company should be freely transferable.

The Division Bench, however, overruling the aforesaid judgment, held that such private
arrangements are not in violation of Section 111A of the Act in a pubic company in reliance of the
following:

Section 111A of the Companies Act, 1956, is perhaps the most significant unresolved controversy
in contemporary Indian Corporate Law. Section 111A of the Companies writes that “Subject to
the provisions of this section, the shares or debentures and any interest therein of a company shall
be freely transferable”. The section speaks about free transferability of the shares and debentures
of the Public Limited Company.

Given the historical background of the deletion of Section 22A of the Securities Contracts
(Regulations) Act, 1956 (SCRA) by the Depositories Act, 1996 and the introduction of Section
111A in the Act, it can be inferred that the provisions of Section 111A was meant to regulate the
powers of the board of directors of a company qua the transfer of shares or debentures of a

23
Supra note 8
company and any interest therein. The board of directors cannot refuse to register a transfer of
shares unless there is sufficient cause to do so.

Section 111A of the Act is not a law dealing with the right of the shareholders and does not
expressly restrict or take away the right of shareholders to enter into consensual
arrangement/agreement by way of pledge, pre-emption/sale or otherwise. The expression freely
transferable in Section 111A of the Act does not mean that the shareholder cannot enter into
consensual arrangements/agreement with the third party (proposed transferee) in relation to his
specific shares.

The concept of free transferability of shares of a public company is not affected in any manner if
the shareholder expresses his willingness to sell the shares held by him to another party with the
right of first purchase (pre-emption) at the prevailing market price at the relevant time. So long as
the member agrees to pay such prevailing market price and abides by other stipulations in the Act,
Rules and Articles of Association, there can be no violation. For the sake of free transferability,
both the seller and purchaser must agree to the terms of sale. Freedom to purchase cannot mean an
obligation on the shareholder to sell his shares.

Reliance was also placed on Section 9 of the Companies Act, 1956 which stipulates that provisions
of the Act shall have the effect notwithstanding anything to the contrary contained in the
Memorandum or Articles of the Association.

The decision in M.S.Madhusoodhanan v. Kerela Kamaudi Pvt. Ltd.24 is an authority on the

proposition that consensual agreements between particular shareholders relating to their
specific shares do not impose restrictions on the transferability of shares. Further, such
consensual agreements between particular shareholders relating to their shares can be enforced
like any other agreements. It was not required to be embodied in the Articles of Association. The
Division Bench also relied on the distinction drawn by the Supreme Court in Madhusoodhanan
case from the proposition laid down in the case of V.B Rangaraj, in that the judgment arrived at
by the Supreme Court was on account of the restriction being a blanket restriction on all the

24
M.S.Madhusoodhanan v. Kerela Kamaudi Pvt. Ltd., (2003) 117 CompCas 19 SC
shareholders present and future and could not be imported to a private agreement between
particular shareholders.

The Defendant too relied on a few judgments, but it was also observed by the Learned Single Judge
that the dictum in the relied decisions were of no avail as the case on hand was in relation to a
public company whereas the decisions in those respective judgments are in concern with the
Private Company under which the transferability of shares is restricted. It is held that in case of
public company, Section 111A provides that the shares or debentures and any interest therein of
the company shall be freely transferable.

As aforesaid, Section 111A is not a law dealing with the right of the shareholders to enter into
consensual arrangement/agreement by way of pledge, pre-emption/sale or otherwise. If that right
is not covered by Section 111A of the Act as has been found by us, then consensual
arrangement/agreement between shareholder and third party or shareholders inter se to which
company is not a party, Section 9 of the Act will not come into play at all. Thus, the expression
“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. The legal provision as obtained in the form of Section 111A of the
Companies Act does not expressly restrict or take away the right of shareholders to enter into
consensual arrangement/agreement in respect of shares held by him.25

25
Somasekhar Sundaresan, “Public Company shares cannot be fettered at all”, Available at:
http://indiacorplaw.blogspot.in/2010/02/public-company-shares-cannot-be.html