The investor community heaved a huge sigh of relief with the
cloud clearing over the legality of restriction on
transferability of shares in a public company. Strategic
investors often insist upon restrictive clauses, commonly known
as Right of First Refusal clause or Pre-emption clause (ROFR
clause) in investment agreements and joint venture
Such provisions are often reproduced into the articles of
association (AOA). Such clauses stipulate that any alienation
of securities by pre-identified shareholders can be done only
after having first made an offer to the other contracting
shareholder and only on such person refusing, can it be
alienated in favour of anyone else.
For various reasons, there has been ambiguity for a long
time about the enforceability of such (and other related)
provisions as regards shares of public companies.
Earlier this year, in Western Maharashtra Development
Corporation v Bajaj Auto, a single judge of Bombay High
Court ruled that such provisions were violative of Section 111A
of the Companies Act, 1956 (Section 111A), which stipulates
that securities of public companies have to be freely
It was held that the expression freely
transferable should be interpreted in the widest sense in
order to fulfil the object of law thereby stating that the
restriction on transferability contained in ROFR clause
violative of Section 111A.
In a subsequent decision in Messer Holdings Limited v
Shyam Madanmohan Ruia, an appellate bench of the Court
(hearing an appeal from the decision of a single judge) upheld
the legality of a similar ROFR Clause.
The Court, delving into the legislative history behind
Section 111A, held that the legislative intention behind
enactment of Section 111A was to prevent the Board of Directors
from refusing to register the shares in the name of the
transferee on their whims and fancies.
It held that the general the expression freely
transferable in Section 111A cannot be construed to mean
that specific shareholders cannot enter into a consensual
agreement with the transferee in relation to their shares held
The Court further held such consensual agreements are
contractually enforceable like any other agreements and that if
the company intends to restrict the shareholders from enforcing
ROFR clause then such condition has to be expressly provided in
the Articles of Association.
Interestingly, the Court in Messer Holdings has explicitly
overruled the Bajaj Auto decision while an appeal in that very
matter is pending before the Court.
The judgment in the Messer Holdings case for the time being
provides clarity at least as regards ROFR Clauses. However, the
debate on Section 111A is far from settled. It is likely that
an appeal against the decision of the two-member bench in
Messer Holdings will be filed before the Supreme Court.
Then there is the 2009 version of the Companies Bill to be
thought of. The Bill is the third attempt in overhauling the
current statute, which is the Companies Act, 1956. The Bill
does not contain the restriction set out in Section 111A and in
fact explicitly allows for insertion of more exacting
requirements in the AOA.
However, the Parliamentary committee to whom this Bill was
referred to has recommended a whole host of changes, two of
which, in some manner, seek to negate this.
By Ankur Kashyap and Bharat Budholia