Analysing restrictions on the transfer of shares

The issue of restriction on the transfer of shares of a company incorporated under the Companies Act, 1956, has been an area of concern for some time. While the law is fortified under the act, which has specific provisions dealing with the transfer of shares, there have been several judicial pronouncements arising out of disputes between various persons in this regard.

Section 82 of the act provides that shares of a company incorporated under the act will be movable property, transferable in the manner set out in the company’s articles of association. Thus, a restriction on transferability not contained in the articles of a company would not be enforceable in law.

The case of VB Rangaraj v VB Gopalakrishnan involved a family consisting of two brothers, who held 25 shares each in a company. In accordance with an oral agreement (and not incorporated into the articles of association of the company) between the brothers, each of the family’s branches would always hold an equal number of shares. The agreement stated that if any member in either branch wished to sell their shares, he would give the first option of purchase to the members of his respective branch and only if the offer was rejected, would the shares be sold to others.

Contrary to the agreement, the defendant sold the shares to the other branch without first offering the shares to his own branch. The Supreme Court, relying on Shanti Prasad Jain v Kalinga Tubes, held that the articles of association are the regulations of the company, binding on the company and its shareholders, and regulating the transferability of shares of a company, which are a movable property. It further held that the only restriction on the transfer of shares of a company would be those laid down in its articles and any restriction not specified in the articles is, therefore, not binding on the company or its shareholders.

Pursuant to the decision of the Supreme Court in Rangaraj’s case, in the wake of the Depositories Act, 1996, the Companies Act was amended to incorporate section 111A providing for the free transferability of shares of a public company, subject only to the provisions of that particular section.

The principle of law enunciated in Rangaraj’s case was followed by Gujarat High Court in Mafatlal Industries Limited v Gujarat Gas Company Limited, Madras High Court in the case of Crompton Greaves v Sky Cell Communication Limited and Bombay High Court in the case of IL & FS Trust Co Ltd v Birla Perucchini Ltd. In the last case, Bombay High Court went as far to say that since Rangaraj’s case relied on Kalinga Tubes, the principle laid down by the Supreme Court in Rangaraj’s case is not confined to a situation involving only a transfer of shares.

Delhi High Court, in Pushpa Katoch v Manu Maharani Hotels Limited, has gone a step further and said that in the case of a public company, a restriction on transfer of shares irrespective of the fact that it is incorporated in the articles of association would be void and unenforceable.

The issue of transferability of shares arose once again for consideration before the Supreme Court in MS Madhusoodhanan v Kerala Kaumudi Pvt Ltd. The Kerala Kaumudi case involved a dispute between four brothers of a family who held shares in a private limited company promoted by their parents. At the root of the dispute lay an agreement dated 16 January 1986 (the Karar) executed by the four brothers and their mother. The Karar provided that after the death of the mother, the shares in the company would be transferred to divide the effective control of the various family concerns among the four brothers.

The Karar provided that Madhu-soodhanan would be entitled to 50% of the total shares of the company including the shares owned by one of the brothers and the remaining two brothers were to receive 25% each. On the death of the mother, Madhusoodhan an filed a suit for specific performance of the Karar and transfer of shares in accordance with the terms of the Karar.

When the case came up in appeal to the Supreme Court, the respondent sought to argue, on the basis of Rangaraj’s case that since the terms of the Karar were not included in the articles of association of the company, it would be unenforceable. Rejecting the argument, the court, after discussing the decision in Rangaraj’s case, held that the decision does not in any way state that the transfer of shares agreed to between shareholders did not bind them or cannot be enforced like any other agreement.

The Supreme Court reinforced the law laid down in Rangaraj’s case and so has only made a distinction between an agreement to transfer shares between particular shareholders (as in the Kerala Kaumudi case) on the one hand, and on the other, an agreement imposing blanket restrictions on the ability to transfer shares on all the shareholders, present and future, contrary to the company’s articles of association, as in Rangaraj’s case.

The applicability of the decision in Kerala Kaumudi case must thus be restricted to agreements for transfer of shares between parties and does not extend to agreements imposing restrictions on the transferability of shares, which continues to be subject to the law laid down in Rangaraj’s case and the provisions of the Companies Act.

Harry Chawla is a partner and Chandrasekhar Tampi is a Principal Associate at Amarchand & Mangaldas & Suresh A Shroff & Co.