Free transfer of shares: Approach under 2013 act

Joint ventures, particularly between a foreign party and an Indian party, are ordinarily founded on the understanding that if one party wants to exit, it will offer its share in the joint venture to the other party before selling to a third party. This could be embodied in a lock-in period, right of first offer/refusal, or options of various kinds.

While many foreign parties consider such pre-emption rights as a given, Indian law until recently did not expressly permit such pre-emption rights in the case of public companies, listed or unlisted. The Companies Act, 2013 (2013 act), has brought some respite regarding validity of pre-emption rights in relation to public companies, but certain issues remain.

Background

Section 111A of the Companies Act, 1956 (1956 act), provides that shares of a public company must be freely transferable. Courts have interpreted section 111A in different ways with conflicting outcomes. A Bombay High Court division bench, in Messer Holdings v Shyam Madanmohan Ruia (2010), seems to have settled the position that certain contractual restrictions do not impinge the free transferability requirement, after overruling an earlier decision in Western Maharashtra Development Corporation Ltd v Bajaj Auto Limited (2010). However, a subsequent decision in Jer Rutton Kavasmaneck v Gharda Chemicals Limited (2012) muddled the position by differentiating between restrictions incorporated in articles of association and those not so incorporated. Additionally, some of these decisions have been appealed in the Supreme Court of India.

In summary, while most joint ventures through public companies in India have transfer restrictions, the permissibility of such restrictions still was not free from all doubt.

The 1956 act

If joint ventures through public companies involve such issues, then why aren’t all joint ventures structured as private companies? This is because the 1956 act did not permit a public company to have a private company as a subsidiary, except where the entire share capital of the subsidiary was held by foreign companies.

Section 3(1)(iv)(c) of the 1956 act provides that public company includes a private company which is a subsidiary of a public company. While some registrars of companies permitted the incorporation of such subsidiaries as private companies, the largely accepted position is that all provisions applicable to a public company under the 1956 act would apply to such subsidiaries. Accordingly, if a joint venture partner which is a public company wished to acquire more than 51% of the shareholding in the joint venture company or to appoint a majority of its directors, the joint venture company (being a subsidiary of a public company) must be a public company, either in fact or be deemed so.

The 2013 act

The 2013 act seems to provide a solution to both of the aforementioned issues by: (a) recognizing contractual restrictions regarding transfer of shares as valid and not impinging on free transferability, in the proviso to section 58(2); and (b) omitting a provision similar to section 3(1)(iv)(c) of the 1956 act (discussed above) and clarifying that a private subsidiary of a public company may remain a private company under its articles, but would be deemed to be public company under in section 2(71). Both section 2(71) and section 58(2) came into force on 12 September 2013.

While the proviso to section 58(2) provides validity to “contracts” containing transfer restrictions in the case of public companies, it is silent with respect to incorporation of such restrictions in the articles of association, which may impact the remedy in case of a breach, particularly considering various judicial pronouncements with respect to incorporation of transfer restrictions in articles of association.

Separately, with respect to the ability of a company to retain its private characteristics under its articles, more clarity is required as the proviso to section 2(71) applies to a subsidiary of a “company”, and “company” has been defined as a company incorporated under the 2013 act but does not include a company incorporated outside India. While the definition of subsidiary considers corporate bodies outside India, it is not expressly clear if an Indian subsidiary of a foreign public company would also be able to retain its private characteristics under its articles.

Conclusion

The 2013 act is an improvement over the 1956 act in many ways. With respect to joint ventures in India, the change from an ambiguity regarding restrictions on transferability to an express recognition of contractual arrangements regarding transferability reflects the sensitivity of government and parliament to business realities. The changes will avoid a lot of ambiguities and provide much needed certainty in the Indian business environment with respect to transferability of shares.

Amit Kumar is a partner and Ambarish is a senior associate at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.