Western Maharashtra Development Corpn. Ltd. Vs Bajaj Auto Limited [MANU/MH/0109/ 2010]
In a decision, which is likely to have a wide impact on joint ventures/investment in public companies, the Bombay High Court (“Court”) has recently held that any clause in an agreement which restricts the free transfer ability of shares of public companies is void and non- enforceable, even if such restrictive clause is incorporated in the Articles of Association of the company.
Western Maharashtra Development Corporation (“Petitioner”) entered into a Protocol Agreement (“Agreement”) with Bajaj Auto Limited (“Respondent”) pursuant to which Maharashtra Scooters Ltd. (“MSL”) was incorporated as a public limited company as per the provisions of the Companies Act, 1956 (“Act”). The Petitioner and the Respondent held 27% and 24% of the shareholding of MSL respectively.
In order to ensure that the parties controlled at least 51% of the equity share capital of MSL, the Agreement contained a Clause (“Clause 7”) whereby the Petitioner and Respondent were restricted from transferring their shares to any other person without first offering the same to the other party at such rate as may be agreed to between the parties or decided upon by arbitration.
In the year 2003, the Petitioner offered to sell its shares to the Respondent at a price of Rs. 232.20 per share. The Respondent confirmed its interest in buying the shares but was not convinced with the price offered by the Petitioner and thus made a counter offer to the Petitioner to buy the shares at a price of Rs. 75 per share. Since this price was not acceptable to the Petitioner, the matter was referred to Arbitration in terms of Clause 7 of the Agreement by a joint reference made by both the parties.
Thereafter, during the pendency of the reference, the Petitioner made an application questioning the jurisdiction of the Arbitrator on the ground that :
a) the Agreement was illegal and void since
b) the joint reference made by the parties was void since it was made on the premise that it was a concluded contract.
The Arbitrator rejected this application made by the Petitioner and passed an award with a determination on the offer price to be paid by the Respondent for the purchase of shares of the Petitioner.
Aggrieved with this award passed by the Arbitrator, the Petitioner made an application seeking setting aside of the award under section 34 of the Arbitration and Conciliation Act, 1996 to the Court. The grounds of challenge included, inter alia, – the Agreement in so far as it restricted transfer of shares, was illegal in view of Section 111A of the Act, and hence was void.
The primary issue of law before the Court was whether an Agreement which imposes restrictions on the transfer of shares of a public company is void?
The Petitioner contented that since MSL is a public company, its shares are freely transferable and the Articles of Association must yield to the principle of free transfer ability as embodied in Section 111A of the Act. The Petitioner further contended that the Agreement is illegal and any determination under the Agreement is void, since Clause 7 of the Agreement creates a right of pre-emption in MSL i.e. restricts the free transfer ability of shares of a listed company. Any such clause even though incorporated in the Articles would be inoperative in terms of Section 111A read with Section 9 of the Act.
In its response, the Respondent contented that restrictions placed by Clause 7 on transfer of shares of MSL are not invalid since the restriction is not one that binds all shareholders, but which binds two shareholders in a specified contingency. For this purpose, the Respondent referred to the decision of the Supreme Court in the case of Madhusoodhanan Vs Kerala Kaumudi Pvt. Ltd. 2003 117 Comp Cas 19 wherein it was held that the Act does not prohibit agreement entered into between specific shareholders regarding specific shares, particularly when incorporated in the Articles of Association.
Decision of the High Court
The Court analysed the relevant provisions of the Act and after considering the legal position and the rival contentions, set aside the award of the Arbitrator.
Before determining the validity of Clause 7 of the Agreement, the Court went through the distinction provided by the Act with regards to public companies and private companies. By definition, a private company is a company which restricts the right to transfer its shares. In the case of a public company, however Section 111A of the Act provides that the shares or debentures and any interest therein of a company shall be freely transferable. The law of free transfer ability of shares in a public company is founded on the principle that members of the public must have the freedom to purchase and every shareholder must have the freedom to transfer.
The Court referred to the judgement of the Supreme Court in the case V.B Rangaraj Vs Gopalkrishnan (1992) 73 Comp Cas 201 wherein it was held that provisions contained in a shareholders agreement which imposed a restriction on the shareholder’s right to transfer the shares being contrary to the Articles of Association is not enforceable. The Court held that the judgement delivered by the Supreme Court in the Rangraj’s Case could not be relied upon since it dealt with a private company, while the issue in question in the instant case was with regard to transfer ability of shares of a public company.
The Court also referred to the judgement of the Supreme Court in Madhusoodhanan’s case, relied upon by the Respondent, and held that this case too could not be relied upon since it dealt with private companies and the position in law for public companies is materially different from that of private companies.
The Court observed that in the instant case, Clause 7 of the Agreement creates a right of pre-emption between the Petitioner and the Respondent. The effect of such a clause is that it mandates either party desirous of transferring its shares to give an option to the other party to purchase the shares at such rate as may be agreed to between the parties or decided upon by arbitration. The Court held that this clause though incorporated in the Articles of Association is against the fundamental principle of free transfer ability of shares laid down in the Act. The Court reasoned that, notwithstanding the inclusion of such a clause in the Articles, such a provision is void to the extent to which it is repugnant to the provisions of the Act as per Section 9 of the Act.
For this purpose, the Court relied on the judgement of the Delhi High Court in the case of Puspha Katoch vs Manu Maharani Hotels Limited 121 (2005) DLT 333 wherein it was held that by virtue of Section 111A of the Act, a public company cannot have a provision recognising pre-emptive rights to its members and the right of a shareholder of such a company to transfer his/ her shares could not be fettered.
Applying this principle to the instant case, the Court held that Clause 7 of the Agreement was void and not enforceable and thus set aside the award of the Arbitrator.
Note: It is a common practice for investors and joint venture partners to include certain transfer restrictions in their Shareholders’/ Joint Venture Agreement and have such transfer restrictions incorporated in the Articles of Association of the company so as to make such provisions legally enforceable not only inter-se shareholders but also against the company. This judgement and the earlier judgement delivered by the Delhi High Court in Puspha Katoch’s case will have serious repercussions on all such agreements in relation to public companies which have any kind of transfer restrictions. These judgements may also bring to doubt the enforce ability of other standard clauses like the clauses relating to lock-in-period, ROFR, drag along right and call option, which form part of a Shareholders’/ Joint Venture Agreement.
While in the instant case, the transfer restrictions in question related to a public company which was “listed”, the fact that the decision of the Court is based on Section 111A of the Companies Act. 1956, raises concern about the validity of transfer restrictions with regard to any public company, whether listed or not. Furthermore, the practise post Rangraj’s case of incorporating the transfer restrictions in the charter documents will also no longer be of any help as the Bombay High Court has virtually rejected application of Rangraj’s case principle to any public company.