Enforcement of contractual restrictions on the transfer of shares which are not incorporated in Articles of Association (AOA) of a company

One of the first judgments of the Supreme Court on enforcement of contractual restrictions on the transfer of shares, is the landmark case of V.B. Rangaraj vs. V.B. Gopalkrishnan and others on 28th November, 1991, wherein the court, relying on Section 82 of the Companies Act, 1956 [82. Nature of shares. The shares or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company], held that a restriction which was incorporated in the Shareholder Agreement (‘SHA’), but not specified in the Article of Association (‘AOA’), was not binding either on the company or the shareholders. 

The main question that falls for consideration is whether the shareholders can among themselves enter into an agreement which is contrary to or inconsistent with the Articles of Association of the company.

Contractual Restrictions on Transfer of Shares

In this case, an agreement had been entered into between shareholders of a private company wherein a restriction was imposed on a living member of the company to transfer his shares only to a member of his own branch of the family. Such restrictions were however not envisaged nor provided for within the articles of the company. The court referred to sections of the Companies Act which provide that the articles of associations are the regulations which are binding upon the company and thus any restriction regarding transfer of shares must be provided for in the AoA.

In the aforesaid matter, the Apex Court examined the Articles of Association of the defendant company wherein restriction on the transfer of shares was found in Article No. 13.

The Article No. 13 reads as follows: 

“No new member shall be admitted except with the consent of the majority of the members on the death of any member of his heir or heirs or nominee, shall be admitted as member. If such heir, heirs or nominee is/are unwilling to become a member, such share capital shall be distributed at par among the members equally or transferred to any new member with the consent of the majority of the members.”

It can be seen that the aforesaid Article in effect consists of three parts.

  • The first part states that no new member shall be admitted except with the consent of the majority of the members.
  • The second part states that on the death of any member, his heir or heirs or nominee/s shall be admitted as members.
  • The third part states that if such heir or heirs or nominee/s is/are unwilling to become member/s, the share capital of the deceased member shall be distributed among the existing members equally or transferred to any new member with the consent of the majority of the members.

It is, therefore, clear that even a new member can be admitted provided the majority of the members are agreeable to do so. It also appears from the word “nominee” that a living member has a right to nominate even a third party to succeed to him as a member on his death.

Further the restriction on transfer by way of a right of pre-emption which is incorporated in the third part of the Article is only in respect of the shareholding of the deceased member and not of a living member. Whereas the heirs/nominees are as a matter of right entitled to become members if they are willing to do so, the restriction on the transfer of shares steps in only when they are unwilling to become members. The restriction states that in the latter event the shares of the deceased member shall be first distributed among the existing members equally and if they are to be transferred to any new member, it would be done so with the consent of the majority of the existing members.

It may be noticed from this restriction, that

  • Firstly, there is no limitation on the transfer of his shares by a living member either to the existing member or to a new member. The only condition is that when the transfer is made to a new member, it will have to be approved by the majority of the members.
  • The transfer may be to any existing member whether he belongs to one or the other branch of the family and in such case there is no need of a consent of the majority of the members.

The Article in fact envisages the distribution of the shareholding of the deceased member (and not of the living member) equally among the members of both branches of the family and not of any one of the branches only. Even the shares of the deceased member can be transferred to any new member when his heirs/nominees are not willing to become members. However, this can be done only with the consent of the majority of the members.

Hence, the private agreement which is relied upon by the plaintiffs whereunder there is a restriction on a living member to transfer his shareholding only to the branch of family to which he belongs in terms imposes two restrictions which are not stipulated in the Article.

  • Firstly, it imposes a restriction on a living member to transfer the shares only to the existing members and secondly the transfer has to be only to a member belonging to the same branch of family.

The agreement obviously, therefore, imposes additional restrictions on the member’s right to transfer his shares which are contrary to the provisions of the Article 13. They are, therefore, not binding either on the shareholders or on the company. 

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Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the authors whatsoever and the content is to be used strictly for educative purposes only.

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One Comment

  1. PUROHIT VIJAY JAYANTILAL says:

    what happens when AOA restict the transfer in accordance with will of the deacesed member. they only approv to transfer in the name of joint holder only. what will happen to his shares if that joint holder also expires>

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