RIGHT OF FIRST REFUSAL: A CONTRACTUAL RESTRICTION ON

TRANSFER OF SHARES

PROJECT

5.5 CORPORATE LAW

SUBMITTED BY: SUBMITTED TO:

Pranoy Goswami Miss Monmi Gohain

Semester V( SM0117037)

NATIONAL LAW UNIVERSITY AND JUDICIAL ACADEMY, ASSAM

ODD SESSION

(AUGUST- DECEMBER, 2019)

 TABLE OF CONTENTS

1. Table of Contents...........................................................................................................2
2. Acknowledgement..........................................................................................................3
3. Abstract..........................................................................................................................4
4. Introduction....................................................................................................................5
5. Pre-Emptive Right..........................................................................................................6
6. Background....................................................................................................................7
7. Judicial Precedents.........................................................................................................9
- High Courts view...............................................................................................9
- Supreme Courts view.......................................................................................10
8. Current Position in India..............................................................................................12
9. Provision under the Companies Act, 1956...................................................................14
10. Messer Holdings Limited v. Shyam Madanmohan Ruia and Ors................................16
- Analysis............................................................................................................19
11. Provision under The Companies Act, 2013.................................................................19
12. Restrictions on the transferability of shares in Public and Private Companies............21
13. The Right of First Refusal still remains a significant unresolved controversy in Indian
Corporate Law..............................................................................................................22
14. Conclusion....................................................................................................................24
15. Bibliography.................................................................................................................26
- Articles.............................................................................................................26
- Books................................................................................................................27
- Cases................................................................................................................27
- Reports & Notifications...................................................................................27
- Statutes.............................................................................................................28
- Websites...........................................................................................................28

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 ACKNOWLEDGEMENT

This project is a major milestone in our journey of learning in the subject of Company Law. I
would like to begin by thanking God for the wisdom and perseverance that he has bestowed
upon me during this research project. I would also like to take this special opportunity to
thank Miss Monmi Gohain, Assistant Professor of Law for providing such an opportunity to
learn, in the form of this project. Needless to say that without his timely and valuable
guidance and his patient replies to my queries, howsoever trivial they may have been we
would not have been able to complete this project. The experience has definitely been an
interesting and enriching one.

Pranoy Goswami

SM0117037, 3rd Year, Semester 5

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 ABSTRACT

The aim of this project is to analyse the current position of the clause Right of First Refusal
(“ROFR”) which is one key term in commercial contracts involving shareholders of
corporate entities. ROFR is a pre-emptive option of a non-selling shareholder to purchase
shares of a company that a selling shareholder proposes to liquidate. If the non-selling
shareholder refuses to purchase such shares, the selling shareholder can sell the shares to a
third party usually with a stipulation that the terms of such sale and more importantly the
sale price should not be more favourable than those offered to the non-selling shareholder.
In a nutshell, ROFR forms an integral part to investors’ protection in a shareholders
agreement (“SHA”). ROFR (among other shareholders’ rights such as right to first offer, tag
along, drag along), has however been viewed as a hindrance to the principle of ‘free
transferability’ of shares of a public limited company laid down in Section 111-A of the
Companies Act, 1956.

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 INTRODUCTION

Among various provisions of incorporating documents such as shareholder’s agreement in a

corporation, an item will often appear labelled “ROFR” / “Right of First Refusal.” ROFR is a
contractual right that obliges the selling shareholder not to sell its shares in the company to a
third party without offering his shares to another party (usually the other existing
shareholders). If the existing shareholder(s) does not accept the offer, the selling shareholder
is free to sell his stake to a third party, provided the sale is not on more favourable terms
than those offered to the existing shareholders. Meaning thereby, the ROFR requires the
owner of a property to offer the same to the right holder, on the same terms as those offered
by the third party, before the owner can sell the property to that third party. By adopting this
provision, the shareholders of the corporation promise that they only will sell their shares
after negotiating a price with a third party and offering the shares at that price to their fellow
shareholders.

Right of First Refusal in a shareholder’s agreement provides the grantee with a contingent
option to purchase an asset if the grantor elects to sell the shares 1. Before taking into account
the legal position with regard to the aforesaid issue, it would be worthwhile to have a brief
insight into some of the focal concepts pertaining to the provisions incorporated in
agreements such as ‘Joint Venture Agreements’ or ‘Shareholders Agreement’.

These agreements signed amongst the shareholders may include some provisions, which
broadly include the following:

i. The Right of first refusal;

ii. Drag-Along Right; and A right that enables a majority shareholder to force a minority
shareholder to join in the sale of a company. The majority owner doing the dragging
must give the minority shareholder the same price, terms, and conditions as any other
seller.
iii. Tag-Along Right. If a majority shareholder sells his or her stake, then the minority
shareholder has the right to join the transaction and sell his or her minority stake in
the company.

1
David I. Walker, Rethinking the Right of First Refusal, 5th Stanford Journal of Law, 1999, Discussion Paper
No. 261, The Harvard Law School.

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A Rofo essentially means that if a shareholder entity decides to sell its share in the company,
the selling shareholder must first offer its shares to the other shareholder (to whom a Rofo is
granted), who in turn may offer a price for the shares to the selling shareholder. If satisfied by
the price offered by the other shareholder or if the selling shareholder is unable to obtain a
higher price from a third party, then the selling shareholder entity only has the option to sell
its shares to the shareholder who has the Rofo right. However, if the selling shareholder
receives a price higher than that offered by the other shareholder from a third party, the
selling shareholder is free to sell shares to the third party at the higher price.

For instance, if there are two shareholders in a private company, say, A and B, with a Rofo in
favour of B granted by A, and A decides to sell his shares, then A must first offer his shares
to B. Only if B refuses to purchase A’s shares, or if A can obtain a higher price for his shares
from a third party than that offered by B, can A sell his share to a third party. On the other
hand, if there is a Rofr in favour of B, then A is first required to offer his share to third parties
and obtain a price from them for this. A is then required to approach B with the price offered
by third parties. If B can match or better the price offered by third parties, A must sell his
share to B.

Contractual right under which a party has the first opportunity to buy an asset before it is
offered to a third party. Compare with right of first refusal. Also called pre-emptive right or
right of preemption.

Typically in the Right of first refusal (ROFR), at least three parties are implicated – the
owner and right holder who have contracted for the grant of the right and one or more
potential third-party buyers, should be to whom the company wishes to offer / sell the shares. 2
In brief, the right of first refusal is akin in concept to a call option. The ROFR can cover
almost any sort of assets and is commonly employed in a variety of contractual settings. It is
found, among others, in real estate sale, lease contracts, personal property, a patient license, a
screenplay, in agreements among shareholders of a closely held company or in an interest in a
business. It might also cover business transactions that are not strictly assets, such as the right
to enter into a join venture, a distribution agreement or management agreement. For instance,
in the entertainment industry, a right of first refusal on a concept or a screenplay would give

2
Enforceability of provisions not forming part of the company documents: An analysis in the law, SEBI &
Corporate Law Weekly Issue, September 22, 2008

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the holder the right, assumingly, to make that movie first. Only if the holder turns it down
may the owner then shop it around to other parties.

Taking the above into consideration, it may be noted that the aforementioned right is framed
so as to enforce the interests of the investors and the promoters/ current shareholders in a
particular venture. Considering the same, it would be a futile exercise if the enforceability of
the said right is not known to the parties to such agreements.

PRE-EMPTIVE RIGHT

As compared to ROFR, there is an almost similar right which is known as a pre-emptive

right. It may not be easy proposition to differentiate between the ROFR and the pre-emptive
rights, as the two seem to be similar, if not identical. Contrary to a right of first refusal, a pre-
emptive right appears to be similar to a right of first offer. A Right of first offer is a close
cousin to the right of the first refusal. Under the right of first offer, before an owner can
sell property subject to a right of first offer, the right holder must be given the chance to
make an offer for the property. The owner can then either accept the offer; or the
owner can sell the property to a third party, but only at a price above the one offered by
the right holder. For this right to be effective and enforceable, in the case of private
company, the same may be inserted in the Articles of Association of the Company. As per the
said right, the right to transfer shares to non-members is restricted. Further, it is worthwhile to
note that a private agreement between two or more shareholders in which they impose
restrictions upon each other as to their right of transfer does not bind the company and,
consequently, the same is likely to be a subject matter of a civil suit between the parties to the
agreement and the party committing breach may have to answer in terms of damages to the
other. To bind the company, the agreement has to include the company as one of the parties,
and it has to be a subject matter in the Articles of Association.3

BACKGROUND

3
Supra note 1

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The discussion on this subject began in the year 1992 when the Supreme Court in the case of
V.B.Rangaraj v. V.B.Gopalakrishnan4 held that in case of a private limited company transfer
restrictions, if any, agreed by the shareholders unless embodied into the articles of association
would not be valid and binding. On the other hand, the Delhi High Court and the Company
Law Board held that in case of listed shares there cannot be any restrictions namely rights of
first refusal or any such rights. This was because Section 111A (2) 5 of the Companies Act
1956, provides that the shares and debentures and any interest therein of a company shall be
freely transferable. Justice Chandrachud of the Bombay High Court also took the same view
in 2010 in the case of Western Maharashtra Development Corporation v. Bajaj Auto Ltd 6
and observed that “the principle of free transferability must be given a broad dimension in
order to fulfil the object of the law. Imposing restrictions on the principle of free
transferability is a legislative function, simply because the postulate of free transferability
was enunciated as a matter of legislative policy when Parliament introduced Section 111A
into the Companies Act, 1956. That is a binding precept which governs the discourse on
transferability of shares. The word “transferable” is of the widest possible import and
Parliament by using the expression “freely transferable”, has reinforced the legislative intent
of allowing transfers of shares of public companies in a free and efficient domain. The effect
of a clause of pre-emption is to impose a restriction on the free transferability of the shares by
subjecting the norms of transferability laid down in Section 111A to a pre-emptive right
created by the agreement between the parties. This is impermissible.”

This interpretation was causing lot of hardship on the PE investors / Strategic Partners in
negotiating the right of first refusal or tag / drag rights with the Promoters, which are
typically exit options negotiated to protect their commercial interest. Question therefore was
whether in a listed company one can validly offer right of first refusal or tag/drag along rights
that would ultimately be legally enforceable?

The aforesaid decisions came up for consideration before the Division bench of the Bombay
High Court in case of Messer Holdings Limited v. Shyam Madanmohan Ruia and Ors 7. The
judgment is interesting as it comes in the wake of the Bombay High Court judgment in Bajaj
Auto case8; it changed the way to negotiate restriction on transfer of shares in a public
4
V B Rangaraj v. V B Gopalakrishnan, [1991] 6 CLA 211
5
Section 111A (2) of Companies Act, 1956: Subject to the provisions of this section, the shares or debentures
and any interest therein of a company shall be freely transferable.
6
(2010) 154 CompCas 593 (Bom)
7
Messer Holdings Ltd. v. Shyam Madanmohan Ruia, [2010] 98 CLA 325
8
Western Maharashtra Development Corporation v. Bajaj Auto Ltd., (2010) 154 CompCas 593 (Bom)

Page 8 of 29
company. That judgment had ruled that any pre-emptive rights over shares in public limited
companies were illegal in view of the principle of “free transferability” enshrined in Section
111A of the Companies Act, 1956. The debate on enforceability of terms of shareholder
agreements governing public limited companies is definitely not over yet.

The Court with respect rejected the earlier interpretation given to the words “free
transferable” used in section 111A by the single Judge in the Bajaj Auto case 9. The Division
bench for the first time examined the true intent of section 111A, the reason for its insertion
in the Companies Act, 1956 and observed that earlier when the shares were in physical form,
board of directors used arbitrary powers to reject transfer of shares leading to lot of
complaints by the transferees. That situation was partially remedied by insertion of section
22A of the Securities Contract Regulation Act, which laid down only four grounds on which
any board could reject transfers. With the introduction of the concept of dematerialized shares
through the Depositories Act, 1996, section 22A got deleted and section 111A was
introduced in the Companies Act to deal with rectification of register. The Court observed
that the whole purpose of section 111A is to regulate the right of the board of directors
to refuse transfer of shares. Under Section 111-A, the Company Law Board has been
empowered to direct any depository or company to rectify its register or records on an
application made to it by a depository, company, participant or investor or SEBI.10

JUDICIAL PRECEDENTS

HIGH COURTS VIEW

a. Judgments in favour of ROFRs

9
Ibid.
10
A Ramaiya, Guide to the Companies Act, 17th edn., 2010, Part 1, Lexis Nexis Butterworths, Wadhwa, Nagpur

Page 9 of 29
 i. Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd.

Gujarat High Court has held in favour of ROFRs. The decision of Gujarat High Court in the
case of Mafatlal Industries in 1997 is an important precedent relating to subject matter. This
was the case relevant to a public limited company. In this case a shareholder disposes the
3.87% share holding in the open market in violation of the agreed terms. Very interestingly
and according to the author, rightly argued that “free transferability” refers to absence of
restriction which may be imposed by the third parties, but it cannot exclude the right of a
shareholder to impose restrictions on himself in the matter of transfer of shares to another
person. This argument was rejected by the then Judge Mr. Shah who pointed out that ratio
laid down in the case of V B Rangarajan by the Apex Court is having much greater force and
can be applied to public company also. This decision had changed the whole scenario for
public company.11

ii. Messer Holdings Limited v. Shyam Madanmohan Ruia

Bombay High Court has also accepted the legality of ROFRs in 2010. This case upheld the
validity of such pre-emptive rights including ROFR and opined that such rights do not violate
the provisions of Section 111-A. It also observed that a shareholder has freedom to transfer
his shares on terms defined by him, including ROFR and subject to compliance with existing
laws, such arrangements do not restrict free transferability of shares. It was also held by the
Hon’ble Court that pre-emptive rights arise out of a private contract between shareholders
with a third party and these need not be embodied in the articles of association of the
company since the company is not a party to such arrangements.12

b. Judgments not in favour of ROFRs

i. Pushpa Katoch v. Manu Maharani Hotels Limited

Delhi High Court has held that there could not be any fetters on the right of a shareholder to
transfer his/her shares in a public company. It was specifically held that pre-emptive rights
are unenforceable even if incorporated in the articles of association, since such rights would
be ultra vires to Section 111-A.13

ii. Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd

11
Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd., 1999 (97) CompCas 301 Guj
12
Supra note 7
13
Pushpa Katoch v. Manu Maharani Hotels Limited, 2006 (131) CompCas 42 Del

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Bombay High Court relied on Pushpa Katoch and held ROFRs to be patently illegal. It held
that pre-emptive rights go against the spirit of Section 111-A, and therefore are not legally
tenable. Single Judge of the Bombay High Court held that the principle of free transferability
must be given a broad dimension in order to fulfil the object of the law. The word
“transferable” is of the widest possible import and Parliament by using the expression “freely
transferable”, has reinforced the legislative intent of allowing transfers of shares of public
companies in a free and efficient domain. The Court further held that the Agreement and
provision in Articles of Association restricting the transfer shares is violative of section 111A
read with section 9 of the Companies Act and therefore it is void and accordingly the award
is contrary to substantive provisions of law and is patently illegal.14

SUPREME COURTS VIEW

a) V.B. Rangaraj v. V.B. Gopalakrishnan15

In this Case shareholders of a private limited company were two branch of family and it was
agreed orally in 1951, it means in backdrop of Independence and partition, that the proportion
of the shareholding of respective branches would not change, and further agreed that for this
purpose, any member of a branch want to sell his shares must first offer the share to his own
branch. The crux in this case is the oral agreement about restriction was not incorporate in
Articles. Referring its own earlier relevant decision in Kalinga Tubes, the Supreme Court
held that the shares are “freely transferable” and that a private agreement imposing
restriction on transfer of shares which is not stipulated in Articles of association is neither
binding to the Company nor to shareholders. It means such kind of agreement is void in toto.
One thing very clearly established in this case is any restriction on share transfer must be
incorporated in the Articles of the Company otherwise it will not have any effect and
aggrieved shareholder can not have any legal remedy against violation of such restrictive
provisions of agreement or understanding.

The Supreme Court held that a restriction on the transfer of shares contrary to the articles of
association of a private company was not binding on the private company or its shareholders.
Although this judgment was in relation to a private company, its reasoning has also been
applied to public companies. Therefore, if restrictions on transfer of shares are to be

14
Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd, (2010) 154 Comp Cas 593 (Bom)
15
AIR 1992 SC 453

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enforceable, provisions in the articles of association of a company are needed. The Court had
taken the view that provisions of the SHA imposing restrictions even when consistent with
company law are to be authorized only when they are incorporated in the articles of
association.

b) Vodafone International Holdings B.V. v. Union Of India and another16

The Court has taken a view that freedom of contract can be restricted by law only in cases
where it is for some good of the community. The Companies Act, 1956, or the other
legislations do not explicitly or impliedly forbid shareholders of a company to enter into
agreements as to how they should exercise voting rights attached to their shares.

In this case the Supreme Court did not subscribe with the view taken in the Rangaraj case (as
stated above) and stated that SHA is a private contract between the shareholders compared to
the articles of association of the company, which is a public document. SHA is essentially a
contract between some or all other shareholders in a company, the purpose of which is to
confer rights and impose obligations over and above those provided by the company law.

Further, the Court stated that the provisions of the SHA incorporating ROFRs need not
necessarily be authorized by the articles of association of the concerned company.
Accordingly, the Court has implied that in the event the articles of association of a company
are silent with regards the provision of ROFR’s, they can be legally enforceable, subject to
the same being incorporated in the SHA.

CURRENT POSITION IN INDIA

Recently on the October 3, 2013 a Notification 17 was issued by SEBI (Securities Exchange
Board of India), which said that Right of First Refusal was legally allowed and valid in the
Shareholders Agreement. It also allowed tag along and drag along rights. Through this, SEBI
has rescinded its previous notification of March 1, 2000 that prohibited contracts other than
spot delivery contracts or those entered into through the stock exchange mechanism.

16
2012 (1) UJ 334
17
The Gazette of India Extraordinary, Part III, SEBI Notification (Mumbai), 3rd October, 2013

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Accordingly, SEBI now permits various types of pre-emption rights and put and call options,
but subject to certain conditions. The new position is as follows:

1. Spot delivery contracts are permitted, consistent with the previous position;

2. Sale and purchase contracts on securities are permitted so long as they are in accordance
with securities regulations and stock exchange regulations and by-laws. These would include
transactions, including in derivatives, which are carried out through the stock exchange.

3. Contracts for pre-emption including right of first refusal (ROFR) or tag-along or drag-
along rights contained in shareholders agreements or articles of association are allowed. Note
that this is only an inclusive provision and is not exhaustive of all the types of provisions in
the agreements or articles that can be enforced. This enables investors to exercise their exit
rights in companies through the above mechanisms that are generally recognized. No
conditions are attached for the exercise of these rights.

4. Put and call options contained in shareholders agreements or articles of association are
treated somewhat differently from pre-emption rights discussed in item 3 above. The reason
is that the exercise of options is subject to certain conditions:

a) The underlying securities that are the subject matter of the options must have been
held by the relevant party for a minimum period of 1 year from the date of entering
into the option contract. This seems to be to ensure that options are not short-term in
nature and are permitted only when the holding of the securities is for a considerable
period of time. The genesis for the erstwhile prohibition on options was to prevent
speculation in securities, and this approach is imposing a minimum 1-year term on the
options is consistent with that philosophy.
b) The pricing of the options and the exercise is to comply with applicable laws. More
specifically, the notification states that all contracts permitted through it must comply
with the provisions of the Foreign Exchange Management Act, 1999. This applies
when options and pre-emption rights are granted by or in favour of a non-resident
investor. Where the exercise of the option or pre-emption results in a transfer of
securities between a resident and a non-resident investor, then the idea is that the
relevant pricing norms imposed by the Reserve Bank of India (RBI) must be complied
with. This is significant for foreign investors to take into account. Merely because
SEBI has now conditionally permitted options, it does not mean that parties have

Page 13 of 29
 complete freedom in exercising the options. The pricing is still regulated by the
relevant RBI norms, and hence the commercial understanding between the parties
regarding the exercise price will be subject to these regulatory constraints.
c) The new permissible regime applies only to physically-settled options where there is
an actual delivery of the underlying securities. It does not cover cash-settled options,
which are essentially contracts for differences. This is understandable given the
philosophy of the legal regime to curb speculation. Moreover, investment agreements
(where investors seek exit rights) usually relate to an actual sale or purchase of
securities rather than a contract for differences, and hence this should not pose
difficulties for customary investment transactions.
5. This new permissible legal regime applies only prospectively, and does not “affect or
validate any contract which has been entered into” prior to the date of the notification.
Hence, past contracts with pre-emption rights or put and call options will not be
“grandfathered”. One possibility to overcome this restriction would be for parties to
existing contracts to re-execute them as of a future date.
6. Finally, an explanation to the notification states that the contracts specified in the
notification would be valid without regard to anything contained in section 18A 18 of the
Securities Contracts (Regulation) Act, 1956, which refers to exchange traded contracts.
In other words, such pre-emption rights and option contracts would be permissible even
though they are entered into on an over-the-counter (OTC) basis and not traded on the
stock exchange.

Overall, SEBI’s notification represents a momentous regulatory change. Companies,

investors and their advisors have been grappling with concerns regarding the enforceability of
pre-emption rights and options for nearly two decades now. The oddity of the situation was
the expansive application of SEBI’s previous regime that applied not only to listed companies
but also to unlisted public companies. Moreover, while speculation was the concern, it
seemed to encompass genuine transactions as well, making customary investment
transactions inefficient in terms of structuring (particularly of exit options).

The current move is welcome as it rectifies a previously ambivalent and restrictive legal
regime. This will augur well to investors as well as companies requiring capital. There may

18
Section 18A: Notwithstanding anything contained in any other law for the time being in force, contracts in
derivative shall be legal and valid if such contracts are- (a) traded on a recognised stock exchange; (b) settled on
the clearing house of the recognised stock exchange, in accordance with the rules and bye-laws of such stock
exchange.

Page 14 of 29
very well be issues regarding the specifics of the recent notification and the conditions
imposed therein, but the overall development is positive in nature.19

PROVISION UNDER THE COMPANIES ACT, 1956

One of the most controversial questions raised and still being ambivalent is:

Whether ROFR agreements, Tag along and Drag along rights are enforceable under law
and in compliance with section 111A of the Companies Act, 1956?

It is pertinent to highlight that this point is no longer Res Integra (untouched), but is covered
by the decision of the Supreme Court in the celebrated case of V.B.Rangaraj v.
V.B.Gopalakrishnan20. In the said case, the Apex Court has held that a restriction which is
not specified in the Articles of Association is not binding either on the Company or on the
shareholders. The court further held that the arrangement (as in the said case) imposed
additional restrictions on the member’s right of transfer of his shares which were not
stipulated in the articles and, therefore, were not binding either on the shareholders or on the
company. It was also held that the shares are movable property and transfer thereof is
regulated by the articles of association of the Company. The Court held that even if the
Articles of Association provide for a ROFR, if the right is a restriction on the free
transferability of shares and not a mere process, then it is not likely to be enforceable.

Later the Judicial view point decided in 2010 in the case of Messer Holdings Limited v.
Shyam Madanmohan Ruia and Ors. 21, A Division Bench of the Bombay High Court had
ruled in this case that a private arrangement between shareholders of a public limited
company on a voluntary basis relating to share transfer restrictions (right of first refusal) is
not violative of Section 111A of the Companies Act, 1956. The judgment also goes on to
suggest that it is not mandatory for the Company to be a party to such an agreement relating
to share transfer restrictions and it is not necessary to incorporate share transfer restrictions in
the articles of association of the Company.

19
Supra note 17
20
Supra note 4
21
Supra note 7

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Shareholders can enter into a consensual agreement in case of shares of public companies,
can also freely negotiate and enter into agreement containing the ROFR or what is commonly
known as Pre-emption/ Tag Along/ Drag Along rights even in the case of listed shares, which
was recently confirmed by the Division bench of A.M. Khanwilkar and A.A. Sayed, JJ. of the
Bombay High Courts. These Share Purchase Agreement (SPA) are usually assent between
the Promoters, PE Investors, Technical or Financial Collaborators.

The decision in the case of Messer Holding provided some relief to shareholders of a public
company however not resolved issues and concerns of corporates and joint venture parties.
But some questions yet to find their stands. Without a company being a party to the
agreement between the shareholders, its terms cannot be inserted in to Articles and even in
case it is incorporated in the Articles, the validity of restriction on share transfer in a public
company would not be sustained and uphold looking the decisions delivered so far. In such
circumstances, since shareholders agreement is not biding to a Company, a shareholder
cannot restrict the company from transferring shares which is in violation of the agreement.
Unless and until the role of the company and such restrictions validly find the place in
Articles, Company Law Board would not have jurisdiction for civil breach. Therefore remedy
available for aggrieved shareholder is to approach civil court, which is costly and lengthy and
many times parties reluctant to prefer it in joint venture business22. An in-depth analysis of
the aforementioned case is required as it is the most recent decision on the point in issue.

MESSER HOLDINGS LIMITED V. SHYAM MADANMOHAN RUIA AND ORS.

The facts in brief, Bombay Oxygen Ltd is defendant no. 2 company was listed on BSE.
Messer holding was the major shareholder of the Company. It entered into agreement dated
June 23, 1997 where under the German company to acquire shares and management of the
company and provide some technology to company. It was condition in the agreement that
either party want to sale its share then offer first to other party except some situation as
provided in the agreement. In this case, the arguments were (a) the agreement was void
because of fraud and misrepresentation (b) the agreement was void because it was in
violation of SEBI rules and regulation and (c) the agreement was void as it restrict free

22
Satyajit Gupta, A twist in the tale: Share transfer restrictions in a public limited company legal?, Available at:
http://indiacorplaw.blogspot.in/2010/09/twist-in-tale-share-transfer.html

Page 16 of 29
transferability in term of section 111A of the Companies Act and recent decision of Bombay
High Court in the case of Bajaj Auto.

Clause 6.1 of the SPA dated June 23, 1997 between the parties conferred a right of first
refusal on the Ruias in respect of the shares of Bombay Oxygen Ltd., unless the shares were
to be sold to a member of the Hoechst group of companies.

The controlling shareholders of Bombay Oxygen Ltd, a public listed company agreed to
divest a majority of their shareholding to Messer Griesheim Gmbh (MGG) pursuant to which
the controlling shareholders agreed to divest a majority of their shareholding in the Company
to MGG. As per Clause 6.1, in the event either party intended to sell the entire or any
part of the shares in the Company, the transferring party was required to first offer the
shares being transferred to the other party. Although this case dealt with various other
issues, we analyze the issue pertaining to the legality of Clause 6.1 of the SPA and whether
the same is violative of free transferability of shares in a public company provided by Section
111 A of the Act. MGG relied on inter-alia the decision of the Single Bench in Bajaj Auto
Ltd.23 where this Court held that pre-emptive rights on shares of a public company are
contrary to the provisions of Section 111A of the Act which requires that the shares of a
public company should be freely transferable.

The Division Bench however, over ruling the aforesaid judgment, held that such private
arrangements are not in violation of Section 111A of the Act in a pubic company in reliance
of the following:

Section 111A of the Companies Act, 1956, is perhaps the most significant unresolved
controversy in contemporary Indian Corporate Law. Section 111A of the Companies writes
that “Subject to the provisions of this section, the shares or debentures and any interest
therein of a company shall be freely transferable”. The section speaks about free
transferability of the shares and debentures of the Public Limited Company.

Given the historical background of the deletion of Section 22A of the Securities Contracts
(Regulations) Act, 1956 (SCRA) by the Depositories Act, 1996 and the introduction of
Section 111A in the Act, it can be inferred that the provisions of Section 111A was meant to
regulate the powers of the board of directors of a company qua the transfer of shares or

23
Supra note 8

Page 17 of 29
debentures of a company and any interest therein. The board of directors cannot refuse to
register a transfer of shares unless there is sufficient cause to do so.

Section 111A of the Act is not a law dealing with the right of the shareholders and does not
expressly restrict or take away the right of shareholders to enter into consensual
arrangement/agreement by way of pledge, pre-emption/sale or otherwise. The expression
freely transferable in Section 111A of the Act does not mean that the shareholder cannot
enter into consensual arrangements/agreement with the third party (proposed transferee) in
relation to his specific shares.

The concept of free transferability of shares of a public company is not affected in any
manner if the shareholder expresses his willingness to sell the shares held by him to another
party with right of first purchase (pre- emption) at the prevailing market price at the relevant
time. So long as the member agrees to pay such prevailing market price and abides by other
stipulations in the Act, Rules and Articles of Association there can be no violation. For the
sake of free transferability both the seller and purchaser must agree to the terms of sale.
Freedom to purchase cannot mean an obligation on the shareholder to sell his shares.

Reliance was also placed on Section 9 of the Companies Act, 1956 which stipulates that
provisions of the Act shall have the effect notwithstanding anything to the contrary contained
in the Memorandum or Articles of the Association.

The decision in M.S.Madhusoodhanan v. Kerela Kamaudi Pvt. Ltd. 24 is an authority on the

proposition that consensual agreements between particular shareholders relating to
their specific shares do not impose restriction on the transferability of shares. Further,
such consensual agreements between particular shareholders relating to their shares can be
enforced like any other agreements. It was not required to be embodied in the Articles of
Association. The Division Bench also relied on the distinction drawn by the Supreme Court
in Madhusoodhanan case from the proposition laid down in the case of V.B Rangaraj, in that
the judgment arrived at by the Supreme Court was on account of the restriction being a
blanket restriction on all the shareholders present and future and could not be imported to a
private agreement between particular shareholders.

The Defendant too relied on a few judgments but it was also observed by the Learned Single
Judge that the dictum in the relied decisions were of no avail as the case on hand was in

24
M.S.Madhusoodhanan v. Kerela Kamaudi Pvt. Ltd., (2003) 117 CompCas 19 SC

Page 18 of 29
relation to a public company whereas the decisions in those respective judgments are in
concern with the Private Company under which the transferability of shares in restricted. It is
held that in case of public company, Section 111A provides that the shares or debentures and
any interest therein of the company shall be freely transferable.

As aforesaid, Section 111A is not a law dealing with the right of the shareholders to enter into
consensual arrangement/agreement by way of pledge, pre-emption/sale or otherwise. If that
right is not covered by Section 111A of the Act as has been found by us, then consensual
arrangement/agreement between shareholder and third party or shareholders inter se to which
company is not a party, Section 9 of the Act will not come into play at all. Thus, the
expression “freely transferable” in Section 111A does not mean that the shareholder cannot
enter into consensual arrangement/agreement with the third party (proposed transferee) in
relation to his specific shares If the company wants to even prohibit that right of the
shareholders, may have to provide for an express condition in the Articles of Association or
in the Act and Rules, as the case may be, in that behalf. The legal provision as obtained in the
form of Section 111A of the Companies Act does not expressly restrict or take away the right
of shareholders to enter into consensual arrangement/agreement in respect of shares held by
him.25

ANALYSIS

(a) This division bench has gone into the intent of 111A. The division bench has rightly held
now that when shares are freely transferable doesn’t mean that the shareholders lose the right
to dispose off or deal with the shares in the manner in which they like.

(b) The Bench has explained the intent that the section 111A was never incorporated to take
away the rights of the shareholders to dispose, which is one of the rights enjoyed by any
owner of any movable property. ROFR and other such agreements are important exit
provisions for any financial or strategic investor.

25
Somasekhar Sundaresan, “Public Company shares cannot be fettered at all”, Available at:
http://indiacorplaw.blogspot.in/2010/02/public-company-shares-cannot-be.html

Page 19 of 29
(c) This may not be the last word because this controversy may knock the doors of the
Supreme court, but certainly it’s a division bench judgment and is the only judgment in the
case of a public companies of 111 (A) therefore in that sense it certainly it sets aside the
controversy which was raised right from the beginning of Rangarajan from 1992.

PROVISION UNDER THE COMPANIES ACT, 2013

No judgments have been cited here, as it has been even 4 months from now, when the act
came into force. This does not means we should forget old Companies Act, 1956 which will
be applicable for some time and we have to come back for to it in practice; for forensic or
other historic purpose.

Given Under Section 56 of the newly drafted act of 2013, which requires A company to
register a transfer of securities or interest of members only when such a proper instrument of
transfer; duly stamped, dated and executed by or on behalf of the transferor and transferee
and specifying the name, address and occupation has been delivered to the company by either
party within a period of sixty days from date of execution, along with the certificate of
security or the letter of allotment of securities. Free transferability of share is one essential
condition for Company form of business, subject to some restrictions under private
companies. New Act, deals with substantially.26

Section 56 of the new Act also talks about the consequences, if the instrument of transfer
which has to be stamped and signed gets lost or not delivered to the place in that case, the
company may register the transfer on an indemnity bond.

On receipt of intimation, a company has power to register transmission of any right to

securities by operation of law from any person to whom such right has been transmitted.
Where an application is made by transferor alone and relates to partly paid shares, the transfer
shall be registered by the company only after giving notice of the application to the
transferee, and transferee gives no objection to the transfer within two weeks from the receipt
of notice.27

26
Transfer and Transmission of Securities (Companies Act, 2013), Available at:
http://aishmghrana.me/2013/10/01/transfer-and-transmission-of-securities-companies-act-2013/
27
S. Muralidharan, When shareholder’s Agreement is enforceable?, November 1, 2010, Available at:
http://www.thehindubusiness line.com/2006/08/03/stories/2006080300251100.htm

Page 20 of 29
The transfer of any security or other interest of a deceased person in a company made by his
legal representative shall be valid as if he had been the holder at the time of the execution of
the instrument of transfer.

Penal provision (Section 447)

Where any default is made under this section, the company shall be punishable with fine
which shall not be less than twenty-five thousand rupees but which may extend to five lakh
rupees and every officer of the company who is in default shall be punishable with fine which
shall not be less than ten thousand rupees but which may extend to one lakh rupees liable
under section 447 of the Act.

Punishment for personation of shareholder (Section 57)

If any person deceitfully personates as an owner of any security or interest in a company, or

of any share warrant or coupon issued in pursuance of this Act, and thereby obtains or
attempts to obtain any such security or interest or any such share warrant or coupon, or
receives or attempts to receive any money due to any such owner, he shall be punishable with
imprisonment for a term which shall not be less than one year but which may extend to three
years and with fine which shall not be less than one lakh rupees but which may extend to five
lakh rupees.

Simply, any person, who deceitfully represent himself as holder of any security or interest in
a company shall be punishable with imprisonment and with fine, minimum fine being one
lakh rupees.

RESTRICTIONS ON THE TRANSFERABILITY OF SHARES IN PUBLIC AND

PRIVATE COMPANIES

In Messer Holding v. Shyam Madanmohan Ruia, The Judge observe that “a situation
involving a restriction of transferability of shares in a private company has to be contrasted
with cases involving public companies where the law provides for free transferability. It is
thus held that free transferability of shares is the norm in the case of shares in a public
company.”

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Private limited company occupies a unique position in the scheme of the company law. It
enjoys several privileges and exemptions as opposed to a public company. It is immune from
a number of restrictions, controls and regulations, which a public company is subjected to. It
has the character of ‘close corporation’. The most vital privilege a private company enjoys is
lesser governmental control and interference. It is a blend of partnership and a limited
liability body corporate. It enjoys the benefits and advantages of both.

Section 3(1) (iii) of the Companies Act, 1956 defines ‘private company’ 28, and stipulates four
ingredients that constitute a company as a private company. One of the four ingredients of the
definition is that a private company, by its articles, restricts the right to transfer its shares.
Any restrictions imposed by the articles are binding upon the members of the company by
virtue of Section 3629 of the Act. To what extent and in what form the right to transfer can be
restricted has been left to the discretion of these companies, the Act does not provides any
direction in this regard. However, conventionally, certain common restrictive provisions are
found in the articles of most private companies.

Two chief ones of them are: one, the directors are given absolute and uncontrolled discretion
in the matter of approval of transfers for registration, and second, the members are given the
right of pre-emption for purchasing the shares offered by any member. There is, however,
nothing to limit the restrictions which a company’s articles may place on the right of transfer;
but there cannot be complete fetter on the right.

Although private companies are free to impose any restrictions, however in character, on the
rights of transfer and prescribe any manner in which the shares can be transferred, yet the
mandatory provisions of Section 108 of the Act are as much applicable to the transfers of
shares of private companies as they apply to public companies. Furthermore, the articles
laying down the manner of transfers are equally binding upon the members and the company
as well.

It should be noted that, as held by the Supreme Court V. B. Rangaraj v. V. B.

Gopalkrishnan, the articles of a private company may contain provisions restricting the right
to transfer of shares, but any restriction outside the articles (e.g., a private agreement between

28
Defined under Section 2(68) of The Companies Act, 2013
29
Section 36(1) of The Companies Act, 1956 : Effect of memorandum and articles as mentioned below:
Subject to the provisions of this Act, the memorandum and articles shall, when registered, bind the company and
the members thereof to the same extent as if they respectively had been signed by the company and by each
member, and contained covenants on its and his part to observe all the provisions of the memorandum and of the
articles.

Page 22 of 29
the shareholders) is inoperative and unenforceable. The only restriction on the transfer of
shares of a company is as laid down in the articles. A restriction which is not specified, is not
binding either on the company or on the shareholders. Thus, an agreement restricting the right
to transfer, contrary to or inconsistent with the provisions in the articles, is not enforceable.

THE RIGHT OF FIRST REFUSAL STILL REMAINS A SIGNIFICANT UNRESOLVED

CONTROVERSY IN INDIAN CORPORATE LAW

ROFRs are legally enforceable as per the latest division bench of the Bombay High Court.
Accordingly Tag/ Drag and similar covenants can also be considered as enforceable between
the shareholders agreeing for such covenants. As on date this is the final verdict on ROFR as
it is a Division Bench decision. Yes it could get challenged in the Supreme Court, but it is
highly unlikely that it would get reversed. And hence this should remain as a good law. The
said judgment may provide relief to the private equity investors regarding enforceability of
their rights culminating from the private arrangements entered into by them.

But this interpretation by the Bombay High Court might be a barrier to implement as it will
be very difficult for the listed companies to raise capital, as they will have to offer their
shares to the existing shareholders whenever they wish to raise capital, they will have to offer
it to all the existing share holders as such provision will be incorporated in the article of
association, for instance, If a company having 2500 share holders, the company who is need
of share capital will have to before raising the capital, ask all the existing 2500 shareholders,
and only if they refuse can the company go for the external sources for help.

Though the draftsmen have enumerated a provision regarding this in the 2013 act, it would be
curious to see the application of the same in the future, keeping in view the SEBI guidelines 30
issued which said ROFR was legally allowed and valid in the Shareholders Agreement. Also
allowed tag along and drag along rights. Through this, SEBI has rescinded its previous
notification of March 1, 2000 that prohibited contracts other than spot delivery contracts or
those entered into through the stock exchange mechanism.

After all the said laws and decisions given by the various courts, it is believed that these
provisions and preferential clauses shall not be allowed in the agreements as the stipulates
30
SEBI Notification on Pre-Emption Rights, Put and Call Options, Issued on October 4, 2013

Page 23 of 29
that provisions of the Act shall have the effect notwithstanding anything to the contrary
contained in the Memorandum or Articles of the Association 31, and by applying these rights
the Section 111A of the Companies Act, 1956 (which mandates that there can be no
restriction whatsoever on the transferability of shares in a public company) gets violated and
should not be applied at the cost of the statutory laws and for the sake of satisfying the
existing shareholders.32

While the recent judgment of Messers Holdings offers strategic investors the much-needed
reprieve, legal experts believe that some corporates are likely to knock on the doors of the
Supreme Court looking for clarity since it has great impact on various joint venture
agreements across corporate India.

A Special Leave Petition33 challenging the judgment of the Bombay High Court in Messer
Holdings is presently pending before the Supreme Court. This is a welcome opportunity for
the Court to emphasize once and for all that there is nothing in Indian or English legislation
or case law that makes ineffective a promise by one contracting party to another in relation to
the disposition of his shares in a company, whether public or private.

CONCLUSION

At this point it may be interesting to take note of the fact that The Companies Act, 1956,
which is applicable to shareholders of all Indian Companies, The Foreign Exchange
Regulation Act, 1973 which encompasses investment made in Indian Companies by persons
resident outside India and non Indian persons resident in India and the Government
Guidelines relating to foreign investment do not explicitly or impliedly forbid shareholders of
a Company to enter into agreements whereby they choose to use the voting rights attached to
their shares in a befitting manner.34 As a result mutual rights and obligations outlined in a
shareholder’s agreement is valid under the existing legislations.

31
Section 9 of the Companies Act, 1956
32
Krishna Datta, Right Of First Refusal, Corporate Law Reporter Part 4, December 3, 2013, p.4, Available at:
http://corporatelawreporter.com/2013/12/03/right-first-refusal-contractual-restriction-transfer-shares/
33
SLP (C) 33429-33434 of 2010
34
Tony Khindria, Scope and Enforceability of Shareholders’ Agreements, International Business Law Journal,
Vol. 2, 1995, pp. 261-271

Page 24 of 29
It may then be wisely argued that as long as any provision in the agreement does not defeat
the purpose of an existing statute, the same must receive valid recognition under the law. In
fact, the Supreme Court itself in the celebrated case of Gherulal Parekh v. Mahadeo Das 35
has clearly ruled that the freedom of contract can be restricted by law only in cases where it is
incontestably for the established good of the community and courts cannot invoke new heads
of public policy.36 The court also stated that though sanctity of contract is of paramount
importance, yet courts may relieve parties of their duties under the rule founded on public
policy which extend not only to harmful cases but also to harmful tendencies.

Using this argument, it would not be justifiable for courts to strike down the validity of
shareholder agreements only on the ground that they are inconsistent with the articles of the
company, even though they conform to the spirit of law. If parties in the agreement, by
themselves agree to waive certain rights and if the same is not deleterious for other parties to
the agreement, then freedom of contract should not be relegated. In modern times,
shareholder’s agreements have assumed greater importance keeping in mind the growing
volume of international commercial transactions entered into by the Indian Companies.
Parties sign such agreements with clarity of mind and awareness. In such circumstances, it is
indeed not fair to allow parties to evade their duties outlined in the agreement at their own
convenience simply because the law in India is still vague regarding the same. The law needs
to take cognizance of practical situations that arise in real life and protect such agreements
along with the parties against whom the breaching parties make use of the protection of law
to get away without fulfilling their share of duties.

Commercially, restrictions on transfer of shares are common and often form the basis of a
partnership or joint venture or investment arrangements. The Supreme Court by way of its
latest Vodafone judgement has shown inclination towards enforceability of ROFRs
provisions incorporated in the SHA. However, whether the decision in Rangaraj case has
been truly overruled or not is still debatable since the principle of ROFR discussed in the
judgement was not dealt as a part of the Ratio of the judgement. However, ROFRs are viewed
as bonafide arrangements of commercial nature entered between shareholders and in light of
the view taken by the Supreme Court in the Vodafone judgement favoring the enforceability
of ROFR provision in the SHA, notwithstanding the same being incorporated in the articles
of the associations, seems like a change in the mindset of the Indian Judiciary.
35
1959 SCR Suppl. (2) 406
36
Priyoma Majumdar, “Enforceability of Shareholder Agreements in India: A Legal Paradox?” , J. Corp.
Affairs & Corp. Crimes, pp. 103-105

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In light of the revised definitions under Companies Act, 2013 and the recent judgments, the
legal position with respect to validity of restrictions on transfer of shares of a public company
can be summarized as under:

- An agreement between shareholders restricting the transfer of shares in a public

company does not violate the legal mandate of free transferability of shares of a
public company;
- Restrictions on transfer of shares as aforesaid, must not be in violation of the articles
of association of the public company or the governing law;
- Such agreement restricting transfer of shares, can be enforced as a contract amongst
and against the shareholders who are party thereto;
- However, such contractual restrictions on transfer of shares of a public company are
not enforceable against the company, in case the company is not a party to the
agreement containing such restrictions.

BIBLIOGRAPHY

ARTICLES

1. Dr.K.R. Chandratre, Restrictions on transfer of shares in a private limited company,

Available at: http://www.bcasonline.org/articles/artin.asp?49
2. Hemant Shah, Controversy on Section 111A of the Companies Act, 1956, Available
at: www.hedge-square.com/wp-content/uploads/2012/01/resources4.pdf
3. Nitin Potdar, ROFR’s Now Enforceable? Available at:
http://thefirm.moneycontrol.com/story_page.php?autono=486144
4. Priyoma Majumdar, “Enforceability of Shareholder Agreements in India: A Legal
Paradox?” , J. Corp. Affairs & Corp. Crimes
5. Ravikumar.G, Section 111A of The Companies Act, 1956, Available at:
http://www.caclubindia.com/judiciary/section-111a-of-the-companies-act-1956-
transfer-of-shares– 120.asp.UpTL3SgrVUS

Page 26 of 29
6. S. Muralidharan, When shareholder’s Agreement is enforceable?, November 1, 2010,
Available at: http://www.thehindubusiness
line.com/2006/08/03/stories/2006080300251100.htm
7. Sanjay Mathur, ROFR is not a Restriction on free transferability under Section 111A,
Available at: http://ezinearticles.com/?Right-of-First-Refusal-Is-Not-a-Restriction-on-
Free-Transferability-Under-Section-111A&id=5907974
8. Satyajit Gupta, A twist in the tale: Share transfer restrictions in a public limited
company legal?, Available at: http://indiacorplaw.blogspot.in/2010/09/twist-in-tale-
share-transfer.html
9. Somasekhar Sundaresan, “Public Company shares cannot be fettered at all”,
Available at: http://indiacorplaw.blogspot.in/2010/02/public-company-shares-cannot-
be.html
10. Suresh Savaliy, Restriction on Transfer of Shares in a Public Company, Available at:
http://www.lawyersclubindia.com/articles/Restriction-on-Transfer-of-Shares-in-a-
Public-Company-4407.asp
11. Tony Khindria, Scope and Enforceability of Shareholders’ Agreements, International
Business Law Journal, Vol. 2, 1995, pp. 261-271

BOOKS

1. A Ramaiya, Guide to the Companies Act, 17th edn., 2010, Part 1, Lexis Nexis
Butterworths, Wadhwa, Nagpur
2. Sethna Jehangir, The Indian Company Law, 11th edn., Vol. 1, 2005, Modern Law
Publications

CASES

1. Gherulal Parekh v. Mahadeo Das, 1959 SCR Suppl. (2) 406

2. M.S.Madhusoodhanan v. Kerela Kamaudi pvt. Ltd., (2003) 117 CompCas 19 SC
3. Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd., 1999 (97) CompCas 301 Guj
4. Messer Holdings Ltd. v. Shyam Madanmohan Ruia, [2010] 98 CLA 325
5. Pushpa Katoch v. Manu Maharani Hotels Limited, 2006 (131) CompCas 42 Del
6. V B Rangaraj v. V B Gopalakrishnan, [1991] 6 CLA 211

Page 27 of 29
7. Vodafone International Holdings B.V. v. Union Of India and another, 2012 (1) UJ
334
8. Western Maharashtra Development Corporation v. Bajaj Auto Ltd., (2010) 154
CompCas 593 (Bom)

REPORTS & NOTIFICATIONS

1. Abhijeet Swarup & Vivek Kumar Aggarwal, Enforceability of Provisions not forming
part of the Company Documents, SEBI & CORPORATE LAWS, The Corporate Law
Weekly, Vol.86, September 22, 2008
2. David I. Walker, Rethinking the Right of First Refusal, 5th Stanford Journal of Law,
1999, Discussion Paper No. 261, The Harvard Law School
3. Enforceability of provisions not forming part of the company documents: An analysis
in the law, SEBI & Corporate Law Weekly Issue, September 22, 2008
4. Krishna Datta, Right Of First Refusal, Corporate Law Reporter Part 4, December 3,
2013, p.4, Available at: http://corporatelawreporter.com/2013/12/03/right-first-
refusal-contractual-restriction-transfer-shares/
5. Report on Companies Act, 2013, Available at: http://aishmghrana.me/companies-act-
2013/
6. Report on Companies Bill, Available at:
http://www.thehindu.com/business/Industry/companies-bill-
passed/article5003777.ece
7. SEBI Notification issued on October 3, 2013, Available at:
http://indiacorplaw.blogspot.in/2013/10/sebi-notification-on-pre-emption-rights.html
8. SEBI Notification on Pre-Emption Rights, Put and Call Options, Issued on October 4,
2013
9. The Gazette of India Extraordinary, Part III, SEBI Notification (Mumbai), 3 rd
October, 2013
10. Transfer and Transmission of Securities (Companies Act, 2013), Available at:
http://aishmghrana.me/2013/10/01/transfer-and-transmission-of-securities-companies-
act-2013/

Page 28 of 29
 STATUTES

1. The Companies Act, 1956

2. The Companies Act, 2013
3. The Depositories Act, 1996
4. The Securities Contract (Regulation) Act, 1956

WEBSITES

1. www.manupatra.com
2. www.indiankanoon.com
3. www.indiancorplaw.in
4. www.jstor.org
5. www.lawyersclubindia.com

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