In Western Maharashtra Development Corporation v. Bajaj Auto Limited, Arbitration Petition No. 174 of 2006, decided on 15th February, 2010 (the pdf version of the judgment is available here), the Bombay High Court has held that Section 111A of the Companies Act, 1956 mandates that there can be no restriction whatsoever on the transferability of shares in a public company. Consequently, an agreement granting a right of pre-emption in respect of some such shares has been held as patently illegal. Justice D.Y. Chandrachud held, “The principle of free transferability must be given a broad dimension in order to fulfill 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 preemption 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 preemptive right created by the agreement between the parties. This is impermissible…”
The argument was taken that a right of pre-emption in an agreement between two parties, embodied in the Articles of Association of the company, bound only the two specific parties and was not a general restriction on transferability. This argument was rejected. The judgment of the Supreme Court in Madhusoodhan v. Kerala Kaumudi (which in turn had distinguished on facts the earlier decision in V.B. Rangaraj v. Gopalkrishnan) was held to be applicable only to private companies. The Bombay High Court followed the judgment of the Delhi High Court in Pushpa Katoch v. Manu Maharani Hotels in reaching its conclusion. It noted, “56. Counsel appearing on behalf of the Respondent submitted that Section 111A has no application to contracts for the transfer of particular shares between particular shareholders when incorporated in the Articles of Association. The submission is that restrictions which bind third parties are bad. Section 111A was intended to curb the power of the Board of Directors to obstruct transfers and clearer words would be required to destabilize bargains which are the heart of commerce. 57. The submission that Section 111A would not interdict "an agreement between particular shareholders relating to the transfer of specified shares" is based on the judgment of the Supreme Court in Madhusoodhanan (supra). In that case, as already noted earlier, the Supreme Court noted that the Karar was an agreement between "particular shareholders relating to the transfer of the specified shares". What is significant is that the Company in that case was a private Company. The Supreme Court noted with some emphasis that in the case of a private Company, the Articles of Association would restrict the right of shareholders to transfer shares and prohibit invitation to the public to subscribe for shares or debentures of the Company. The position in law of a Public Company is materially different. By the provisions of the Companies' Act, 1956, restrictions on the transferability of shares which are contemplated by the definition of a "private company" under Section 3(1) (iii) are expressly made impermissible in the case of a public company by the provisions of Section 111A. Once that be the position, the submission urged on behalf of the Respondent cannot be accepted. In essence, the submission of the Respondent is that the provisions of Section 111A should be read as being subject to a contract to the contrary. A restriction to that effect cannot be read into the provision of Section 111A; firstly because, such a restriction is not mentioned in the statutory provision; secondly, the word "transferable" is of the widest import; and thirdly, the context in which the provision has been introduced, is susceptible to the inference that it should be given a wide meaning. Where the language of the statute is plain and unambiguous, neither the consequence nor the conduct of parties would be of relevance…”
The implications of the judgment are discussed by Mr. Somashekhar Sundaresan in his post on Indian Corporate Law. I will analyse the judgment in another post subsequently.