The Division Bench in this decision held that such a private arrangement would not violate Section 111A of the Act for reasons discussed below.  This pronouncement overrules the judgment by the Single Bench of the Court in the matter of Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd wherein pre-emptive rights over shares of a public company were held to be patently illegal.
 
Judicial Precedents

A synopsis of the law as it stood prior to the decision of the Division Bench on Messrs Holdings:

• The Supreme Court in 1992 in its decision in V.B. Rangaraj v. V.B. Gopalakrishnan; 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.


• The Gujarat High Court in 1998 in its decision in Mafatlal Industries Ltd., v. Gujarat Gas Co. Ltd relying on the Supreme Courts decision in V.B Rangaraj, did not enforce the pre-emptive rights of the shareholders of a public company as the same were not incorporated Articles of association of the said public company. 


• The Supreme Court in 2003 in its decision in M.S. Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd. not disagreeing with the decision in V.B Rangaraj but distinguishing itself from the facts in that judgment, held that a restriction in relation to identified members on identified shares of a private company did not amount to restriction of transferability of shares per se.


• The Delhi High Court in 2005 in its decision in Pushpa Katoch v. Manu Maharani Hotels Limited held that as per the provisions of Section 111A of the Act, there could not be any fetters on the right of a shareholder to transfer his/her shares in a public company and observed that a right of pre-emption, even if found in the articles of association, would be ultra vires the provisions of the Act


• The Single Bench of the Court in 2010 in its recent decision in Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd , in relying on the decision of the Delhi High Court in Pushpa Katoch held that pre-emptive rights over shares in a public company are a fetter on the transferability of such shares and therefore patently illegal.

• 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 111 A was meant to regulate the powers of the board of directors of a company qua the transfer of shares or 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, preemption/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.
  


• The decision in Madhusoodhanan's case 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 is not required to be embodied in the Articles of Association.  The Division Bench also relied on the distinction drawn by the Supreme Court in Madhuoodhanan from the proposition laid down in V.B Rangaraj in that the judgment arrived at by the Supreme Court in V.B Rangaraj 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.

Given the aforesaid rationale, it may still be questionable as to whether exit rights such as put option agreements and call option agreements where shareholders are obligated to buy or purchase shares (as the case may be) at a price other than the prevailing market price would fall within the framework of freely transferable as analyzed by the Division Bench in this judgment. 

(2) Amending articles of association – Rangaraj overruled?

The Division Bench in Messrs Holdings has also questioned the necessity of amending the articles of association of a public company to include such transfer restrictions. In fact the Division Bench has specifically stated that such consensual agreements between particular shareholders relating to their shares can be enforced like any other agreements and it is not required for such arrangement to be embodied in the Articles of Association.  Further, the Division Bench in relying on the Supreme Courts decision in S.P. Jain v. Kalinga Tubes has also commented on the non-necessity of a company being party to such private arrangements between shareholders.

In light of the aforesaid, it is questionable as to whether the principles enumerated in the Supreme Courts decision in V.B Rangaraj, namely for a company to be bound by a restriction on transfer of shares the same would have to form part of the articles of association of a company, have been negated by the decision of the Division Bench in the Messers Holdings judgment. In our opinion this may not be the case. It may be noted that the principles laid down by the Supreme Court in V.B Rangaraj were further analysed by the Supreme Court in Madhusoodhan which concluded that the judgment arrived at by the Supreme Court in V.B Rangaraj 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 Division Bench in this case of Messers Holdings has agreed with the interpretation of the Rangaraj decision by the Supreme Court in Madhusoodhan and in the spirit of free transferability has extended this concept to private arrangements between shareholders in a public company. However, should certain provisions be required to enforced against a company, the rationale relied on by the Division Bench for not incorporating such transfer restrictions in the articles of association of the company or making the company a party to such arrangements, may not necessarily hold well. Consequently, the rationale behind V.B Rangaraj may come into play which means that principles laid down in V.B Rangaraj still hold good.

(3) Liberalization of investor rights