India: Restrictions on Transferability of Shares

Last Updated: 14 June 2010

Article by Subashini R

A recent judgment rendered by the High Court of Bombay in February 2010 [Western Maharashtra Development Corpn. Ltd. Vs. Bajaj Auto Limited, (2010) 154 Comp Cas 593 (Bom)] firmly establishes the fact that a public company in India cannot provide for restrictions on the transferability of its shares.

A brief analysis of judicial precedents demonstrates that the mere execution by shareholders of a binding agreement or the inclusion thereof in the articles of association does not suffice to restrict the transferability of the shares held by them in a public company. It is therefore prudent to decide on a suitable form of entity - public or private company - to operate the joint venture business, in due consideration of the restrictions on transfer of shares sought to be imposed on parties to a joint venture or collaboration and the enforceability of the same under Indian laws.

One of the primary things that springs to mind about a public limited company is the liquidity of investment made in its shares. Such liquidity is created by the concept of free transferability of shares of a public limited company. The Indian Companies Act, 1956 ("Act") prescribes that the shares of a private limited company are not freely transferable and such restriction on the transferability of its shares must be expressly recorded within its articles of association (section 3(1)(iii)(a) of the Act). In contradiction, the shares of a public limited company are freely transferable and this is one of the key identifying attributes of a public limited company in India.

Business, however, has its own requirements and therefore parties entering into joint ventures and collaborations find it necessary to impose certain restrictions on the rights of each other to deal in the shares of the joint venture company through which they jointly conduct the business. Such restrictions may take the form of right of first offer/refusal, pre-emptive rights, negative covenants and other similar contractual arrangements. These usually find place within the shareholders agreements or other similar joint venture agreements executed between the parties who are the shareholders of that company and at times, the company in which the joint venture exists, may also be made a party to such agreements.

This review briefly examines whether such clauses restricting the free transferability of shares are in fact enforceable under the Indian Companies Act, against the company or the shareholders of such companies. In this article, we have restricted our analysis to the provisions of the Act.

Restrictions on Transferability of Shares in a Private Company

As stated above, the articles of association of a private limited company must state expressly that the right to transfer its shares is as restricted therein. It may thus provide for such grounds upon which the board of directors of the company may refuse the registration of its shares.

The pivotal position of law in this regard is in the oft-quoted case of [V B Rangaraj Vs. V B Gopalakrishnan (1992) 73 Comp Cas 201 (SC)]. On the question of whether shareholders can, amongst themselves, enter into an agreement which is contrary to or inconsistent with the articles of association of the company, the Supreme Court of India held, that the only restriction on the transfer of shares of a private company is as laid down in its articles of association, if any. A restriction which is not specified in the articles of association is therefore not binding either on the company or on the shareholders.

Reiterating the above principle and elaborating on the enforceability of the same among shareholders, the Supreme Court observed that "As far as private companies are concerned, the articles of association restrict the shareholder's right to transfer shares and prohibit any invitations to the public to subscribe for any shares in, or debentures of, the company." This is how a "private company" is now defined in section 3(1)(iii) of the Companies Act, 1956 and how it was defined in section 2(13) of the 1913 Act. Subject to this restriction, a holder of shares in a private company may agree to sell his shares to a person of his choice. Such agreements are specifically enforceable under section 10 of the Specific Relief Act, 1963, which corresponds to section 12 of the Specific Relief Act, 1977. The section provides that specific performance of such contracts may be enforced when no standard exists for ascertaining the actual damage caused by the non-performance of the act agreed to be done, or when the act agreed to be done is such that, compensation in money for its non-performance would not afford adequate relief. In the case of a contract to transfer movable property, normally specific performance is not granted except in circumstances specified in the explanation to section 10. One of the exceptions is where the property is "of special value or interest to the plaintiff, or consists of goods which are not easily obtainable in the market". It has been held by a long line of authority that shares in a private limited company would come within the phrase "not easily obtainable in the market". [M S Madhusoodhanan and Anr. Vs. Kerala Kaumudi Pvt. Ltd. and Ors, (2004) 9 SCC 204].

It is interesting to note that the Principal Bench of the Company Law Board has pronounced that even though a private company, being a subsidiary of a public company is defined as a public company in the Act, all the provisions in the articles of association to maintain the basic characteristics of a private company in terms of section 3(1)(iii) will continue to govern the affairs of such a company. One of the basic characteristics of a private company in terms of that section is the restriction on the right to transfer the shares and the same will apply even if a private company is a subsidiary of a public company. [Hillcrest Realty Sdn. Bhd Vs. Hotel Queen Road Pvt. Ltd. and Ors., [2006] 71 SCL 41 (CLB)]

Based on the above, it can be summed up that the powers for restricting the transfer of shares of a private company are binding only to the extent they are recorded within the articles of association. The following must also be noted:

  1. The right to transfer may be subjected to restrictions contained in the articles of association. Where a restriction is capable of two meanings, the less restrictive meaning will be adopted by the courts.
  2. The power to refuse the transfer of shares cannot be exercised arbitrarily or for any other collateral purpose and can only be exercised for a bonafide reason in the interest of the company and the general interest of the shareholders. Where by its articles of association a company reserves the right to refuse the transfer of shares, the burden of proving that such refusal was not bonafide is on the person who so alleges.
  3. While there may be restrictions on the transferability of the shares, there cannot be an absolute prohibition on the right to transfer of shares. In this regard, it is helpful to note that a right of pre-emption has been held to not amount to a prohibition upon transfer.

Restrictions on Transferability of Shares in a Public Company

The validity of restrictions in private agreements on the transferability of public companies has been the subject matter of several judgments. The Principal Bench of the Company Law Board examined a provision in the articles of a public limited company requiring a selling member to give notice to the board, who would then act as an agent to sell the shares to other members at an agreed price or at a price to be determined through arbitration and held that the articles of a public company cannot contain provisions destructive of free transferability and therefore, such a provision was held to be misfit with the concept of a public company. [Arjun S Kalro Vs. Shree Madhu Industrial Estates Ltd (1997) 1 Comp LJ 318 (CLB – PB)]

The High Court of Delhi upheld an order of the Company Law Board on the ground that the articles of association of the company, which was a public limited company, shall prevail over any family settlement. The Court noted that even if there was a provision for pre-emptive rights in the articles of association, it would have been ultra vires the provisions of the Act, as no company can provide in the articles of association any matter which offends the specific provision of an Act, namely, sub-section (2) of section 111A of the Act which specifically provides that the shares or debentures and any interest therein of a public company shall be freely transferable. [Smt. Pushpa Katoch Vs. Manu Maharani Hotels Ltd. and Ors., [2006] 131 Comp Cas 42 (Delhi)]

The recent Bombay High Court judgment clearly lays to rest any open questions on the issue of restricting the free transferability of shares of a public limited company. The Court observed that, "The effect of a clause of pre-emption is to impose a restriction on the free transferability of the shares...This is impermissible."


The judgment of the Bombay High Court addresses, directly and forcefully, the question of whether adopting of restrictions on the transfer of its shares within the articles of association of a public company would provide any legitimacy to such restrictions and answers the same in the negative. The Court declined to accept the submission that an agreement restricting transferability of only specified shares between particular shareholders would not be offensive of the doctrine of free transferability of shares in a public company. Thus, the views expressed by the Bombay High Court in the aforesaid judgment provide valuable guidance to all parties to a joint venture/business collaboration, on the implications and consequences of incorporating a public limited company in India to act as the joint venture company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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