India: JV: Ride On Private Or Public Co Vehicle?

Last Updated: 4 July 2011
Article by Lalit Kumar

It is quite common to find in a joint venture agreement provisions regarding the transferability of shares held by the joint venture partners in such a company. These provisions pertain to lock-in period when no partner can sell the shares, the right of first refusal in favour of the other partner in case a partner wishes to sell her shares, and put or call options on the occurrence of certain events.

These provisions are of critical importance for joint venture partners, and thus, it is important to have a joint venture entity where these can be legally enforced. Otherwise, the purpose of providing these provisions will be defeated. Enforceability of these provisions also vary, depending on the kind of company - private or public - formed by the joint venture partners.

The Companies Act, 1956 - which governs private and public companies - permits a private company to impose restrictions on the transferability of its shares. A public company, however, cannot impose such restrictions, as the shares of a public company are freely transferable under the Act.

Further, as a private company is permitted to impose restrictive provisions on transferability of shares, it also has freedom to incorporate those restrictive provisions in its by-laws, or the articles of association. Also, given that the articles of association is a constitutional document of a company, any provision incorporated in it becomes the constitutional provision of that company and binds all shareholders of the company inter se and also the company. In such cases, restrictive provisions on transferability of shares provided in the articles of association will become binding for that private company.

The position is completely opposite in case of a public company. Section 111A of the Act provided that the shares of a public company shall be freely transferable. This implies that there cannot be a restriction imposed on the transferability of shares held in a public company. Therefore, a public company cannot incorporate a provision in its articles of association that restricts the free transferability of shares.

If such a provision is provided in the articles of association, it would be in contravention of the Companies Act and, hence, would be void. This interpretation of the Act was upheld by many judicial pronouncements. The courts have held that a provision - whether in a joint venture agreement or in the articles of a public company that restricts the transferability of shares - will be void and, accordingly, not enforceable.

This position was again discussed recently by a division Bench of the Bombay High Court in the matter of Messer Holdings Ltd vs Shyam Madanmohan Ruia where the Bench disagreed with the precedents and held that the expression 'freely transferable' used in Section 111A does not mean that shareholders cannot enter into consensual arrangement or agreement in relation to specific shares held by them.

It said that the legal provision of Section 111A of the Act does not expressly restrict or take away the right of shareholders to enter into consensual arrangement or agreement in respect of shares held by them. This judgment is a positive step for shareholders of public companies, as it upholds their right to deal with their shares in the manner they want, including contractually agreeing with other shareholder(s) to such provisions that impose restriction on the transferability of shares held by them. The contractual arrangement so agreed will be binding on the shareholders who agree to such an arrangement.

However, it may be noted that in the case of a public company, such provisions in the joint venture agreement will remain only as contractual provisions. This implies that they can be provided only in the joint venture agreement but not in the articles of a public company.

Therefore, even after the Messer judgment, the fundamental difference is that while in the case of a private company, these provisions are constitutional provisions provided in the articles and, hence, binding and enforceable against all the shareholders and the private company, the same will not apply to a public company.

In the case of a public company, such provisions cannot be provided in the articles of association and will remain contractual provisions enforceable only against the shareholder(s) who has/have contractually agreed to those provisions. Also, it cannot be enforceable against a public company.

Though this recent judgment has brought relief to the shareholders of public companies as far as their freedom on transferability of shares is concerned, and now even in a public company, the shareholders, private equity and strategic investors can negotiate and enter into shareholders' or joint venture agreements that contain such restrictive provisions and have them enforced against the other shareholders who agreed to such provisions.

Given that the ability to specifically enforce these provisions against the company stands at much better legal footing in case of a private company than a public one, a private company would be a better vehicle to run joint ventures.

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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