India: Whether Breach Of Contractual Obligations Is A Ground For Rectification Of The Register Of A Public Company

Last Updated: 29 August 2017
Article by Solomon & Co.

Introduction

On 22nd February 2016, the Hon'ble High Court of Bombay considered an appeal under Section 10F of the Companies Act, 1956 against an order of the Company Law Board on an application under section 111A of the Companies Act 1956, which deals with rectification of the register of public companies on transfer of shares, in the case of Industrial Development Bank of India Ltd. v. Parmeshwari Fabrics Private Limited & Ors.

Section 111A (2) states that the shares of a public company are freely transferable and that a public company cannot refuse to register a transfer of its shares without sufficient cause. Section 111A (3) states that if shares have been transferred in contravention of any of the provisions of the Securities and Exchange Board of India Act, 1992, the Sick Industrial Companies (Special Provisions) Act, 1985 or any other law for the time being in force, the Tribunal may direct the company to rectify its register or records.

The Bombay High Court had to consider whether breach of contractual obligations in a private agreement amounted to a contravention of "any other law for the time being in force" and was thereby a ground for rectification of the register of a public company.

Facts

Pursuant to a Notification issued by the Government of India, the erstwhile United Western Bank Ltd. ("UWB") was amalgamated with Industrial Development Bank of India Ltd. ("IDBI") under a Scheme of Amalgamation. Under the Scheme, IDBI had to make a payment of Rs.28 per share to the shareholders of UWB whose names were reflected in the register of UWB on a prescribed date.

IDBI argued that when IDBI examined the records of UWB after the prescribed date, it found that UWB had entered into Articles of Agreement in 2002 with one Mr. Makharia (who represented other members and associate enterprises of the Makharia group) and under these Articles of Agreement, UWB had a right of pre-emption upon the transfer of shares held by the Makharias in UWB. However, in contravention of the Articles of Agreement, the shares held by the Makharias in UWB had been transferred by way of pledge or sale to various third parties without offering them to UWB. As a result, the names of these third party purchasers were reflected in the register of UWB on the prescribed date.

Therefore, IDBI filed a petition before the Company Law Board ("CLB") under Section 111A of the Companies Act 1956 seeking rectification of the register of UWB by deleting the names of these third parties and reinserting the names of the transferors i.e. the Makharias.
This petition was dismissed by the CLB because the CLB held that a breach of the Articles of Agreement i.e. a breach of contractual obligations was not a ground specified in Section 111A (3) for rectification of the register of a public company.
IDBI filed an appeal before the Bombay High Court challenging the order of the CLB.

Arguments by IDBI before the Bombay High Court

IDBI submitted that that sub-sections (2) and (3) of Section 111A must be read together. It argued that "in contravention of any other law for the time being in force" under Section 111A (3) was wide enough to include circumstances which amounted to "sufficient cause" under sub-section (2), including a breach of contractual obligations. IDBI contended that the transfer of shares by the Makharias to third parties in breach of their contractual obligations under the Articles of Agreement was tantamount to a contravention of law. Therefore, the petition for rectification of the register of UWB was maintainable under Section 111A (3).

Decision of the Bombay High Court

The Court rejected the arguments of IDBI and held that the expression "sufficient cause" in section 111A (2) is far wider than the expression "in contravention of... any other law for the time being in force" in section 111A (3). Although former could include contravention of contractual obligations, the latter would only apply if, after the transfer, it becomes apparent that the transfer has been effected in contravention of a law.  Therefore, it is not correct to say that sub-section (2) and sub-section (3) have to be read together or that they overlap each other. The breach of an agreement is a violation of a contractual obligation and cannot be stretched to say that it is the same thing as a contravention of a law.   

Therefore, the Court dismissed the Appeal by IDBI and held that Section 111A (3) does not apply when shares have been transferred in violation of a private agreement.

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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