The Securities and Exchange Board of India (SEBI) is investigating Punjab National Bank Housing Finance (PNB Housing Finance), a business founded in 1988 and registered under the National Housing Bank, for its recent preferential issue of shares.

PNB Housing Finance's board of directors authorized the preferential allocation of equity shares and warrants to four businesses on May 31, 2021: Carlyle Group, General Atlantic, Salisbury Investments, and Alpha Investments. Following this assignment, Carlyle Group, a US-based private equity firm, would have been the dominant owner, and Punjab National Bank's interest in the company would have been cut to 20% from its current 32.64 percent. Unfortunately, before the contract could be implemented, it became embroiled in a slew of issues, drawing attention to the finer points of the agreement.

Stakeholders Empowerment Services (SES), a proxy advisory business, believed the acquisition was unjust and pushed minority shareholders to vote against it, bringing the issue to public notice. They argued the sale was unjust, claiming that the price set for the shares was not fair and did not reflect the genuine worth of the stock. To make matters worse for PNB Housing Finance, SEBI has ordered the company's Extraordinary General Meeting (EGM) to be halted. The EGM notification was found to be in violation of the company's Articles of Associations (AoA) because the mechanism used to calculate the price of the shares was not in compliance with their AoA.

Article of Association Violation

The most controversial of all the claims against PNB Housing Finance is the process used to price the shares. These shares were allotted at a price of INR 390 per share, which was lower than the current market price of INR 540 per share. In such a scenario of preferential allocation, the price of shares should be established on the basis of a valuation report from a registered valuer, according to the PNB Housing Finance AoA. PNB, on the other hand, opted to do the appraisal in accordance with statutory standards, disregarding the approach outlined in its own AoA. According to SEBI, this is ultra-vires the AoA and so prohibited.

The pricing of preferential allotment shares is subject to Section 62(1)(c) of the Companies Act 2013, Rule 13(1) of the Companies (Share Capital and Debentures) Rules 2014 (Share Capital Rules), and Regulation 164 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 under the existing legal framework (ICDR). Section 62(1)(c) of the Act authorizes the issuing of additional shares by preferential allocation and directs the procedure to Rule 13 of the Share Capital Rules.

The provision to Rule 13 of the Share Capital Rules states that if a listed business issues preferential shares, the price of the shares does not have to be established by a registered valuer's valuation report. In this case, if a registered valuer's valuation report is not required, Regulation 164 of the ICDR lays out the procedure for determining price using the average approach. PNB Housing Finance claims that they followed this approach in arriving at the INR 390 per share price and that they were correct in doing so since they met all regulatory criteria, even though they did not examine the needed report from a registered valuer as needed by their AoA. They argue that the AoA is essentially a contract between the company's members, and that after they have completed the statutory criteria, it is up to them whether or not they desire to fulfil the AoA's obligations. PNB Housing Finance's explanation for non-compliance with its AoA was determined to be unacceptable by SEBI.

As a result, SEBI issued a letter prohibiting the EGM, which the company appealed before the Securities Appellate Tribunal (SAT). The corporation was given permission to hold the EGM, but the results could not be released until the case was resolved. Due to a difference of opinion between the two judges, a two-judge bench of the SAT issued an inconclusive decision on August 9, 2021. The temporary restraining order on releasing the results remained in effect. The Supreme Court will most likely rule on the case immediately.

The Supreme Court will have to decide whether a valuation report from a registered valuer in accordance with the AoA is necessary for accurate pricing. In other words, the question is whether the company's AoA is applicable if the statutory criteria have already been met.

Analysis of the AoA Violation

The AoA of a corporation is a well-established idea that the shareholders and directors are bound by it, as the Supreme Court recently confirmed in the case of Tata Consultancy Services Limited v. Cyrus Investments Private Limited and Others [2021]. The AoA is the "bedrock" of the firm, according to which choices must be made, and it represents a shared understanding for all of the organization's stakeholders. As a result, it cannot be dismissed without careful scrutiny.

At the same time, if the AoA is determined to be in violation of the Act, Section 6 of the Act states that the Act takes precedence over the AoA and the memorandum of association. As a result, if any provision of the AoA is ultra-vires the Act, the Act will take precedence over the provision, and there will be no need to adhere to it.

PNB Housing Finance has given the following two grounds to explain its act of non-compliance with its AoA in this case:

  1. That the AoA provision addressing a registered valuer's calculation for future preferential allocation of shares is in disagreement with the Act, and that the Act, as provided in Section 6 of the Act, shall take precedence over the AoA; and
  2. That the AoA is just a contract that must be followed at the discretion of the Board, and that it may or may not be followed if statutory conditions are met.

We argue that both these arguments are unsatisfactory and lack legal support.

In response to the claim that the AoA provision is in contradiction with the Act, we argue that such a reading is wrong, and that the two must be read together. The proviso to Rule 13 of the Share Capital Rules [2014] (which governs the procedure for further allotment of shares) simply specifies that obtaining a valuation report from a registered valuer is not required. As a result, it does not outright prohibit, but rather allows the listed business to pick its preferred method of valuation in accordance with the ICDR Regulations. When a company specifies in its AoA that the method of valuation to be used is valuation by a registered valuer, it signifies that the company has agreed to have the valuation done by a registered valuer exclusively. This finding is also consistent with the concept of harmonious construction, which states that, to the extent practicable, two seemingly contradictory clauses should be read in a way that gives effect to both. As a result, rather than understanding the two separate methods as contradicting each other, the AoA requirement and Rule 13 might be understood to suggest that the AoA imposes an extra responsibility regarding the valuation technique. The Supreme Court found in V.B. Rangaraj v. V.B. Gopalkrishnan and others [1992], a case involving the transfer of shares, that the AoA is binding on the company and its shareholders. As a result, AoA establishes a binding agreement among shareholders on the transfer or allotment of shares. To respect this common understanding as well as a company's liberty to operate when an alternative has been offered, it is vital to read the AoA and the legislation in a way that is harmonious wherever there is a potential for conflict.

Second, PNB's argument that AoA is just a contract that the board may or may not follow depending on whether the statutory conditions are met is erroneous. The AoA is the "bedrock" of the corporation, as stated in countless decisions and recently confirmed in Tata Consultancy Services Limited v. Cyrus Investments Private Limited and Others. It cannot be disregarded in a way that negatively affects the rights and position of the shareholders.


PNB Housing Finance's board of directors has authorized a value of the preferential issue of shares at a discount of 30% to the book price. More crucially, such a problem would eventually lead to Carlyle gaining control of the company's operations. This plainly implies that this preferential issue has a direct influence on the interests and standing of the shareholders, and that only complying with the law without also complying with the AoA would be a major breach of the board's duties.

Author: Abhishek Jena - a student of Symbiosis Law School (Hyderabad).

Justification Of Articles Of Associations (AoA) Violation By Statutory Compliance: The PNB Housing Finance Case

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