The National Company Law Tribunal (“NCLT”), Mumbai in the matter of Riverdale Infrastructures Private Limited v. Kirloskar Ebara Pumps Limited, Ebara Corporation and Kirloskar Brothers Limited (decided on May 26, 2020), dismissed the appeal against refusal to register share transfer in a public company, thereby upholding the validity of clauses of joint venture agreement and articles of association.

Facts
Kirloskar Ebara Pumps Limited (“KEPL”) was incorporated pursuant to a joint venture agreement dated January 27, 1988 (“JVA”) between Ebara Corporation (“Ebara”) and Kirloskar Brothers Limited (“KBL”). KEPL had a total of 68 shareholders with Ebara holding 2,25,000 shares of KEPL. KEPL, Ebara and KBL are hereinafter collectively referred to as “Respondents”.

In terms of Clause 6.01 of JVA and Article 51(b) of Articles of Association of KEPL (“AoA”), a party was barred from transferring its shares unless prior written consent was obtained from the other party; and, in case either party offers to transfer any such shares with the consent of other party, such other party shall have the Right of First Refusal (“RoFR”) of such offer. Under Clause 11.02 of JVA, in the event of refusal, if no reply is communicated within 3 months to offering party, it may sell the shares so offered to any third party within 3 months thereafter.

In December 2016, Ebara had offered to sell its shares to KBL. Even after several rounds of discussion, the parties could not arrive at an amicable resolution regarding the terms of sale. Thereafter, in March 2017, Ebara sold its shares to Riverdale Infrastructures Private Limited (“Appellant”) under a Share Sale and Purchase Agreement (“SSPA”). KEPL refused to register the transfer as Ebara had failed to obtain prior written consent of KBL as required under the JVA and AoA. Aggrieved by this, the Appellant filed an appeal with NCLT, Mumbai to strike down Clause 6.01 of JVA and Article 51(b) of AoA to the extent that they were ultra vires Section 58 of the Companies Act, 2013 (“Companies Act”) and to direct KEPL to register the transfer of shares.

Issue
Whether the refusal by KEPL to give effect to the registration of shares acquired by the Appellant from Ebara is permissible within the framework of law, given that KEPL is a public company, and public companies, by definition, cannot restrict transfer of shares as is permissible in a private company.

Arguments

Contentions raised by the Appellant:

The counsel for Appellant contended that the two requirements under the JVA and AoA, namely, prior consent of non-exiting party, and, pre-emptive right to acquire the shares of exiting party, are inter-linked. The right to consent (or to reject consent, as the case may be) is a right in aid of first refusal, intrinsically embedded in the very same provisions. If they were not inter-linked; it would amount to an unconditional restriction on transfer of shares without consent of other party, which would have the effect of converting KEPL into a private limited company. Such an agreement would also not be valid under proviso to Section 58(2)of the Companies Act (recognizes enforceability of a contract or arrangement between two or more persons in respect of transfer of securities even in a public company where shares are freely transferable) because the said proviso is not a proviso to Section 2(68) and Section 2(71) of the Companies Act defining a private company and public company respectively. If a public company could put a blanket restriction on transferability of shares by virtue of said proviso, it would in effect render nugatory the basic difference between a private and public company.

It was further contended that KBL had consistently evaded responding to the offer made by Ebara. Therefore, the non-reply constitutes deemed refusal after completion of 3 months period. The consent to proceed with transfer to third party in line with Clause 11 of JVA and Article 51(b) of AoA was implicit in such rejection.

Contention raised by the Respondents:

The primary contentions of Ebara:

The provision of prior written consent cannot be an absolute embargo at the instance of one party, which would permit such party to impose harsh conditions whereby other party would not be able to exit. The parties only intended to incorporate a RoFR and not anything more. If prior written consent is considered as a condition precedent in addition to RoFR, it would amount to an absolute prohibition, which is impermissible in law and unenforceable even under proviso to Section 58(2) of the Companies Act. Upon rejection of Ebara’s offer by KBL, no additional consent from KBL would be required.

The primary contentions of KEPL and KBL:

In rejecting the transfer, KEPL was bound by the terms of JVA and AoA. A mere restriction in a contract as between two or more shareholders in respect of transfer of shares, in terms of proviso to Section 58(2) of the Companies Act cannot be held to be contrary to the definition of a public company. The JVA does not violate Section 58(2) of the Companies Act as it binds only 2 out of the 68 shareholders.

A proviso operates as an exception and not the general rule laid down. (Relying on S. Sundaram Pillai and Others v. R. Pattabiraman and Others [(1985) 1 SCC 591] and Ali M.K. v. State of Kerala [(2003) 11 SCC 632]. Thus, by the proviso to Section 58(2)of the Companies Act, a contract or arrangement between two or more persons in respect of transfer of securities was enforceable, as an exception to the general rule.

In the judgment of Honourable Bombay High Court in Bajaj Auto Limited v. Western Maharashtra Development Corporation Limited [(2015) (4) Bom CR 299], which was also affirmed by Honourable Supreme Court on January 9, 2019,the pre-emption agreements relating to transferability of shares of a public company entered into by two or more shareholders under proviso to Section 58(2) were held to be valid and enforceable.

Observations of the NCLT

The observations of NCLT, Mumbai were as follows:

(i) The principle of law embodied in the proviso to Section 58(2) of the Companies Act is not in conflict with the definition of a public company under Section 2(71)of the Companies Act. There is nothing in law that stops two or more shareholders from entering into a covenant containing clauses for pre-emption. This was recognized through judicial pronouncements under earlier Companies Act, 1956, and was then embodied in proviso to Section 58(2) of the Companies Act, 2013.

(ii) Both parties knew fully well the consequences of their contract.

(iii) KEPL cannot be expected to be run in violation of the AoA without inviting trouble for itself. It had no option but to refuse the transfer.

(iv) Only a civil court can decide whether the contract itself contains clauses that are too onerous or incapable of performance. The fact that Ebara did not opt for novation, rescission or alteration of the contract, shows that it did not think that the contract was unfair.

(v) Under Clause 7.6 of the SSPA (requiring the Appellant to sign and deliver to KBL a letter agreeing to comply with and be bound by the terms of the JVA), Ebara effectively accepted its responsibility under the JVA and shifted it to the Appellant. This shows that neither Ebara nor Appellant found the terms of JVA to be onerous or contrary to the law. In case the Appellant found the terms of JVA to be unfair, the choice was always open to it to approach a civil court for alteration of the contract.

Order of the NCLT

The appeal against refusal to register the transfer of shares was dismissed by NCLT.

Vaish Associates Advocates View
The primary object of allowing free transferability of shares in a public company is to ensure that the interest of investors is not hampered by refusal on part of the company to register the transfer without assigning any sufficient reason and to ensure that the shareholders are able to monetize their shares freely. However, a consensual arrangement between two or more shareholders to incorporate a pre-emption clause in respect of transfer of shares does not impede the legal mandate of free transferability of shares. Such an agreement, by its very terms, binds only the contracting parties and does not in any way impose the restriction on all the shareholders of the company to sell its shares only to other existing members.

The proviso to Section 58(2) of the Companies Act expressly recognizes the validity of such private arrangements between two or more shareholders of a public company. By this order, NCLT, Mumbai re-affirms the same and clarifies that requirement of prior consent of the non-exiting party for transfer of shares by exiting party does not infract the proviso to Section 58(2) of the Companies Act and is not in conflict with the definition of a public company. It cannot amount to changing the character of a public company to a private company. If the case be so, it would render the said proviso a nullity.

For more information please write to Mr. Bomi Daruwala at [email protected]

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