May 31, 2021
Compulsory Share Transfer Provisions - A Tool To Oppress Minority?
By Mohit Sharma
Abstract
Corporate Governance refers to the set of practices through which a company is governed. In India, there are various compliance requirements under Companies Act, 2013 and SEBI (LODR) Regulations, 2015, for a company from the point-of-view of corporate governance. Some of these requirements are appointment of independent directors, prior disclosure of related party transactions, quorum for board meetings etc. These practices ensure that a company is managed in a way that is in the best interests of minority shareholders and other stakeholders. However, the question of validity of compulsory share transfer provisions and their exercise by a company to forcefully oust a shareholder, has not been covered extensively by a lot of academicians in India. In this article, the author shall discuss the legal validity of compulsory transfer of shares in India and examine their justification from the lens of corporate governance.
I. INTRODUCTION
Share, as per Section 2(84) of the Companies Act, 2013, means a share in the share capital of the company. Apparently, the definition given under the Companies Act, 2013 does not properly describes the characteristics of a share. In the general parlance, shares represents ownership in a company and allows the shareholder to participate in the decision-making process in the company. Further, a shareholder is also entitled to receive dividends, if declared by the company.
Under Section 44 of the Companies Act, 2013, share is a movable property and can be transferred in the manner provided in the Articles of Association of the company. Under the Companies Act, 1956, Section 84 was the corresponding provision. However, there is no provision under the Companies Act, 2013 which allows or prohibits compulsory transfer of shares. Hence, compulsory transfer of shares is generally dealt either by the Articles of Association (AoA) or the shareholder’s agreement.
Compulsory transfer of shares refers to a mechanism where a shareholder becomes bound to transfer his shares, if the other shareholders of the company decides so, by way of a general resolution or special resolution or a higher threshold, in case, the AoA or the shareholder’s agreement provides so. While this can be an additional way to kick out the shareholders creating nuisance, it can become a tool to oppress minority shareholders as well.
II. JUDICIAL POSITION IN INDIA
In Mallina Bharathi Rao v. Gotham Solvents Oils Limited¹, the Articles of Association was amended to include an article saying that if 90% of the members in share capital and number agree by way of a special resolution, the shareholder will be deemed to have served a notice on the company to transfer his shares under Section 108 (1) of the Companies Act, 1956. Eventually, this article was used by the company and shares of two particular shareholders were transferred forcefully.
This action of the company was challenged by the two shareholders before the Company Law Board, Chennai (CLB). The two shareholders were spouses of each other. The company alleged that the two shareholders were writing malicious letters to various authorities like Income Tax Department, Department of Company Affairs etc., in order to harass the management and their actions had brought the company to disrepute. Hence, their acts warranted the company to exercise the powers under Article 16B of the AoA regarding compulsory transfer of shares.
The CLB, in this case, refused to go into the issue of whether a company can have the powers to expel a member through passing a resolution in the general meeting. Instead, the CLB examined the issue with respect to Section 108 of the Companies Act, 1956. Section 108 (1) of the Companies Act, 1956 provides that a share transfer instrument duly signed by the transferor or by a person on his behalf and by the transferee or by a person on his behalf along with the share certificates has to be served on the company for it to register transfer of shares or debentures. In this case, no share certificates were served on the company, since it was not a voluntary transfer. Further, even though the Articles of Association allowed a director to sign on the transferor’s behalf, as per the CLB, it was against Section 108 (1), since only transferor could authorize a person to sign on his behalf and not Board of Directors. Therefore, such transfer was held to be void under Section 9 of the Companies Act, 1956, being in contravention of Section 108 (1).
The Andhra Pradesh High Court, however, examined the issue of validity of Article 16B which facilitated compulsory transfer of shares. Relying on Sidebottom v. Kershaw², the AP High Court ruled that a provision facilitating compulsory transfer of shares is perfectly valid. However, it comes with a catch. The catch is that the provision must be exercised in the interests of the company and not just for the benefit of majority shareholders. Further, the Court emphasized on the fact that AoA is a contract between the parties and is binding on the parties as long as it is lawful. Having said this, the AP High Court went on rule that the exercise of power under Article 16B was not justified since writing letters to various authorities alleging mismanagement in the company was not against the interests of the company as it only brought disrepute to the management and not to the company.³ Further, with respect to Section 108 of the Companies Act, 1956, the Court overruled CLB, Chennai stating that the expression “by or on behalf of the transferor” allowed one of the directors to act on shareholder’s behalf and execute the share transfer instrument.
Interestingly, the Department of Company Affairs in 1975 had issued a circular which stated that companies incorporating provisions regarding compulsory transfer of shares were contrary to the principles of companies’ jurisprudence and were therefore, void. The circular further said that such a provision was against various provision of the Companies Act, 1956. For example, under Section 395 of the Companies Act, 1956, the Courts could interfere if a member was forcefully driven out of a company.⁴
In K. Leela Kumar v. Government of India⁵, there was a Section 25 company engaged in sports and other recreational activities. Article 28 of the AoA of the company had a clause which permitted compulsory transfer of shares by virtue of passing of a special resolution. The company exercised its powers under Article 28 and shares of certain shareholders were transferred on ground of their misconduct resulting into tarnishing the image of the company. The members approached the Madras HC against the action of the company. The Madras High Court noted that the 1975 circular merely represented the Department’s view and was not a statutory order. Further, it was only applicable to a public limited company and not to a company formed under Section 25 of the Companies Act, 1956. Hence, Article 28 being present in the AoA of the company (which is a contract), was absolutely valid.
Recently, this issue again came into limelight in the Tata-Mistry corporate saga. In Cyrus Investments Pvt. Ltd. v. Tata Sons Ltd⁶, amongst other issues, the validity of a compulsory transfer provision which was present in the nature of Article 75 of the AoA of Tata Sons Pvt. Ltd, was also in question. Article 75 provided that if a special resolution is passed in a general meeting, then it will be deemed that the members has served a notice upon the company for selling its shares under Section 56 of the Companies Act, 2013. The NCLT upheld the validity of Article 75 saying that the members of the Shapoorji Palonji group knew about the existence of Article 75 when they voluntarily agreed to become members of Tata Sons. Although the NCLAT overruled the NCLT’s decision on various points, it agreed with NCLT on the validity of Article 75. NCLAT reiterated saying that AoA is a contract which is binding on all the members and the company and every member who agrees to become a member of the company, is bound by the AoA. The only limitation is that it should be exercised in the interests of the company and not just for the benefit of the majority shareholders.⁷ This view has been upheld by the Supreme Court of India in its final judgment⁸ dated 26th March 2021 as well.
III. JUDICIAL POSITION IN UNITED KINGDOM
In Sidebottom v. Kershaw⁹, an alteration was made to the Articles of Association of the company whereby if a shareholder was engaging in competitive business, his shares could be compulsorily transferred. In pursuance of the compulsory transfer provision, shares of certain members were transferred. This action was challenged but the Court of Appeal held that the the action of the company was in the interests of the company and was therefore, justified.
In Staray Capital Ltd v. Cha¹⁰, the Privy Council was faced with a similar situation. In this case, two individuals incorporated a company to undertake some business. However, later on, their relationship started deteriorating and one members was accused of providing false credentials. Eventually, the AoA was amended and an provision enabling compulsory transfer of shares by virtue of passing of a special resolution, was inserted. Under the provision, shares of the member who had made material misinterpretations during acquisition of shares of the company, could be compulsorily transferred. The company acted on this provision and shares of the other member was transferred.
The Privy Council relied on Sidebottom v. Kershaw¹¹ to rule that compulsory transfer provisions are legal as long as they are used for the benefit of the company. However, in this case, the Privy Council nullified the exercise of compulsory transfer provision saying that the misinterpretations made were not material enough to meet the test laid down in the case of Sidebottom v. Kershaw¹².
Hence, it can be concluded that in both UK and India, the judicial position on the validity of compulsory share transfer provisions is one and the same.
IV. EXAMINING THE PROS AND CONS OF COMPULSORY SHARE TRANSFER PROVISIONS
Under the company law jurisprudence, the principle of majority rule is one of the most important principle of corporate governance. The majority rule says that the company is run as per the decisions of the majority shareholders expressed by way of general resolution or special resolution. In Foss v. Harbottle¹³, two members approached the Court alleging mismanagement by the directors of he company. The Court dismissed the case saying that the minority shareholders could not have brought a suit on company’s behalf. Further, it said that the Courts could not interfere with those decisions which have been approved by the majority in a general meeting.
In Cyrus Investments Pvt. Ltd. v. Tata Sons Ltd¹⁴, the NCLT noted that majority rule is still the law of the land in most jurisdictions and it is completely in consonance with the principles of corporate governance. This view was upheld by the Supreme Court of India in Tata Consultancy Services Limited v. Cyrus Investments Pvt. Ltd.¹⁵. Further, one of the benefits of having compulsory transfer provisions is that it facilitates smooth functioning of a company if a member is creating nuisance or is acting against the values of the company.
However, compulsory transfer provisions can be used to oppress minority shareholders given that there are not many precedents to guide the judicial discretion which has been conferred on the Courts by the AP High Court in the case of Mallina Bharathi Rao¹⁶. Further, there are already many ways to squeeze out minority shareholders under the Companies Act framework. For example, capital reduction can be done under Section 66 of the Companies Act, 2013 as well. However, Section 66 requires Tribunal’s approval necessarily. Similarly, minority squeeze out can be done through consolidation of shares and under various other provisions such as Section 235 (which regulates inter-corporate transfers) etc. Hence, having one more way to squeeze out minority shareholders might not be a very good idea.
V. CONCLUSION
While the observations of NCLT, NCLAT and the Supreme Court of India in the Tata-Mistry case settles the issue permanently, there are certain points which need to be kept in mind. Firstly, the process of natural justice should be strictly followed. It means that the concerned member should be served notice and should be given a chance to present his case. Without following the due procedure, no compulsory transfer of shares should take place. Secondly, the valuation of shares should be reasonable. It is very important to remember that members have unequal bargaining power as compared to a company and being motivated by financial incentives, they agree on whatever terms are present in the AoA. Hence, valuation of shares should not be unfair if it is determined by a method provided in the AoA. Nevertheless, one can expect to see a lot of litigation based on compulsory transfer provisions in the future, which is problematic since the Indian judiciary is already overburdened with cases.
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[1] Mallina Bharathi Rao v. Gotham Solvents Oils Limited, (2001) 3 Comp LJ 119 (CLB).
[2] Sidebottom v. Kershaw, [1920] 1 Ch 154.
[3] Gotham Solvents Oils Limited v. Mallina Bharathi Rao, 2001 (2) ALD 516.
[4] GK KAPOOR ET. AL., COMPANY LAW 215–216 (TAXMANN 2017).
[5] K. Leela Kumar v. Government of India, [2002] 108 Comp Cas 610b (Mad).
[6] Cyrus Investments Pvt. Ltd. v. Tata Sons Ltd, MANU/NC/9485/2018.
[7] Cyrus Investments Pvt. Ltd. v. Tata Sons Ltd, (2020) 2 Comp LJ 11.
[8] Tata Consultancy Services Limited v. Cyrus Investments Pvt. Ltd., 2021 SCC OnLine SC 272.
[9] Supra note 2.
[10] Staray Capital Ltd v. Cha, [2017] UKPC 43.
[11] Supra note 2.
[12] Id.
[13] Foss v. Harbottle, [1843] 67 ER 189.
[14] Supra note 6.
[15] Supra note 8.
[16] Supra note 3.
The author is a final year B.B.A. LL.B(Hons.) student at the National Law University, Jodhpur.
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