Share Transfers Can the Company Say No

Share transfer restrictions come in various shapes and sizes and in so far as they relate to shares of public companies, their validity has been a topic of hot debate. In several cases, Indian courts have considered and opined on the legality of contractual restrictions on the transfer of shares of public companies. The position in this regard now appears to be much clearer than before with changes also being introduced in the Companies Act, 2013 (CA 2013). However, one aspect of this debate that has hitherto gained lesser traction is the ability of a public company to refuse registration of share transfers pursuant to section 58(4) of the CA 2013.

Section 58(2) of CA 2013 states that the securities of any member in a public company are freely transferable, while under section 58(4) of CA 2013, it is open to the public company to refuse registration of the transfer of securities for a ‘sufficient cause’. To that extent, section 58(4) of CA 2013 can be read as a limited restriction on the free transfer permitted under section 58(2) of CA 2013. However, the statute does not provide any guidance on what would constitute ‘sufficient cause’ and leaves it open to the company itself to ascertain the same.To analyse the historical background of the provision in question, it may be noted that the provision contained in section 58(4) of CA 2013 mirrors the proviso contained in section 111A(2) of the erstwhile Companies Act, 1956 (CA 1956). Section 111A was introduced in CA 1956 by the Depositories Act, 1996. Subsequently, since certain automatic transfers made through the depository mode were causing a contravention of extant laws, the proviso to section 111A(2) and section 111A(3) were introduced by way of the Depositories Related Laws (Amendment) Act, 1997. A review of section 111A of CA 1956 would indicate that while the proviso to subsection (2) deals with the pre-registration issues, subsection (3) deals with the post-registration scenario. Accordingly, section 111A(2) of CA 1956 deals with the refusal to register a transfer of shares and section 111A(3) thereof deals with the rectification of the register of members once registration has been done.

It is pertinent to note that while section 111A(2) of CA 1956 used the term ‘sufficient cause’ as a reason for refusal for registration, section 111A(3) set out an exhaustive list of three instances where rectification of register could be undertaken, namely (i) where the transfer was in violation of any provision of SEBI Act or regulations; (ii) where the transfer would violate any of the provisions of The Sick Industrial Companies Act (SICA), or (iii) where the transfer would violate any other law in force.

Tracing the precedents emerging out of Indian courts with respect to section 111A of CA 1956, there appears to be a dichotomy in the views taken by various courts while evaluating the meaning of ‘sufficient cause’ as used in section 111A(2) and 111A(3) of CA 1956. On the one hand, some courts have held that section 111A(2) must be read homogenously with section 111A(3), so as to limit the scope of the term ‘sufficient cause’ to the grounds mentioned in sub-section (3); on the other hand, some courts have opined that ‘sufficient cause’, especially as it relates to unlisted public companies, would not be limited to the grounds set out in section 111A(3).[1] While adopting the latter approach, the High Court of Andhra Pradesh in the case of Karamsad Investments Limited v. Nile Limited, (2002) 46 CLA 23(AP), took the view that the expression ‘sufficient cause’ covers within its ambit not just the contravention of law, but would also include other circumstances and reasons that might require the company to refuse the registration of transfer of shares.

The position taken by the High Court of Andhra Pradesh has now been confirmed by the Supreme Court of India in Mackintosh Burn Limited v. Sarkar and Chowdhury Enterprises Private Limited, (2018) 5 SCC 575 (Mackintosh Case). In this case the Supreme Court held that the registration of a share transfer may not only be refused on the ground of it resulting in a violation of any law but also for any other sufficient cause.

The Mackintosh Case involved an unlisted public company, which had refused to register a transfer of shares to its competitor. Here the Supreme Court noted “…The Company Law Board, it appears, was of the view that the refusal to register the transfer of shares can be permitted only if the transfer is otherwise illegal or impermissible under any law. Going by the expression “without sufficient cause” used in section 58(4), it is difficult to appreciate that view. Refusal can be on the ground of violation of law or any other sufficient case. Conflict of interest in a given situation can also be a cause…”

While the Supreme Court ultimately left it to the National Company Law Tribunal (NCLT), Kolkata to decide whether there was “sufficient cause” to refuse registration on the basis of the facts of the given case, the decision of the Supreme Court in the Mackintosh Case significantly enlarges the scope of the expression ‘sufficient cause’ used in Section 58(4) of CA 2013. In this context it is worthwhile to mention an older landmark ruling on this issue by the Supreme Court of India in the case of Bajaj Auto Ltd. v. NK Firodia AIR 1971 SC 321. In that case the Supreme Court of India held that “the discretion of directors is to be tested as the opinion of fair and sensible men in the interest of the company…

Applying this to the present context it can be said that ‘sufficient cause’ would include matters that are not in the best interests of the company. It would appear that the Mackintosh Case has not only reiterated this principle and applied it in cases under section 58 of CA 2013, but has also implied that acquisitions by competitors could be considered ‘sufficient cause’ as they may give rise to a conflict of interest.

Based on the analysis above, what can be included within the meaning of ‘sufficient cause’? Subject to the determination made by the NCLT in the Mackintosh Case, it can be argued that the board may refuse registration, where the transfer of shares is being made to its competitors on account of a conflict of interest. While the Andhra Pradesh High Court was wary of setting out an exhaustive list of factors that may be covered within the meaning of ‘sufficient cause’, it considered refusal on the grounds that the transfer would in any way be against the company’s interests or would violate any of the company’s existing contractual obligations.

What does this analysis mean for transactions? Under the circumstances, while purchasing shares of an unlisted public company, which is not a party to the transaction documentation, the acquirer must exercise caution. In hostile scenarios, it may be advisable to ensure that the documentation provides adequate protection to the acquirer in case the transfer of shares in its favour is refused by the Board of the target.

[1] For judgments limiting the scope of ‘sufficient cause’ please see – Estate Investment v. Siltap Chemicals (1999) 96 Comp Cas 217 (CLB); McDowell & Co. Ltd. v. Shaw Wallace & Co. Ltd. (2002) 108 Comp Cas 306 (CLB). In E-first Technologies Pvt. Ltd. v. Hiperworld Cybertech Ltd. (2005) 126 Comp Cas 306 (CLB) the CLB broadened the scope of ‘sufficient cause’.