Background
Section 58(2) of the Companies Act, 2013 (“Act”), read along with its proviso, lays down that while the shares of a public company are freely transferable, any contract or arrangement entered into between two or more persons for the transfer of securities shall be enforceable as a contract.
In this blog, we analyse the ambit of the phrase “two or more persons”, the two potential views on the interpretation and its scope, and the impact of the two interpretations on ESOP Schemes.
Some Interpretational Tools
While interpreting a provision, it is imperative to examine the purpose behind it. The Supreme Court in RBI v. Peerless General Finance and Investment Company[1] (“Peerless Finance”) held that:
“Interpretation must depend on the text and the context. They are the bases of interpretation. One may well say if the text is the texture, context is what gives the colour. Neither can be ignored. Both are important. That interpretation is best which makes the textual interpretation match the contextual. A statute is best interpreted when we know why it was enacted… No part of a statute and no word of a statute can be construed in isolation. Statutes have to be construed so that every word has a place and everything is in its place.” (emphasis supplied)
It is also well settled that “a proviso does not travel beyond the provision to which it is a proviso. Therefore, the golden rule is to read the whole section, inclusive of the proviso, in such manner that they mutually throw light on each other and result in a harmonious construction.”[2] Similarly, as held in Tribhovandas Haribhai Tamboli v. Gujarat Revenue Tribunal[3]:
“Where the language of the main enactment is explicit and unambiguous, the proviso can have no repercussion on the interpretation of the main enactment, so as to exclude from it, by implication what clearly falls within its express terms. The scope of the proviso, therefore, is to carve out an exception to the main enactment and it excludes something which otherwise would have been within the rule. It has to operate in the same field and if the language of the main enactment is clear, the proviso cannot be torn apart from the main enactment nor can it be used to nullify by implication what the enactment clearly says nor set at naught the real object of the main enactment, unless the words of the proviso are such that it is its necessary effect.”
Finally, in State of West Bengal v. Union of India[4], it was held that – “In considering the true meaning of words or expression used by the legislature the court must have regard to the aim, object and scope of the statute to be read in its entirety. The court must ascertain the intention of the legislature by directing its attention not merely to the clauses to be construed but to the entire Statute; it must compare the clause with the other parts of the law, and the setting in which the clause to be interpreted occurs.”
View 1
As per View 1, the word “person”, as used in the proviso to Section 58(2), cannot be interpreted to include the company itself, and the said proviso would not permit an unlisted public company to impose share transfer restrictions, by virtue of an ESOP Scheme.
While Section 58(2) of the Act corresponds to Section 111A(2) of the Companies Act, 1956 (“1956 Act”), under the 1956 Act, there was no provision similar to the proviso to Section 58(2) of the Act. In fact, the proviso to Section 58(2) was specifically added to settle the debate around whether there could be certain restrictions imposed on the transferability of shares of a public company entered into between the shareholders inter se. Given that different courts had taken conflicting opinions regarding the same, the legislative intent behind the introduction of the proviso to Section 58(2) was to grant statutory legitimacy to private arrangements entered into between shareholders of a public company, so long as they were in compliance with the statute, rules, and the Articles of Association (“AoA”) of the concerned company.
However, extending such legislative intent to apply to situations where the company itself could impose transfer restrictions on shareholders through ESOP schemes or otherwise would be reading a carve-out in the law that the legislature had never intended to create. In fact, as discussed earlier, the law is well-settled that a public company can enter into agreements with its shareholders. However, interpreting such power to extend to the public company’s ability to impose transfer restrictions on its shareholders through ESOP schemes would lead to an exercise wherein the cure is worse than the disease and would strike at the heart of the philosophy of free transferability of shares that underpins a public company, and which has been well-articulated in a catena of judicial pronouncements.
Thus, it stands to reason that the proviso to Section 58(2) necessarily must be read in relation to Section 58(2) and cannot militate against its express language. As discussed earlier, the proviso to Section 58(2) is meant to apply to shareholders of the public company who enter into private arrangements to impose transfer restrictions, and it may not contemplate the arrangements entered into by the company itself to the same effect. If it did, then the provision would have stated so explicitly. In the absence of the same, the proviso cannot be relied upon to argue that it extends to transfer restrictions imposed by the public company through ESOP schemes too. Section 58(2) begins with the words “Without prejudice to sub-section (1), the securities or other interest of any member in a public company shall be freely transferable…” Thus, it is clear that this refers to the interest or the securities held by any member, and not necessarily by the company itself. On reading this in conjunction with the proviso, it would mean that there is no bar on members or shareholders from entering into private arrangements; however, such “persons” do not refer to the company.
The jurisprudence on circumstances wherein the company may register a transfer of shares (such as in the case where the shares are being transferred to the detriment of the company or to a company’s competitors, which is not in the interest of the company) is well-documented and situation such as that contemplated by the present situation cannot be read into it. If read this way, it will defeat the purpose behind the introduction of the proviso to Section 58(2) of the Act. Secondly, the proviso to Section 58(2) cannot be allowed to travel beyond the scope of the Section as it would detract from the well-established limits placed on the scope of a proviso by the principles of statutory interpretation.
View 2
As per View 2, the proviso to Section 58(2) should not be read in isolation and should be interpreted in accordance with the overall scheme of Section 58, including Section 58(4). This enables us to take a view that an unlisted public company would be permitted to incorporate share transfer restrictions in its ESOP Scheme, in certain specific situations, when such restrictions would be justified keeping in mind the larger interest of the company and the other shareholders.
Section 58(4) of the Act provides that if a public company without sufficient cause refuses to register the transfer of securities within a period of 30 (thirty) days from the date on which the instrument of transfer or the intimation of transmission, as the case may be, is delivered to the company, the transferee may, within a period of 60 (sixty) days of such refusal or where no intimation has been received from the company, within 90 (ninety) days of the delivery of the instrument of transfer or intimation of transmission, appeal to the National Company Law Tribunal (“NCLT”).
While interpreting the requirements of Sections 111 and 111A of the 1956 Act (which broadly corresponds with Section 58 of the Act), the Andhra Pradesh HC, in Karamsad Investments Limited v. Nile Limited[5], (“Karamsad Investments”),held that the expression “sufficient cause” (as used in the proviso to Section 111A(2) of the 1956 Act) is not limited solely to situations with a violation of the provisions of other statutes (such as the SEBI Act, 1992. It also held that other possible circumstances and reasons requiring the company to refuse to register the transfer of shares would be considered a refusal for “sufficient cause”.
The Andhra Pradesh HC noted that while it may not be possible to enumerate all reasons that may amount to a “sufficient cause” for refusing to register a transfer of shares, one valid ground would be a situation where the transfer results in the breach of a company’s existing legal or contractual obligation and exposes the company to legal liability.
A similar approach was adopted by the SC in Mackintosh Burn Limited v. Sarkar and Chowdhury Enterprises Private Limited[6] (“Mackintosh”),where a wider meaning was given to the expression “sufficient cause”, as used in Section 58(4) of the Act. In the Mackintosh case, a government company refused to register a transfer of shares on the ground that the shares were being transferred to a competitor-controlled company. The SC held that, “…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 cause.”
The SC also held that the right to refuse the registration of a transfer of shares on “sufficient cause” is a question of law, and whether the cause shown for refusal is sufficient or not in a given case, can be a mixed question of fact and law.
In summary, the expression “sufficient cause”, as interpreted in Karamsad Investments and Mackintosh,wouldpermit a public company to refuse to register a share transfer if the transfer could result in a breach of the company’s legal or contractual obligations or lead to a conflict of interest that could be detrimental to the interest of the company, as a whole.
The preceding parameters may also be referred to for determining the scope of the share transfer restrictions that may be imposed by an unlisted public company, under an ESOP Scheme. By virtue of an ESOP Scheme, an employee would have the option of acquiring the company’s shares at a future date, and in most cases, the exercise price is significantly less than the fair market value of the shares. By undertaking this interpretation, some important covenants may be included to prohibit:
- the employee shareholder from transferring shares to a competitor (or any entity owned or controlled by a competitor), on ceasing to be associated with the company;
- the employee shareholder from transferring shares to any other person/entity against which regulators (such as the MCA or SEBI) and law enforcement agencies (such as the ED) have initiated adverse regulatory action;
- the employee shareholder cannot transfer shares to such a person/entity that stands “contaminated”, by virtue of regulatory or law enforcement proceedings.
Further, as per the duties imposed under Section 166(2) of the Act, a director of a company would be duty-bound to refuse to register a transfer of shares, if the transfer adversely affects the interests of the company. Taking forward the illustrative example discussed earlier here, if the shares of a company are transferred to a business rival/competitor, then the directors would be duty-bound to refuse to register the transfer, to protect the interests of the company as a whole, as well as the interests of the other shareholders.
From the preceding analysis, a view may be taken that a company can impose certain specific share transfer restrictions in its ESOP Scheme to protect its own genuine interests as a whole and the interests of the other shareholders.
Concluding Thoughts
In conclusion, the current ambiguity surrounding the interpretation of Section 58(2) of the Act read with its proviso, particularly regarding the scope of share transfer restrictions in cases like an ESOP Scheme, warrants attention. While View 1 limits such restrictions to shareholder agreements, View 2 recognises the legitimacy of imposing certain transfer restrictions by the issuer public company to protect the company’s legitimate business interest. To resolve this uncertainty, it is recommended that the Parliament may consider amending the Act to clarify the scope and ambit of the expression “two or more persons” in order to incorporate the broader interpretation of View 2, thereby clarifying the legislative intent of the permissible scope of share transfer restrictions.
[1] (1987) 1 SCC 424.
[2] Dwarka Prasad v. Dwarka Das Saraf, (1976) 1 SCC 128.
[3] (1991) 3 SCC 442.
[4] AIR 1963 SC 1241.
[5] (2002) 108 CompCas 58.
[6] (2018) 5 SCC 575.