It is quite common to find in a joint venture agreement
provisions regarding the transferability of shares held by the
joint venture partners in such a company. These provisions pertain
to lock-in period when no partner can sell the shares, the right of
first refusal in favour of the other partner in case a partner
wishes to sell her shares, and put or call options on the
occurrence of certain events.
These provisions are of critical importance for joint venture
partners, and thus, it is important to have a joint venture entity
where these can be legally enforced. Otherwise, the purpose of
providing these provisions will be defeated. Enforceability of
these provisions also vary, depending on the kind of company -
private or public - formed by the joint venture partners.
The Companies Act, 1956 - which governs private and public
companies - permits a private company to impose restrictions on the
transferability of its shares. A public company, however, cannot
impose such restrictions, as the shares of a public company are
freely transferable under the Act.
Further, as a private company is permitted to impose restrictive
provisions on transferability of shares, it also has freedom to
incorporate those restrictive provisions in its by-laws, or the
articles of association. Also, given that the articles of
association is a constitutional document of a company, any
provision incorporated in it becomes the constitutional provision
of that company and binds all shareholders of the company inter se
and also the company. In such cases, restrictive provisions on
transferability of shares provided in the articles of association
will become binding for that private company.
The position is completely opposite in case of a public company.
Section 111A of the Act provided that the shares of a public
company shall be freely transferable. This implies that there
cannot be a restriction imposed on the transferability of shares
held in a public company. Therefore, a public company cannot
incorporate a provision in its articles of association that
restricts the free transferability of shares.
If such a provision is provided in the articles of association, it
would be in contravention of the Companies Act and, hence, would be
void. This interpretation of the Act was upheld by many judicial
pronouncements. The courts have held that a provision - whether in
a joint venture agreement or in the articles of a public company
that restricts the transferability of shares - will be void and,
accordingly, not enforceable.
This position was again discussed recently by a division Bench of
the Bombay High Court in the matter of Messer Holdings Ltd vs Shyam
Madanmohan Ruia where the Bench disagreed with the precedents and
held that the expression 'freely transferable' used in
Section 111A does not mean that shareholders cannot enter into
consensual arrangement or agreement in relation to specific shares
held by them.
It said that the legal provision of Section 111A of the Act does
not expressly restrict or take away the right of shareholders to
enter into consensual arrangement or agreement in respect of shares
held by them. This judgment is a positive step for shareholders of
public companies, as it upholds their right to deal with their
shares in the manner they want, including contractually agreeing
with other shareholder(s) to such provisions that impose
restriction on the transferability of shares held by them. The
contractual arrangement so agreed will be binding on the
shareholders who agree to such an arrangement.
However, it may be noted that in the case of a public company, such
provisions in the joint venture agreement will remain only as
contractual provisions. This implies that they can be provided only
in the joint venture agreement but not in the articles of a public
company.
Therefore, even after the Messer judgment, the fundamental
difference is that while in the case of a private company, these
provisions are constitutional provisions provided in the articles
and, hence, binding and enforceable against all the shareholders
and the private company, the same will not apply to a public
company.
In the case of a public company, such provisions cannot be provided
in the articles of association and will remain contractual
provisions enforceable only against the shareholder(s) who has/have
contractually agreed to those provisions. Also, it cannot be
enforceable against a public company.
Though this recent judgment has brought relief to the shareholders
of public companies as far as their freedom on transferability of
shares is concerned, and now even in a public company, the
shareholders, private equity and strategic investors can negotiate
and enter into shareholders' or joint venture agreements that
contain such restrictive provisions and have them enforced against
the other shareholders who agreed to such provisions.
Given that the ability to specifically enforce these provisions
against the company stands at much better legal footing in case of
a private company than a public one, a private company would be a
better vehicle to run joint ventures.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.