Right Of First Refusal: A Contractual Restriction On Transfer Of Shares

The Right of First Refusal still remains a significant unresolved controversy in Indian Corporate Law

ROFRs are legally enforceable as per the latest division bench of the Bombay High Court.   Accordingly Tag/ Drag and similar covenants can also be considered as enforceable between the shareholders agreeing for such covenants. As on date this is the final verdict on ROFR as it is a Division Bench decision.  Yes it could get challenged in the Supreme Court, but it is highly unlikely that it would get reversed.  And hence this should remain as a good law. The said judgment may provide relief to the private equity investors regarding enforceability of their rights culminating from the private arrangements entered into by them.

But this interpretation by the Bombay High Court might be a barrier to implement as it will be very difficult for the listed companies to raise capital, as they will have to offer their shares to the existing shareholders whenever they wish to raise capital, they will have to offer it to all the existing share holders as such provision will be incorporated in the article of association, for instance, If a company having 2500 share holders, the company who is need of share capital will have to before raising the capital, ask all the existing 2500 shareholders, and only if they refuse can the company go for the external sources for help.

Though the draftsmen have enumerated a provision regarding this in the 2013 act, it would be curious to see the application of the same in the future, keeping in view the SEBI guidelines[29] issued which said ROFR was legally allowed and valid in the Shareholders Agreement. Also allowed tag along and drag along rights. Through this, SEBI has rescinded its previous notification of March 1, 2000 that prohibited contracts other than spot delivery contracts or those entered into through the stock exchange mechanism.

After all the said laws and decisions given by the various courts, I am of the belief that these provisions and preferential clauses shall not be allowed in the agreements as the stipulates that provisions of the Act shall have the effect notwithstanding anything to the contrary contained in the Memorandum or Articles of the Association[30], and by applying these rights the Section 111A of the Companies Act, 1956 (which mandates that there can be no restriction whatsoever on the transferability of shares in a public company) gets violated and should not be applied at the cost of the statutory laws and for the sake of satisfying the existing shareholders.

While the recent judgment of Messers Holdings offers strategic investors the much-needed reprieve, legal experts believe that some corporates are likely to knock on the doors of the Supreme Court looking for clarity since it has great impact on various joint venture agreement across corporate India.

A Special Leave Petition[31] challenging the judgment of the Bombay High Court in Messer Holdings is presently pending before the Supreme Court. This is a welcome opportunity for the Court to emphasize once and for all that there is nothing in Indian or English legislation or case law that makes ineffective a promise by one contracting party to another in relation to the disposition of his shares in a company, whether public or private.

To quench the uprising and for providing more flexibility to entities entering into M&A deals, market regulator SEBI had allowed them to include preferential clauses like “right of first refusal, tag-along and drag-along” in their share purchase agreements. However, since this latest decision that is currently relied on and is valid is that of a High Court[32], the relief granted by this judgment may only be temporary as it is still subject to the affirmation of the Supreme Court.

BIBLIOGRAPHY

BOOKS

Ramaiya™s Guide to Companies Act (16th Edition Part 1) by Justice Y.V. Chandrachud and Dr. S.M. Dugar

STATUTES

a)     The Companies Act, 1956

b)    The Companies Act, 2013

c)     The Securities Contract (Regulation) Act, 1956

d)    The Depositories Act, 1996

REPORTS & WEBSITES REFERRED

1. SEBI Notification issued on October 3, 2013 :

• http://indiacorplaw.blogspot.in/2013/10/sebi-notification-on-pre-emption-rights.html
• http://www.moneycontrol.com/news/market-news/sebi-allows-preferential-clausesshare-purchase-pacts-_962985.html

2. Companies Act, 2013 :

• http://aishmghrana.me/companies-act-2013/
• http://www.thehindu.com/business/Industry/companies-bill-passed/article5003777.ece

3. ROFR™s Now Enforceable? – By Nitin Potdar, Partner, JSA :

• http://thefirm.moneycontrol.com/story_page.php?autono=486144

4. Restrictions on transfer of shares in a private limited company by Dr.K.R.  Chandratre:

• http://www.bcasonline.org/articles/artin.asp?49

5. ROFR is not a Restriction on free transferability under Section 111A by Sanjay Mathur

• http://ezinearticles.com/?Right-of-First-Refusal-Is-Not-a-Restriction-on-Free-Transferability-Under-Section-111A&id=5907974

6. Controversy on Section 111A of the Companies Act, 1956 by Hemant Shah

• www.hedge-square.com/wp-content/uploads/2012/01/…/resources4.pdfŽ

7. Enforeceability of Provisions not forming part of the Company Documents by Abhijeet Swarup & Vivek Kumar Aggarwal

• SEBI & CORPORATE LAWS The Corporate Law weekly (Vol.86) September 22, 2008

8. Section 111A of The Companies Act, 1956 by Ravikumar.G

• http://www.caclubindia.com/judiciary/section-111a-of-the-companies-act-1956-transfer-of-shares–120.asp#.UpTL3SgrVUS

9. Transmission and Transfer of Shares in a Public Company

• Restriction on Transfer of Shares in a Public Company by Suresh Savaliy

http://www.lawyersclubindia.com/articles/Restriction-on-Transfer-of-Shares-in-a-

Public-Company-4407.asp

Other web portals used include :

• www.manupatra.com
• www.indiankanoon.com
• www.indiancorp Law.in

—————————————————-