Case Study of Restrictions on Transfer of Shares

A general understanding of the pre-emption clause and the power of the Board to refuse
registration of transfer could be gained from the decision of the Company Law Board
in Satyanarayana Rathi vs. Annamalayar Textiles (P) Ltd, as reported in 1999 32 CLA 56.

In the said matter the Private Company in its Articles of Association had inserted a clause
wherein no member of the company could transfer his shares to any other person who is not
a member of the company without offering the same to the other members at a price
decided by the Directors of the Company from time to time. If the said shares were not
purchased within a specified time as decided by the Board then the person desiring to sell
his shares may transfer the same to any other party as he likes. Matters being so, the
appellant in the said matter who was supplier of cotton was given shares as security for
payment (to the extent of 52%, being the controlling interest) by 3 members of the
Company. The members also gave the appellant the share certificates and transfer deeds.
Unfortunately due to several factors, the payments for the cotton supplied by the appellant
was not made and therefore the appellant made an application to the Board of the Company
to have the shares transferred to him. But as there were members within the company who
were desirous of purchasing the shares themselves the Board rejected the application as the
same was in violation of the pre-emption clause included in the Articles of Association. This
stand of the Board was upheld by the Company Law Board, which held that in view of the
restriction as provided in the Articles of Association of the Company the Board is bound to
deny the request of the appellant to transfer the shares to him.

Firstly this clearly espouses the concept that even where there exists contracts between the
members of the company and the appellant to the extent that the appellant may transfer
the shares to his name in case where there is a default in payment on the part of the
members of the company the same cannot be upheld in view of the Pre-emption clause as
contained in the Articles of Association. The Company will be bound by the restriction as
imposed under the Articles which are binding on them over and above any other agreements
that may be entered into by the members of the company. Therefore where certain other
members of the Company has shown willingness in purchasing the shares, unless they
decide not to purchase the shares or are unable to do so within a time specified by the
Board of the Company, the shares cannot be transferred to the appellant in the matter.
Secondly, where there is a violation of the Articles of Association, the Directors of the
Company may refuse to register the shares. In the present case, though the transfer deeds
were with the appellant and there was an agreement between him and the members of the
Company, the Board of the Company used its discretionary power to hold that the transfer
violated the Articles of Association and therefore had to be set aside.

Similar decisions were rendered in Cruickshank Co. Ltd vs. Stridewell Leather Pvt. Ltd,
(1996) 86 CompCas 439 CLB, Tarlok Chand Khanna v. Raj Kumar Kapoor, (1983) 54 Com.
Cas. 12 (Delhi) among others.

Conclusion
Shares play an important part in the identity of a Company, be it Private or Public. The
transferability of shares is what sets Companies apart from other forms of businesses, as it
enables the company to cultivate its legal identity. The concept of perpetual succession is
based on the transferability of shares which ensures that the legal entity that is the
Company survives the change in its shareholders. Therefore, the transferability of shares is
an important aspect in any Company.

A private limited company is distinct in that it has to restrict the transfer of shares in its
Articles of Association. This goes with the principle behind the creation of private limited
companies, which is generally started by families or friends or persons who share similar
goals and vision. Therefore in a partnership firm, restrictions in the transferability of shares
ensures that control of the company stays within a small group and unwanted influences can
be kept out. This is distinct from a public limited company where anyone can buy into the
company. While the concept of restriction of transferability of shares ensures that a private
company can maintain its identity and its shareholders, it can also result in untenable
situations where due to the said restrictions there may be conflict. For the said reasons, it is
ensured that said restrictions are not absolute and persons who are not willing to remain in
the company may sell their shares and opt out subject to restrictions imposed. The said
restrictions can also ensure that sales are not made to any persons who are detrimental to
the growth of the company. In view of the above, the restriction of transfer of shares it what
gives the private company its character and allows it to maintain the values of its
shareholders.