Business Laws

Upholding the ‘right of refusal’

A general understanding of the ‘Right of first refusal’ 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, (1999)   -  Getty Images

Restrictions imposed by its Articles of Association binds a company more than other agreements with members

One of the questions before the Supreme Court in the Tatas Vs Mistry case was whether the NCLAT erred by muting the powers of Tata Sons to restrict members from freely transferring shares of Tata Sons. This power was conferred on the Board of Directors of Tata Sons by the Article 75 of the Articles of Association. While deciding over the specific question of law, the Supreme Court did not go into the legality of Article 75 but questioned how the same can be used as a pre-emptive ground for oppression and prejudice.

The observations of the apex court gain significance as the SP Group have been pushing to off-load its 18.37 per cent stake in Tata Sons, however, “the right of first refusal” embedded in Article 75 of the Articles of Association of Tata Sons prevents it from doing so without the blessings of the Tata Sons’ board.

The ‘Right of Refusal’ clause

Private Companies in India are closely held by design and Section 58(1) of the Companies Act, 2013 (‘the Act’) that provides legal sanction to a private Company to embed ‘Right of Refusal’ clause within the by-laws of such private Company. Section 58(2), on the other hand, clearly states that provisions of Section 58(1) would not apply to public Companies – whose shares are freely transferable.

Further, Section 2(68) of the Companies Act 2013 imposes certain restrictions which have to be mandatorily specified in the Articles of Association of Private Companies, one of which is the restriction on transferring the shares.

A general understanding of the ‘Right of first refusal’ 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.

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.

This clearly upholds the concept that 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.

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

Article 75 and its applicability

Article 75 of the Tata Sons’ Articles of Association, inter alia says: “The company may at any time by Special Resolution resolve that any holder of ordinary shares do transfer his (sic.) ordinary shares. Such members would thereupon be deemed to have served the company with a sale notice in respect of his ordinary shares.”

In effect, the Article of Association of Tata Sons confers the right of first refusal on the 18.37 per cent stake owned by SP vide Article 75.

The right to pre-emption, also known as the ‘Right of first refusal’, ensures that the shareholders in a Private company can acquire the shares from the other shareholder who is selling his shares before he can offer those shares to an outsider.

The minority shareholder, i.e., SP Group will therefore have to approach the Tata Sons’ Board, who will take a decision thereafter.

Clause 17.24 of the Supreme Court judgment states that the relief under Article 75 could not have been granted by NCLAT. The reason is in the Company Petition as it was originally filed, there was no prayer challenging Article 75.

The fact that Article 75 had existed for decades and Mistry was a party to amendment to the same Article in 2000 did not go down well with the apex court.

The Supreme Court also reiterated the fact that a person who willingly becomes a shareholder and thereby subscribes to the Articles of Association and who is a willing and consenting party to the amendments carried out to those Articles, cannot later on turn around and challenge those Articles.

Basis the above, the Supreme Court rejected the contention of the SP Group that there had been oppression and prejudice in general and also dismissed the specific question around the validity of the Article 75 with respect to oppression and prejudice.

Way forward

Now that the court has summarily dismissed all contentions raised by SP Group, Tata Sons can enforce their right under the Article 75 of the Articles of Association, which makes it clear that the Tatas have the ball in their court.

The valuation made by SP group of its 18.37 per cent stake in Tata Sons Ltd at ₹1.8-lakh crore, however, is almost ₹1-lakh crore more than what is valued by The Tata Group.

By allowing Tatas and Mistry to work out their separation terms, but not commenting on the valuation terms and whether or not SP Group can pledge its shares in Tata Sons to raise funds to address their financial situation, the Supreme Court has again gone in favour of the Tatas, as the biggest bone of contention will be the valuation.

By stringing the SP Group along even after dismissal of Mistry reminds one of the famous Eagle’s song from the 1970’s Hotel California: “You can check-out any time you like, but you can never leave!”

(The authors are partners in Nangia Andersen, a law firm)

Published on April 04, 2021

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