Legality of restrictive clause in Share Purchase Agreement

Today is the day of joint ventures and corporate marriages. Different corporate bodies enter into agreement to form a special purpose vehicle for undertaking different projects. In such situation, one of the basic requirements is a Shareholding Agreement (SHA) among the partners incorporating the entities. In any typical SHA, one of the terms is the condition as to transferability of the shares belonging to the partners. In a typical such restriction may take the following form:

1. If one partner wishes to sell the shares belonging to him, he would have to make a first offer to the other partner;

2. The other partner may agree or may not. In case he does not agree, then the party is free to sale the same to anybody of his choice;

3. Again, there may be stipulation as to price of share. In case, Share is offered by one partner, its price, in case of disagreement, may be determined by reference to arbitration/ or by expert valuation, etc.

In such typical agreement, the very concept of free transferability of shares as given in Sec 111A of the Companies Act, 1956 was given a go by. The question arises, whether the SHA is at all valid and enforceable in law.

Argument: Shares of public limited company is freely transferable. The Companies Act mandates incorporation of restrictive clauses in the Articles of Association regarding transferability of shares.

The concept of transferability which the Companies Act intends to protect is the transferability in general. The provision is intended to impose duty on the Board of Directors to execute transfer of shares when a valid transfer order has been filed.

As the shares held by an individual is a movable property held by him. It is not in doubt that a shareholder has the full freedom to do anything on his shares. If two such shareholders make a consensual agreement as to the disposition of shares held by them, they are free to enter into any SHA or Share Purchasing Agreement. This agreement leaves untouched the shares held by shareholders except the two partners.

Because of this logic, a particular set of shareholders may always validly enter into any SHA and impose restrictions on transfers of their shares. This is not going to create any legal hurdle as far as Section 111A of Companies Act, 1956 is concerned. In the new Companies Act, 2013, the law is codified in Section 58.

Bombay High Court in Appeal No 855/2003 in the matter of Messers Holdings Ltd Vs S M Ruia, categorically determined the legal enforceability of such a clause in the Share Holding Agreement. The judgment is worth reading which had analysed a series of Supreme Court Judgments dealing with the subject.