Restriction on transfer of shares invalidated


In the case of Western Maharashtra Development Corporation v Bajaj Auto Limited, Bombay High Court held that section 3A of the Companies Act, 1956, mandates that there can be no restriction whatsoever on the transferability of shares in a public company. Therefore any agreement granting a right of pre-emption in respect of shares of a public company was held to be illegal.

In October 1974 Bajaj Auto (BAL) and Western Maharashtra Development Corporation (WMDC), promoted Maharashtra Scooters (MSL). At that time they agreed that if either party intended to part with or transfer its shareholding in MSL, then the other party would be given the first option to purchase the shares. So, in April 2003 WMDC offered to sell BAL its 27% shareholding in MSL at Rs232.20 (US$5) per share. While BAL confirmed its interest in buying the shares it said that the price was unacceptable. In January 2006 an arbitrator decided that 3,085,712 equity shares of MSL held by WMDC, valued at Rs151.63 each, were to be sold to BAL.

While challenging this in Bombay High Court, WMDC sought a ruling that the arbitral tribunal had no jurisdiction to entertain and decide the dispute on the ground that their initial agreement was void. One of the reasons for this was that the initial agreement placed restrictions on the transferability of the shareholding of MSL and so violated the provisions of section 3A read with section 9 of the Companies’ Act, 1956.

Bombay High Court ruled that the arbitral award was contrary to law, as pre-emptive rights over shares in public limited companies are patently illegal in view of the principle of “free transferability” enshrined in section 3A of the Companies Act.

In doing so they referred to V Rangaraj v Gopalakrishnan decided by Supreme Court in 1992 and Pushpa Katoch v Manu Maharani Hotels Ltd decided by Delhi High Court in 2005. In the former the court had held that any restriction on the transfer of shares of a private company is not valid if it is not incorporated in the articles of association of that company. In the Pushpa Katoch case Delhi High Court ruled that even if a restrictive clause such as the right of first refusal was incorporated in the articles of association, a shareholder cannot be restricted from transferring his or her shares as section 3A of the Companies Act states that “the shares or debentures and any interest therein of a company shall be freely transferable” in a public listed company. Further, section 9 of the Companies Act says that any provision in a company’s articles of association that contradicts the Companies Act shall be held to be invalid.

The judgment is significant as the court declared that transfer restriction clauses in joint venture and shareholder agreements of public companies are void. These clauses include rights of first refusal, tag along and drag along rights or put and call options.

The update of court judgments is compiled by Bhasin & Co, Advocates, a corporate law firm based in New Delhi. The authors can be contacted at or Readers should not act on the basis of this information without seeking professional legal advice.