10/3/2011 Transfer of Shares in Private Compani…

Transfer of Shares in Private Companies

by Cont ribut ed Papers | Oct ober 13, 2010 7:49 pm

Corp Law I-T ransfer of Shares in Private Companies[1]

Tabl e O f C ase s

1. Babulal Choukhani v. Western India Theatres Lim ited, AIR 1957 Cal 709.
2. Balwant Transport Com pany v. Deshpande, AIR 1956 Nag 20.
3. Bishan Singh v. Khazan Singh, 1959 SCR 878.
4. Chiranji Lal Jasrasaria v. Mahabir Dhelia, AIR 1966 Assam 48.
5. Dean v. Prince, [1954]1 All ER 749.
6. Greenhalgh v. Mallard, [1943]2 All ER 234.
7. Harinagar Sugar Mills v. Shyam Sunder, AIR 1961 SC 1669.
8. Hunter v. Hunter, 1936 AC 222 HL.
9. Lyle and Scott Lim ited v. Scott’s Trustees, [1959]2 All ER 661.
10. Master Silk Mills Private Lim ited v. D.H Mehta, (1980) 50 Comp Cas 365 Guj.
11. Moodie v. W and F Shepherd Lim ited, [1949]2 All ER 1044.
12. Ontario Jockey Club v. Sam uel Mcbridge, AIR 1928 PC 291.
13. S.P Mehta v. Calico Dyeing and Printing Mills Lim ited, (1990) 67 Comp Cas 533 Bom.
14. Sm ith and Fawcett Ltd. Re, [1942]1 All ER 542.
15. Tett v. Phoenix Property and Investm ent Com pany Lim ited, (1984) BCLC 599.
16. Theakston v. London Trust plc., (1984) BCLC 390.
17. V.B Rangaraj v. V.B Gopalakrishnan and Others, (1992)1 SCC 160.

Tabl e O f Statute s

1. Companies (Amendment ) Act , 1988.

2. Companies Act, 1907.
3. Companies Act, 1913.
4. Companies Act, 1956.
5. T ransfer of Property Act , 1872.

Introducti on

T he popular concept ion of a private company is that of a small concern wit h few shareholders, most of whom are act ively e ngaged in managing
the company’s business, and who regard t heir shares not merely as an invest ment but as t he source of t heir livelihood. In other words, a private
company is visualized simply as an incorporated part nership. In fact it is often said t hat The soul of a private com pany is the Partnership
Principle.[1]

Privat e companies were for the first t ime recognized in England in t he Act of 1907[2] and in t his country in t he Act of 1913.Prior to t hat , t
hey were on t he same foot ing as public companies and did not enjoy the privileges which in India were conferred on t hem by t he Act of
1913[3] and cont inue to be conferred by the Companies Act , 1956. T he t radit ional and proverbial division of companies in t o public and
privat e companies remains intact in company jurisprudence. T he distinction between private and public companies is primarily based on the
idea t hat t he legislat ion int ends t o make available the advantages of corporat e t rading to privat e t raders or privat e persons. T hese advant ages
are embodied in t he form of privileges which are given t o private companies by t he Companies Act . T he principal advant age of privat e
companies which are usually family concerns is t o secure absolut e secrecy as regards t heir affairs and at t he same time to have t he liabilit y of
t heir members limit ed either by shares or by guarant ee. It should be borne in mind t hat the main characterist ic of a privat e company which is
limit ed by shares, is t hat it cannot invite the public t o subscribe to it s shares or accept deposit s from the public. Us ually all it s shares are held by
a few persons who are, more oft en t han not , members of t he same family.[4]

Sect ion 3(1)(iii) of t he Companies Act, 1956 defines a Privat e Company as : “ Private company means a company which has a minimum paid up
capit al of one lakh rupees or such higher paid up capit al as may be prescribed , and by its art icles, -

(a) restrict s the right t o transfer its shares, if any;

(b) limit s t he number of it s members t o fift y not including –

(i) persons who are in the employment of the company; and

(ii) persons who, having been formerly in t he employment of t he company, were members of t he company while in that employment and have
continued t o be members after t he employment ceased; and

(c) prohibit s any invit at ion t o the public to subscribe for any shares in, or debentures
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of t he company;

(d) prohibit s any invit at ion or accept ance of deposit s from persons ot her than its

members, direct ors or their relatives

Provided that where t wo or more persons hold one or more shares in a company jointly, t hey shall, for t he purposes of this definit ion, be t
reat ed as a single member.

In view of this definit ion a privat e company is required by law and must , in it s Articles of Association, incorporat e t he said rest rictions, prohibit
ions and limit at ions. Sub-sect ion (3) of Section 27 furt her endorses t his point by st at ing t hat a privat e company limited by shares must have art
icles cont aining rest rictions, limit at ions and prohibitions required by Sect ion 3(1)(iii) and ot her privat e companies ie. privat e companies not
having share capital must have in its art icles t he limit at ions and prohibitions cont ained in clauses (b) and (c) of Sect ion 3(1)(iii).

T hus the main characterist ics of privat e companies are:

Rest rictions on the rights of its members t o transfer their shares

Limit at ion of t he number of members to a certain figure.
A prohibition of invitation t o t he public t o subscribe t o the shares or debent ures of t he company and prohibit ion of a ccept ing deposit s
from the public.

T he modern privat e company serves t wo purposes:[5] Firstly t o enable small t raders or privat e persons carrying on a family business to avail
t hemselves of t he advantages of corporate trading and, secondly t o act as a subsidiary in a group of companies which help t hem t o avoid t he
st rict requirement s imposed on public companies.

T he limit at ions, prohibit ions and restrict ions required t o be observed by privat e companies are what enable such companies t o meet their goals
and purposes for which they are set up.

A private company by law has t o incorporat e into its articles rest rict ions on t he right s of it members t o t ransfer t heir shares.[6] T his feat ure is
somet hing int rinsic t o a privat e company and different iat es it from public companies which have no rest rict ions on t he right s of t heir members
t o t ransfer t heir shares. T hese rest rict ions on t ransfer of shares in privat e companies flow from t he Partnership Principle which is the soul and
basis of privat e companies.

In order t o understand and analyse ‘T ransfer of Shares in Privat e Companies’ t he focus has t o be on the Rest rictions on T ransfer of Shares in
t hese companies. T his project will go on to explore t he rat ionale for such restrict ions, types of rest rict ions and ot her import ant relat ed issues
which st em from restrict ions on transfer of shares in private companies.

Re se arch Me thodol ogy

Aims and Objectives

T he aim of t his project is to perform a comprehensive st udy and analysis of ‘T ransfer of Shares in Privat e Companies’. T he project seeks t o
analyse and explain t he various statutory provisions relat ing t o the T ransfer of Shares in Private Compan ies, t he rat ional for rest rictions on t
he t ransfer of shares in privat e companies and t he implicat ions and issues related t o these rest rict ions. In order to achieve its object ives t he
project also analyses t he concept of private companies and explores the meaning of ‘transfer of a share’.

Nature of Project
T he project is analyt ical as well as descriptive in nature. However t he majority of t he project is analyt ical in nature.

Sources of Data
T he sources of dat a used are secondary in nature. A host of leading t ext books on Corporat e Law as well as relevant articles from leading Law
Journals have been referred t o. Case reporters like Supreme Court Cases, All England Law Report s, Company Cases and All Ind ia Report er have
been used.

Scope and Limitation

T he scope of t his project is limited t o the performance of an analysis and study of transfer of shares in private companies only. T he law
relating to t ransfer of shares in public companies has not been explored. Moreover t he American posit ion wit h respect to t ransfer of shares in
‘close corporat ions’ has not been looked at.

Chapterisation
Sect ion I deals with t he meaning of t he word ‘T ransfer’ and explores what a ‘t ransfer of a share’ exact ly entails and d ist inguishes a t ransfer of a
share from a t ransmission of a share.

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Sect ion II looks at rest rict ions on t ransfer of shares in privat e companies. It analyses t he need for such rest rict ions and explores t heir validit y
and scope. It also analyses the various types of rest rict ions and t he important issues relat ed t o t hem.

Sect ion III deals wit h the remedies and safeguards t hat are available t o the aggrieved persons in t he case of abuse of powers by the Board of
Direct ors with respect t o refusal to regist er t ransfer of shares. T his sect ion also analyses whet her these remedies are adequat e and looks at how
t hey are being implement ed and whet her they are actually helping t he cause of justice.

It is t o be noted that all st udy and analysis has been performed in t he light of t he appropriat e st at ut ory provisions and relevant case law.

Research Questions
T he following are the research questions:

What is t he concept of privat e companies?

Why are private companies incorporat ed?
What is t he difference bet ween “ T ransfer of a Share” and T ransmission of a share?
What exact ly does a transfer of a share entail?
Why does a privat e company need to incorporat e restrict ions on transfer of shares in its art icles?
What are the various types of restrict ions on t ransfer of shares in privat e companies?
What are the implicat ions and import ant issues relat ed to t hese rest rict ions?
What are the various remedies available to t he aggrieved persons when t he company refuses t o register t ransfer of shares?
Do these remedies help in providing the appropriat e safeguards and prot ect ing t he int erest s of t he shareholders, transferees and t he
company?
What is t he scope and effect of Section 111 of the Companies Act , 1956 regarding the right of a person to appeal t o t he C ompany Law
Board in t he case of wrongful refusal by t he Board of Direct ors?
Are rest rictions on t he t ransfer of shares in privat e companies act ually needed?
Do these rest rictions serve t heir intended purpose?

Mode of Citation
A uniform mode of citation has been adopt ed t hroughout t he course of t his project .

Unde rstandi ng ‘Transfe r O f Share s’

One of the most import ant feat ures of a company is t hat its shares are t ransferable.

Sect ion 82 of the Companies Act , 1956 provides t hat “ The shares or debentures or other interest of any m em ber in a com pany shall be
m ovable property, transferable in the m anner provided by the articles of the com pany”. T hus Section 82 empowers every shareholder t o
t ransfer his shares in t he manner laid down in t he Art icles and in accordance wit h the various provisions of law. Sect ion 82 is in keeping with
t he philosophy relat ing t o transfer of shares given in Palmer’s Company Law where it is st at ed t hat “ It is well settled that unless the articles
provide otherwise the shareholder has a free right to transfer to whom he will. It is not necessary to seek in the articles f or a power to transfer for
the Act itself gives such a power. It is only necessary to look to the articles to ascertain the restrictions, if any, upon i t. Thus a m em ber has a right
to transfer his shares to another person unless this right is clearly taken away by the articles”.[7]

T ransfer of shares is the volunt ary conveyance of the rights and possibly t he duties of a member as represented in a share in t he company from a
shareholder who wishes to cease t o be a member t o a person desirous of becoming a member.[8] T hus sim ply a t ransfer of shares means a change
in the ownership of t he shares by t he voluntary act of t he part ies. T ransmission of shares as distinct from a t ransfer of shares occurs when a
change of ownership in the shares t akes place, not by agreement and t he voluntary act ion of t he part ies, but by t he operation of the law and as a
result of some ot her event, such as the deat h or insolvency of the shareholder.[9] T ransmission of shares may also take pl ace by legislat ion
providing for t he nat ionalizat ion of a part icular indust ry. Sect ion 109B of t he Companies Act , 1956 deals wit h T ransmission of Shares.

T he cont ract by which a shareholder undert akes t o transfer his shares is usually a contract of sale whereby t he proposed t ransferor agrees t o
sell, and t he proposed transferee agrees t o buy, t he shares; this cont ract may be concluded at the st ock exchange or ot herwise. It is to be noted t
hat t he shares of a privat e company cannot be transferred at a st ock exchange.[10] T he obligat ion t o t ransfer shares may arise from ot her
t ypes of cont racts and agreement s t oo. For example, a sett lor may undertake in the trust inst rument t o t ransfer speci fied shares to t he t rust ees.

In a contract for t ransfer of shares the following are usually t he implied terms:[11]

T hat the transferee will pay t he price and that t he t ransferor will hand over t o him genuine instrument s of t ransfer a nd share cert ificat es
T hat the share certificate carries the rights and int erest s which it purport s to convey
T hat there is no undertaking by t he t ransferor that t he t ransferee will be regist ered
T hat the transferor will do not hing t o prevent t he t ransferee from having the transfer registered or to delay t hat event
T hat the transferee will indemnify t he t ransferor from any calls or liabilit y which may arise in respect of the shares su bsequent t o the t
ransfer

T hese t erms are usually implied in a cont ract providing for t ransfer of shares and t hey may be nullified by clauses which have been expressly
st at ed in t he cont ract .

Once t he contract has been ent ered into t he t ransferee has an equit able tit le t o the shares and t he t ransferor holds t hem, until regist ration, as
t rustee for t he t ransferee. However unt il t he purchase price is fully paid t he seller remaining on t he regist er is en tit led vis-à-vis the purchaser to

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vot e in respect of the shares wit hout respect t o t he wishes of t he purchaser.[12]

It is t o be noted that a transfer is incomplet e and invalid unt il it is regist ered. Pending regist ration, t he t ransferee has only an equit able right t o
t he shares t ransferred t o him. He does not become the legal owner unt il his name is ent ered on t he regist er in respect of t hese shares.[13]

T hus, having underst ood t he meaning of t ransfer of shares and what exact ly a t ransfer of a share ent ails it is imperat ive t o analyse rest rictions
on t ransfer of shares and relat ed issues in order t o fully comprehend transfer of shares in priva te companies.

Re stri ctions O n Transfe r O f Share s In Pri vate C ompani e s

Sect ion 3(1)(iii)(a) of the Companies Act , 1956 compulsorily requires private companies t o impose restrict ions on t he t ransfer of shares by
incorporat ing such rest rictions in t heir Articles of Associat ion. T he Companies Act , 1956 however, does not specify any particular form of rest
riction or prescribe t he maximum ext ent or scope of t he restrict ion required. T hus t he restrict ions may be as slight o r as severe as the framers
of t he art icles desire. T he statute merely requires t hat the articles of a privat e company limit ed by shares must cont ain restrict ions on
t he t ransfer of shares. Such rest rictions should be general and apply uniformly t o all t he shareholders and t o all t ypes of shares[14]. T hey should
not exempt certain shareholders or a certain class of shares.

Restriction Not Prohibition

It is also important t o see t hat t hese restrict ions are not const rued as a ban or a prohibit ion on t he t ransfer of shares. T he Court s have
consist ent ly held t hat the rest rict ion upon t ransfer means any rest riction t hat will give some cont rol to t he company over transferabilit y of
shares[15]. It does not mean a prohibit ion on the transfer of shares. It was held in Chiranji Lal Jasrasaria v. Mahabir Dhelia[16] t hat a
rest riction which amounts t o a prohibit ion on t ransfer of shares or which precludes a shareholder alt oget her from t ransferring is invalid.
Moreover a prohibit ion on the transfer of shares will amount to violation of Section 82 of t he Companies Act , 1956 and Sec tion 6 of the
T ransfer of Property Act , 1872. T herefore if a clause in the articles provides t hat shares are not transferable b ut heritable will be valid. T his is
because: Shares are propert y and under Sect ion 6 of t he T ransfer of Propert y Act, 1872 prohibit ing t ransfer of propert y is not allowed.
T ransferability is the general nat ure of propert y and even when t here is a rest rict ion on transfer, when t he person dies t he rest riction will not
apply.

Need for Restrictions on the Transfer of Shares

In t he Unit ed States of America Private Companies are referred to as ‘Close Corporations’.[17] T his t erm implies t h at privat e companies are
closely knit family or friendly affairs. T he members of a private company are connect ed by bonds of kinship, friendship or similar close t ies and
t he int rusion of a stranger as a shareholder would be felt to be undesirable unless his admission is accept ed by t he exist ing members. Some
privat e companies are in fact so constructed so as t o amount t o in economic terms as not hing more t han incorporated part nerships wit h
extremely close ties bet ween t he members. T hus t hese rest rictions are needed in order to preserve t he soul of the private company ie. t he
part nership principle. T hese rest rictions on transfer of shares prevent anybody or everybody from acquiring shares of t he company by transfer
and help t o keep t he close ties amongst t he members int act.

T hus the main reasons for which Rest rict ions on t ransfer of shares are needed in privat e companies are:[18]

T o keep t he cont rol of t he company in t he hands of a small group of persons bound t oget her by t ies of friendship, kinship et c.
T o ensure that shares are not t ransferred t o persons who are unacceptable t o the existing members.

Strict Construction of Restrictions

Lord Greene MR in Sm ith and Fawcett Ltd., Re[19] st at ed t hat “ In construing the relevant provisions in the articles it is to be borne in m ind
that one of the norm al rights of a shareholder is the right to deal freely with his property and to transfer it to whom soever he pleases and this
right is not to be cut down by uncertain language or doubtful im plications”. Any limit at ion on t he right of t ransfer must be st rictly complied
wit h. T hus as t he rest rict ions on t ransfer of shares are st rict ly construed and wherever a cert ain restrict ion can be int erpreted in several ways
t he narrower const ruct ion will be adopt ed t he framers of t he art icles must be ext remely careful in draft ing the rest rict ions on t he t ransfer of
shares so as to prevent any injust ice to t he shareholders.[20]

T he court s should not always lit erally int erpret t he rest rictions as somet imes a literal interpret at ion of t hese re st rictions can defeat t he very
purpose of t he rest rict ions contained in t he art icles.

In V.B Rangaraj v. V.B Gopalakrishnan and Others[21] t he Supreme Court of India held t hat : Shares are movable property and t heir transfer is
regulat ed by t he Articles of Association of t he company. T he Art icles of Association are the regulations of t he company binding on the
company and its shareholders. T herefore, t he only permissible rest rict ions on t he t ransfer of shares are t hose which a re contained in t he
Art icles of Associat ion. An addit ional restrict ion not contained in t he art icles but in a private agreement bet ween t wo shareholders which places
furt her obstacles in the way of t ransferabilit y is not binding eit her on the company or on the shareholders. T he vendee of t he shares cannot be
denied the registrat ion of t he shares purchased by him on a ground ot her than st at ed in t he Art icles.

Types of Restrictions
Rest rictions on the rights of shareholders to t ransfer t heir shares generally t ake t wo common forms:[22]

a) Right of Pre-empt ion in favour of t he ot her members

b) Powers of the Board of Direct ors t o refuse t o regist er transfer of shares

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Pre-emption Clause
In Bishan Singh v. Khazan Singh[23] the Court st at ed that t he right of pre-empt ion is not a right t o t he thing sold but a right t o the offer of a t
hing t o be sold. T he most common type of t ransfer restrict ion is the right of pre-emption. T he pre-emption clause in t he art icles generally
provides t hat when a member wishes t o sell some or all of his shares, he shall first offer t hem t o t he ot her members for purchase at a price
ascertained in accordance with a formula set out in t he art icles, or at a fair price at which the shares are valued by t he directors or by t he
company’s audit ors and he shall t ransfer t he shares t o his proposed transferee only if the other members do not exercise t heir right of pre-
emption.[24] T he pre-empt ion clause goes a long way in ensuring that t he cont rol of t he shares does not fall into t he hands of undesirable
persons as it ensures t hat the existing shareholders get the opport unit y t o buy t he shares first.

Various t ypes of pre-empt ion clauses are found in the articles of privat e companies. Somet imes it is provided that t he proposing t ransferor s hall
offer the shares first to all other shareholders rat eably; sometimes he is ent it led t o select t he s hareholder t o whom he want s t o sell; sometimes
t he first offer has t o be made t o cert ain shareholders e.g. those holding founder’s shares; somet imes the art icles prov ide that in certain
circumstances e.g. in t he case of death of a member, the surviving members or direct ors are obliged to acquire t he deceased member’s shares. It
is usual to supplement t hese pre-empt ion clauses wit h the general rest rict ion clause by providing, for example, t hat after t he failure of t hose
entit led to pre-empt ive right s t o acquire t he shares and aft er t heir subsequent offer to another person, the direct ors may decline t he
t ransfer[25]. T here is no doubt as t o t he validit y of these pre-emption clauses and courts have consist ent ly upheld the validit y of the pre-
emption clause in t he art icle of a privat e company.[26]

T he pre-empt ive clause is brought into operat ion where shareholders agree to sell t he shares, receive t he purchase price and ret ain it .[27]
Where t he pre-emption clause provides-as is normally t he case- that a share may be t ransferred to any member but shall not be transferred to a
person who is not a member so long as any member is willing t o purchase t he same at t he fair value, t he transfer bet ween members is
complet ely unrestrict ed and does not bring int o operat ion t he provisions of t he pre-empt ion clause.[28]

Implementation of Pre-emptive Rights

Where t he art icles provide a procedure for implement at ion of pre-empt ive right s t he procedure laid down has to be followed. T he procedure
t hat is usually laid down in the articles is t o require t he t ransferor t o give t o the company a notice of his int ent ion to t ransfer his holding and
asking the company t o notify t he ot her members of the availability of t he shares and t he price at which t hey will be available t o them for
acquisit ion and the t ime wit hin which they should communicat e t o the company t heir desire t o purchase t he proffered s hares. When the articles
do not provide any machinery for implement at ion of pre-empt ion right s t he member who want s to t ransfer his shares must not ify all t he
members of his intention t o do so. He should then allow them a reasonable time to inform him of t heir decision.[29]

A member cannot evade a provision for pre-empt ion in t he art icles by cont ract ing t o sell his shares t o a t hird person or by executing an inst
rument of t ransfer t o such a person, with t he int ent ion that t he purchaser shall not apply for registrat ion as a member, but shall rest content
wit h the vendor holding t he legal t it le to t he shares as a bare t rust ee for him[30]. It has been held that a pre -emption provision was complied
wit h where one member sold t o anot her member even t hough t he purchase price was paid by an out sider and t he t ransferee was t o
vot e at t he outsider’s discretion[31]. It is humbly submit t ed t hat t he decision of t he Court t o recognize t his as a valid t ransfer and t o hold it in
compliance wit h the pre-emptive clause is erroneous as t he decision goes against t he very object ive of the pre-empt ive clause ie. to prevent
outsiders and undesirable persons from gaining control of t he company. In t his case although t he pre-emptive provision was complied wit h in
form it was violat ed in subst ance. T he court should have looked at t he substance of t he mat t er and not the form.

Transfers contravening pre-emptive clause

A company can reject a t ransfer contravening the provisions of t he company’s art icles, but t he company can waive its right and accept a
contravening t ransfer and once it does so, it loses the right t o question t he validity of t he t ransfer. Hence, a t ransfer contravening t he articles is
not a nullity or void abinitio[32]. In Tett v. Phoenix Property and Investm ent Com pany Lim ited[33] Just ice Vinelott held that “ despit e t he
disregard of the preemptive provisions there had occurred a complet e and effective transfer bet ween t ransferor and t ransferee in t erms of which
t he equit able t itle passed to t he latt er”. In t his case the shares in quest ion were sold t o an outsider and a t ransfer deed was execut ed in his favour
in complet e disregard t o t he pre-empt ive provisions. Some shareholders were int erested in acquiring t he shares but not at the price which the
outsider was willing to pay. T he Court of Appeal held that t he t ransfer was in violat ion of t he pre-empt ive provisions and the company was not
compelled to accept it . T he decision of the court is praisewort hy as it recognizes t he t rue object ive of the pre-emptive clause and preserves the
part nership principle in the private company. T he privacy of a close corporat ion is more import ant than t he price offered by an outsider,
however great such a price may be. A different decision by t he Court of Appeal would have defeated t he intention of t he incorporat ors when
t hey formed t he company.

Valuation of Shares for Purpose of Pre-emptive Rights

T he art icles of a private company generally provide t hat t he price payable for the shares sold in exercise of a right of pre-empt ion shall be a fair
price. If the pre-empt ion clause requires t he shares which a member wishes to t ransfer t o be offered t o t he ot her members at a fair value
certified by t he direct ors or t he company’s auditor, t he court cannot inquire into t he correctness of the valuat ion, un less t here is evidence t hat
it was not honest ly made, or unless t he person who made it set out the reasons for his valuat ion, and t hose reasons show that he did not apply t
he proper principles. T here is scope for judicial interference even if t he person who made t he valuation act ed negligent ly by not taking relevant
fact ors into account, by giving undue emphasis t o one of t hose factors, or by taking irrelevant fact ors int o account , and in t hat
sit uat ion t he t ransferor’s only remedy is t o sue the person who made t he valuation for the difference between the valua tion and t he real value
of t he shares as damages in an action for negligence. However if t he error appears in the valuation itself, t he fact t hat t he company’s articles
provide that t he valuat ion shall be final, binding and conclusive, or t he fact t hat the shares in quest ion have already been regist ered by t he
company in t he names of the other members who have exercised their pre-empt ion rights on t he basis of an erroneous valuation, does not
prevent t he member whose shares are t he subject of t he valuat ion from challenging its validity[34]. In Dean v. Prince[35] it was held that

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where under a pre-empt ion provision t he price at which t he shares must be offered to t he ot her members is their fair value, t hey should be
valued on the assumpt ion t hat the company’s business could be sold as a going concern, but if t he company is insolvent or has liabilit ies which
has made an immediat e winding up or a sale of its undertaking imperat ive, t he shares should be valued on the assumption t hat t he company’s
asset s will be sold piecemeal, and t hat nothing will be received for it s goodwill. T here are cert ain grey areas wit h respect to valuat ion of shares
for the purpose of pre-empt ive provisions. Uncert aint y prevails over whether any addition should be made t o the value of t he shares
ascertained in t he normal way when t hey carry cont rolling voting rights at general meet ings. T he Courts have t o clear t he ambiguity in t his
regard as t he quest ion can be answered bot h ways. On one hand t he value of the cont rol over t he company conferred by t he shares is t ot ally
dist inct and separate from t he value of the shares ascert ained with reference to t he company’s financial condit ion and thus no addit ion should
be made t o the value of t he shares. On t he other hand, t he power to control the company is inherent in a share and thus value of t he cont rol
over t he company conferred by t he share must form a const it uent element of t he value of the share. T his raises t he complex quest ion as to
how should t he cont rol conferred by a share be valued?

Power of the Board of Directors to Refuse to Register Transfer of Shares

T he art icles of a private company generally vest the Board of Direct ors wit h discret ion with regard t o acceptance of a t ransfer of shares. T his
power vest ed in t he Board is fiduciary in nature ie. it must be exercised in good fait h and for the benefit of t he compan y and not for some
extraneous purpose[36]. T he consequences and implicat ions of t he directors abusing t his power and t he remedies available t o the aggrieved
persons have been dealt wit h in t he next sect ion of t his project .

Exercise of Power of Refusal

T he directors must exercise their right t o decline registrat ion t o a t ransfer of shares only by passing a resolut ion t o that effect; mere failure, due
t o a deadlock or somet hing, t o pass a resolut ion is not a formal, act ive exercise of t he right t o decline and t herefo re t he applicant will be
entit led to be registered as a member of the company. In Moodie v. W & F Shepherd Lim ited[37] the Board comprised of t wo direct ors ne
agreed to grant t he t ransfer while t he ot her refused. It was held t hat t he deadlock did not imply that t he t ransfer had been declined and therefore
t he Court direct ed t hat t he applicant must be registered as a member of the company.

Burden of Proof
T he burden of proving t hat t he Board of Direct ors have wrongfully approved or disapproved t ransfers of shares rest s on the person making that
allegation. T he Court s will always presume bona fide on t he part of the Board of Directors.[38]

T ime Wit hin Which T he Directors Should Exercise T he Power of Refusal to Regist er T ransfer of Shares

According to Sect ion 111(1) of the Companies Act , 1956 the Board of Directors must exercise t heir power of refusal wit hin t wo mont hs from t
he dat e of receiving t he applicat ion. T he quest ion that now arises is t hat if t he direct ors do not exercise t heir power of refus al t hen on t he
expiry of t he t wo mont hs does the company lose t he right of reject ion and t he t ransferee get a vest ed rig ht t o get himself registered? Sect ion
111 is silent regarding t his quest ion. When faced wit h this question t he Bombay High Court[39] did not agree that t he co mpany would lose t he
right of reject ion or t he t ransferee would acquire a vested right to t he shares. It is felt t hat in such cases a court order would be necessary and t he
court should decide t he mat t er on merits. Judicial decisions have det ermined t hat t he power of refusal must be exercised wit hin a reasonable time
and t he period of two mont hs prescribed by Sect ion 111 is reasonable. T he transferee has t o silent ly sit through the period of two months
which is given to t he board to make t heir decision and the transferee cannot resort t o any proceedings unt il t he t wo-mont h period has expired.
A belated exercise of t he power of refusal will st rengt hen t he posit ion of t he aggrieved transferee as delay in exercise of t he power of refusal will
be looked at with suspicion and t he delay on the part of t he Board in making t heir decision will be construed in favour of the transferee in a
court of law.

Abuse O f Powe r O f Board O f Dire ctors To Re fuse To Re gi ste r Transfe r O f Share s- Re me di e s

Privat e companies are required by law t o incorporate int o t heir articles rest rictions on t he t ransfer of shares. A com mon form of these
rest rictions is the power conferred on t he Board of Direct ors t o refuse t o regist er a t ransfer. Very often t he art icles of a privat e company may
vest absolute discretion in t he direct ors t o refuse t o regist er transfer of shares. In Balwant Transport Com pany v. Deshpande[40] t he Nagpur
High Court felt that t he Court would not be just ified in int erfering wit h t he discret ion of t he directors. T he direct ors must exercise t heir
discretion bona fide in what they consider-not what a court may consider-is in the interest of the company. And if t hey have done that t he court
cannot subst it ut e t heir judgment for t heirs.[41]

However the Board of Directors does not always exercise it s powers of refusal in good faith or bona fide. T he Board knows t hat t he Courts will
not int erfere wit h their decision if they act bona fide and in t he int erest s of the company. T hus in the name of act ing in t he int erest s of the
company t he Board may abuse it s power and refuse t o regist er transfer of shares according t o their whims and fancies. In a privat e company the
direct ors will be able t o abuse this power vested in them more easily as t hey are usually bound by close t ies of kinship, friendship et c. and t hus
may conspire to refuse t o register a transfer for personal reasons such as host ility t owards the transferee and use t he d efence of acting in t he
int erest s of t he company as a shield. Such acts may prejudice t he int erest s of genuine t ransferees and shareholders an d might also affect t he
int erest s of t he company adversely.

Sect ion 111 of the Companies Act , 1956 prevents t he Board of Direct ors from abusing t he power of refusal t o regist er t ransfer of shares
granted t o them by the articles of t he company and ensures t hat t he int erest s of genuine and bona fide t ra nsferees and shareholders are not
prejudiced or harmed in any way.

Sect ion 111 provides a right of appeal t o t he Company Law Board in respect of refusal to regist er t ransfer/transmission of shares and Sect ion
111A gives t he right t o pet it ion the Company Law Board for rectification of register of members.

T hus a right to appeal t o the Company Law Board under Section 111 will usually lie on the following grounds.[42]
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When the Board of Directors acts mala fide

Where it is proved t hat t he Board has not exercised it s power of refusal t o regist er t ransfer of shares in good faith or for t he benefi t of t he
company an appeal may lie to t he Company Law Board. T he power of declining a t ransfer is vested in the Board of Direct ors for t he purpose
of protect ing t he interest s of t he company. Hence their refusal must appear to have proceeded out of an honest and genuin e desire t o benefit t
he company. A mala fide refusal t o register a t ransfer will not be sust ained. T hus if t he if t he Board exercises it s power of refusal in order t o
prevent t he t ransferor from selling his shares at all, or because of their hostilit y t owards him or because t he Board of Directors wish to gain
control of the company t hemselves and they consider acquisition of t he shares by the transferee may prevent t hem from doing so t he court will
order t he Board t o register t he t ransfer of shares[43]. In Harinagar Sugar Mills v. Shyam Sunder[44] the Supreme Court st at ed that while
exercising it s appellat e jurisdict ion under Section 111 t he Company Law Board has t o decide whether in exercising their power t he direct ors are
act ing, oppressively, capriciously, or corruptly or in some way mala fide.

Inadequacy of Reasons
Earlier, Courts usually did not ask the Board of Directors to furnish reasons for t heir refusal t o register t ransfer of shares. Only i f t he Board
voluntarily disclosed its reasons the court had t he power to look int o t hem and if t hey did not seem to be suffici ent t o just ify t heir decision t he
court might set it aside. However now, by virtue of the 1988 Amendment , t he Board of Directors is bound by law t o disclose it s reasons for
refusing t o register a transfer of shares. T his gives an opport unit y to t he Company Law Board to examine t he relevancy of the reasons and
make it s decision in a more judicious fashion. It is also in keeping wit h the principles of nat ural just ice.

Irrelevant Considerations
Lord Greene MR in Sm ith and Fawcett Ltd., Re[45] st at ed t hat “ The directors (in refusing a transfer) m ust have regard to those considerations
and those considerations only which the articles on their true construction perm it them to take into consideration ”.

T he power of refusal by t he direct ors should be exercised st rict ly on the grounds specified in t he articles. No ot her ground can be import ed into
t he matt er. A refusal is liable to be struck down if it proceeds on grounds extraneous to t he art icles. In Master Silk Mills Private Lim ited v. D.H
Mehta[46] t he Board of Direct ors refused t o accept a t ransfer in favour of a company whereas t he art icles empowered them to exclude only
undesirable persons. T hus t he Calcutt a High Court held that such blanket ban on admission of companies was beyond t he aut horit y vested in t he
Board of Directors by the articles. T he Court st at ed “ Approval of the transferee m eans approval of the transferee personally as distinguished
from laying down a general rule that no corporate body would be allowed to join the com pany as a shareholder”. T he reasoning of t he
Calcut ta High Court is ext remely well analysed and reasoned and clearly lays down t he principle that if the direct ors exc eed t he power of refusal
granted t o them by the articles the court will strike down t heir order refusing to regist er t ransfer of shares. T hus under no circ umst ance should
t he Board exceed its powers and refuse t o regist er a t ransfer on grounds which are out side t he purview of t he art icles.

It is t hus seen t hat the Companies Act , 1956 has provided adequat e remedies and safeguards t o the aggrieved t ransferee and shareholder in t he
case of wrongful refusal t o register t ransfer of shares by the Board of Directors. T he Co mpany Law Board has been vested with t he appropriat e
judicial teet h in order t o met e out just ice and remedy wrongful refusals by t he Board. T he Court s too have implement e d the law zealously and
int erpret ed t he legislative provisions in their t rue spirit in order t o see t hat just ice is not denied and rights of the Company, shareholder and t he
injured t ransferee are not affected adversely.

C oncl usion

T he core issue with respect t o t ransfer of shares in privat e companies is t he restrict ions on transfer of shares which a privat e company must
incorporat e int o its art icles. Sect ion 3(1)(iii)(a) of t he Companies Act , 1956 requires every privat e company t o inco rporat e restrict ions on t he
t ransfer of shares in it s articles. It must be not ed t hat t he Sect ion does not specify as t o what these rest rictions should be. It is t hus open to t he
framers of t he art icles as t o how many rest rictions t here should be and what should be t heir scope and extent. T he fra mers of t he art icles can
make t he restrict ions as lenient or as st rict as t hey desire. T he law merely requires t hat t hese restrict ions on t he t ransfer of shares should be
present in t he articles of association of a privat e company.

Having rest rictions on the rights of its members t o transfer their shares is one of t he main characterist ics of a privat e company and is
considered somet hing int rinsic t o a privat e company.

A private company is based on the partnership principle. In fact it is said t hat the partnership principle is the soul of a private company. A privat e
company is usually an association of persons bound t oget her by close t ies of kinship, friendship and sharing a camaraderie and trust which cannot
be easily shared wit h anot her person. T hese restrict ions on the t ransfer of shares in a private company help to preserve t his close knit relat
ionship amongst t he members of a privat e company. T he rest rictions on t ransfer of shares enable t he members of a private company t o prevent
admission of members who may be undesirable or hostile to t he exist ing members and also prevent dilut ion of cont rol of th e company. T he
import ance and relevance of t hese restrict ions on the transfer of shares cannot be furt her emphasized. T hey virt ually preserve
t he soul of t he private company and enabler the private company t o achieve it s aims and object ives. T he Courts have pro ved t o be t he
guardians of t hese rest rict ions and have upheld rest rictions on t ransfer of shares in privat e companies in order t o preserve t he part nership
principle in privat e companies.

On anot her level t hese restrict ions also preserve the dist inct ion between privat e and public companies. It is debatable as t o whet her how far this
dist inct ion should be cont inued or maintained but that is not a relevant issue to t he matt er under discussion.

T hese restrict ions creat e some areas of ambiguit y which creat e problems in company law and affairs. For example t here is ambiguit y wit h
respect t o valuation of shares in the case of exercise of pre-empt ion rights.

Moreover care must be taken t o see t hat these rest rictions do not exceed their scope and ext ent as prescribed by the arti cles because if that

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happens then the int erest s and right s of t he shareholders, transferees and the company may be adversely affected. T he power vest ed in t he
Board of Directors t o refuse t o register a transfer is a common rest rict ion found in the articles of a privat e company. T he Board oft en abuses
t his power. T he 1988 amendment which requires the Board to give reasons for its refusal has helped t o check t he abuse of t his power. However
more concret e st eps need t o be t aken to prevent such abuse. T he remedies available in case of abuse of this power are ad equat ely provided for
by Section 111 of the Companies Act . T he Court s t oo have done t heir best to check abuse of t his power and ensure that no injust ice or
prejudice is caused t o t he aggrieved person.

Rest rictions on the transfer of shares in private companies are thus undoubt edly ext remely important and relevant . However in order t o avoid t
he problems and ambiguit ies that t hey may creat e it is essent ial t hat t hese rest rict ions should be extremely well dra ft ed wit h ut most care,
caut ion and foresight . For example t he scope of abuse of the power t o refuse to regist er a t ransfer by the Board of Directors would be
considerably reduced if proper guidelines were incorporat ed int o t he art icles wit h respect t o how t he discret ion and power should be exercised by
t he Board. Concret e steps must be taken t o rectify abuse and to clear t he ambiguous areas creat ed by these rest rictions on t he t ransfer of shares
in privat e companies. It is essential for t he smooth working and success of t he privat e company.

Bibl i ography

A. Arti cl e s

1. Avtar Singh, “ Company Law” Annual Survey of Indian Law, Vol. XV (1979) at 43.
2. Carrie A. Plat t, “ T he Right of First Refusal in Involunt ary Sales and T ransfers by Operat ion of Law” 48 Baylor Law Review 1197 (Baylor
Universit y, 1997).
3. N.Vijia Kumar, “ T ransfer of Shares” SEBI and Corporate Laws, Vol. 35 (2002) at 122.
4. R.Vidhya Shankar, “ Scope of Power of Company Law Board T o Grant Interim Reliefs While Dealing Wit h Petit ions/Applications Under
Sect ions 111 and 111A Of Companies Act, 1956” (2000)3 Com pany Law Journal at 109.
5. T homas J. Andre Jr., “ Restrict ions on t he T ransfer of Shares: A Search for a Public Policy” 53 Tulane Law Review 776 (T ulane
Universit y, 1979).

B. Books

1. A. Ramaiya, Guide to the Com panies Act Part I 14 th ed. (New Delhi: Wadhwa and Company Law Publishers, 1998).
2. A.K Majumdar and Dr. G.K Kapoor, Com pany Law and Practice (New Delhi: T axmann Publicat ions Limit ed, 2000).
3. A.L Saha, Lectures on Com pany Law (Bombay: N.M T ripat hi Privat e Limited, 1990).
4. Avtar Singh, Com pany Law (Lucknow: East ern Book Company, 1999).
5. B.K Sen Gupta, Com pany Law (New Delhi: East ern Law House, 1990).
6. Clive M. Schmit t hoff, Palm er’s Com pany Law Vol. 1 (London: St even and Sons Limited, 1976).
7. P.B Mukharji, The New Jurisprudence (Calcutt a: East ern Law House, 1970).
8. Paul L. Davies, Gower’s Principles of Modern Com pany Law (London: Sweet and Maxwell Limited, 1997).
9. Richard W. Jennings and Richard M. Buxbaum, Corporations-Cases and Materials (Minnesot a: West Publishing Company, 1979).
10. Robert R. Pennington, Com pany Law (London: But t erwort hs, 1995).

[1] Prof. M.P.P Pillai’s Lect ure on Corporat e Law on 29 th October, 2002.

[2] Companies Act , 1907 ( A Brit ish Legislation).

[3] Indian Companies Act , 1913.

[4] A.L Saha, Lectures on Com pany Law (Bombay: N.M T ripat hi Private Limit ed, 1990) at 366.

[5] Clive M. Schmitt hoff, Palm er’s Com pany Law Vol. I (London: St even and Sons Limited, 1976) at 41.

[6] By virt ue of Section 3(1)(iii) of the Companies Act , 1956.

[7] N.Vijia Kumar, “ T ransfer of Shares” SEBI and Corporate Laws Vol. 35 (2002) at 124.

[8] Supra not e 5 at 386.

[9] B.K Sen Gupt a, Com pany Law (New Delhi: Eastern Law House, 1990) at 181.

[10] Supra not e 5 at 41.

[11] Supra not e 5 at 387-388.

[12] Supra not e 5 at 388.

[13] Section 108 of the Companies Act , 1956.

[14] A.K Majumdar and Dr. G.K Kapoor, Com pany Law and Practice (New Delhi: T axmann Publications Limit ed, 2000) at 33.

[15] A. Ramaiya, Guide to the Com panies Act Part I 14 th ed. (New Delhi: Wadhwa and Company Law Publishers, 1998) at 73.

[16] AIR 1966 Assam 48.

[17] Richard W. Jennings and Richard M. Buxbaum, Corporations- Cases and Materials ( Minnesota: West Publishing Company, 1979) at 367.

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[18] Anot her reason may be t o prevent key personnel or members from leaving t he company.

[19] [1942]1 All ER 542.

[20] Paul L. Davies, Gower’s Principles of Modern Com pany Law (London: Sweet and Maxwell Limit ed, 1997) at 345-346.

[21] (1992)1 SCC 160.

[22] Robert R. Penningt on, Com pany Law (London: Butt erwort hs, 1990) at 752.

[23] 1959 SCR 878.

[24] Supra not e 15 at 74.

[25] Supra not e 5 at 394.

[26] In Ontario Jockey Club v. Sam uel Mcbridge, AIR 1928 PC 291 the Court held t hat “ A rest riction which precludes a shareholder
altoget her from transferring may be invalid, but a rest rict ion which does no more than give a right of pre-emption is valid”.

[27] Lyle and Scott Ltd. v. Scott’s Trustee, [1959]2 All ER 661.

[28] Greenhalgh v. Mallard, [1943]2 All ER 234.

[29] Supra not e 15 at 75.

[30] Lyle and Scott Lim ited v. Scott’s Trustees, [1959]2 All ER 661.

[31] Theakston v. London Trust Plc., (1984) BCLC 390.

[32] Hunter v. Hunter, 1936 AC 222 HL.

[33] (1984) BCLC 599.

[34] Supra not e 22 at 758.

[35] [1954]1 All ER 749.

[36] Supra not e 22 at 753.

[37] [1949]2 All ER 1044. Similar views were expressed in Babulal Choukhani v. Western India Theatres Lim ited, AIR 1957 Cal 709.

[38] Supra not e 15 at 80.

[39] S.P Mehta v. Calico Dyeing and Printing Mills Ltd., (1990) 67 Comp Cas 533 Bom.

[40] AIR 1956 Nag 20.

[41] Sm ith and Fawcett Ltd. Re, [1942]1 All ER 542.

[42] T hese grounds have developed in the light of judicial decisions and t he views expresses by the Court s.

[43] Supra not e 22 at 753-754.

[44] AIR 1961 SC 1669.

[45] [1942]1 All ER 542.

[46] (1980) 50 Comp Cas 365 Guj.

Endnote s:

1. Corp Law I-T ransfer of Shares in Private Companies: ht t p://www.legalsut ra.com/wp-cont ent /uploads/2010/10/13/t ransfer-of-shares-in-
privat e-companies/Corp-Law-I-T ransfer-of-Shares-in-Private-Companies.doc

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