RE Mptive Ight: V.B.Rangaraj v. V.B.Gopalakrishnan

PRE-EMPTIVE RIGHT
As compared to ROFR, there is an almost similar right which is known as a pre-emptive right. It
may not be easy proposition to differentiate between the ROFR and the pre-emptive rights, as the
two seem to be similar, if not identical. Contrary to a right of first refusal, a pre-emptive right
appears to be similar to a right of first offer. A Right of first offer is a close cousin to the right
of the first refusal. Under the right of first offer, before an owner can sell property subject to
a right of first offer, the right holder must be given the chance to make an offer for the
property. The owner can then either accept the offer; or the owner can sell the property to
a third party, but only at a price above the one offered by the right holder. For this right to
be effective and enforceable, in the case of private company, the same may be inserted in the
Articles of Association of the Company. As per the said right, the right to transfer shares to non-
members is restricted. Further, it is worthwhile to note that a private agreement between two or
more shareholders in which they impose restrictions upon each other as to their right of transfer
does not bind the company and, consequently, the same is likely to be a subject matter of a civil
suit between the parties to the agreement and the party committing breach may have to answer in
terms of damages to the other. To bind the company, the agreement has to include the company
as one of the parties, and it has to be a subject matter in the Articles of Association.1
BACKGROUND
The discussion on this subject began in the year 1992 when the Supreme Court in the case of
V.B.Rangaraj v. V.B.Gopalakrishnan2 held that in case of a private limited company transfer
restrictions, if any, agreed by the shareholders unless embodied into the articles of association
would not be valid and binding. On the other hand, the Delhi High Court and the Company Law
1
Supra note 1
2
V B Rangaraj v. V B Gopalakrishnan, [1991] 6 CLA 211
Board held that in case of listed shares there cannot be any restrictions namely rights of first
refusal or any such rights. This was because Section 111A (2) 3 of the Companies Act 1956,
provides that the shares and debentures and any interest therein of a company shall be freely
transferable. Justice Chandrachud of the Bombay High Court also took the same view in 2010 in
the case of Western Maharashtra Development Corporation v. Bajaj Auto Ltd4 and observed
that “the principle of free transferability must be given a broad dimension in order to fulfil the
object of the law. Imposing restrictions on the principle of free transferability is a legislative
function, simply because the postulate of free transferability was enunciated as a matter of
legislative policy when Parliament introduced Section 111A into the Companies Act, 1956. That
is a binding precept which governs the discourse on transferability of shares. The word
“transferable” is of the widest possible import and Parliament by using the expression “freely
transferable”, has reinforced the legislative intent of allowing transfers of shares of public
companies in a free and efficient domain. The effect of a clause of pre-emption is to impose a
restriction on the free transferability of the shares by subjecting the norms of transferability laid
down in Section 111A to a pre-emptive right created by the agreement between the parties. This
is impermissible.”
This interpretation was causing lot of hardship on the PE investors / Strategic Partners in
negotiating the right of first refusal or tag / drag rights with the Promoters, which are typically
exit options negotiated to protect their commercial interest. Question therefore was whether in a
listed company one can validly offer right of first refusal or tag/drag along rights that would
ultimately be legally enforceable?
The aforesaid decisions came up for consideration before the Division bench of the Bombay
High Court in case of Messer Holdings Limited v. Shyam Madanmohan Ruia and Ors 5. The
judgment is interesting as it comes in the wake of the Bombay High Court judgment in Bajaj
Auto case6; it changed the way to negotiate restriction on transfer of shares in a public company.
That judgment had ruled that any pre-emptive rights over shares in public limited companies
were illegal in view of the principle of “free transferability” enshrined in Section 111A of the
3
Section 111A (2) of Companies Act, 1956: Subject to the provisions of this section, the shares or debentures and
any interest therein of a company shall be freely transferable.
4
(2010) 154 CompCas 593 (Bom)
5
Messer Holdings Ltd. v. Shyam Madanmohan Ruia, [2010] 98 CLA 325
6
Western Maharashtra Development Corporation v. Bajaj Auto Ltd., (2010) 154 CompCas 593 (Bom)
Companies Act, 1956. The debate on enforceability of terms of shareholder agreements
governing public limited companies is definitely not over yet.
The Court with respect rejected the earlier interpretation given to the words “free transferable”
used in section 111A by the single Judge in the Bajaj Auto case 7. The Division bench for the first
time examined the true intent of section 111A, the reason for its insertion in the Companies Act,
1956 and observed that earlier when the shares were in physical form, board of directors used
arbitrary powers to reject transfer of shares leading to lot of complaints by the transferees. That
situation was partially remedied by insertion of section 22A of the Securities Contract
Regulation Act, which laid down only four grounds on which any board could reject transfers.
With the introduction of the concept of dematerialized shares through the Depositories Act,
1996, section 22A got deleted and section 111A was introduced in the Companies Act to deal
with rectification of register. The Court observed that the whole purpose of section 111A is to
regulate the right of the board of directors to refuse transfer of shares. Under Section 111-
A, the Company Law Board has been empowered to direct any depository or company to rectify
its register or records on an application made to it by a depository, company, participant or
investor or SEBI.8
7
Ibid.
8
A Ramaiya, Guide to the Companies Act, 17th edn., 2010, Part 1, Lexis Nexis Butterworths, Wadhwa, Nagpur

RE Mptive Ight: V.B.Rangaraj v. V.B.Gopalakrishnan

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PRE-EMPTIVE RIGHT

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