Transfer of shares under scheme of amalgamation wouldn’t come under pre-emption clause of Articles – An Analysis

The Bombay High Court has held in the matter of Shakti Insulated Wires (P) Ltd. v. Great View Properties (P) Ltd. [2016] 135 SCL 80/68 taxmann.com 169 that the transfer of shares under the Scheme of Amalgamation sanctioned by the Court is not a transfer of shares but is transmission by operation of law which would not come within the pre-emptive clause of the Articles of Association of the company. This article highlights the nuances in determining the pre-emption clause in the Articles of Association and clarifies the difference between transfer of shares under the Scheme of amalgamation and transfer of shares covered under the pre-emption clause of the Articles of Association of the Company.

AN ANALYSIS

1. Introduction

Section 58(2) of the Companies Act, 2013 provides that any contract or arrangement between two or more persons in respect of transfer of securities should be enforceable as a contract. This section has clarified the major issue of enforceability of pre-emption rights and options being exercised by the shareholders. This article highlights the nuances in determining the pre-emption clause in the Articles of Association and clarifies the difference between transfer of shares under the Scheme of amalgamation and transfer of shares covered under the pre-emption clause of the Articles of Association of the Company. The same has been explained by a landmark judgment dated 1^st March, 2016 of the Bombay High Court in the matter of Shakti Insulated Wires (P) Ltd (supra)

2. Meaning of Pre-emption clause

Pre-emption rights are often defined as those rights that shareholders may have to be offered shares in a company before they are made available to anyone else. Pre-emption rights can arise on allotment of shares, transfer of shares and /or transmission of shares. Pre-emption is one way to ensure that existing shareholders' proportion of voting and other rights in a company are not diluted. Contracts for pre-emption including right of first refusal tag along or drag along rights can be provided in the Shareholders Agreements or in the Articles of Association of the companies.

3. Facts of the case -Shakti Insulated Wires (P) Ltd. (supra) & Judgment delivered by Bombay High Court on 1.3.2016

Jayalaxmi Holdings Pvt. Ltd (JHPL) held 1980 shares of the Appellant Company and the said shares are the subject shares. In pursuance of a Scheme of Amalgamation sanctioned by the Bombay High Court, all assets and liabilities of JHPL were transferred to the first Respondent. It is to be noted that the assets included the subject shares as well. The first Respondent thereafter applied for registration of transfer of shares and for inclusion of its name in the Register of Members. But the Appellant rejected the application on the ground that the transfer of shares was in breach of the relevant Articles of Association providing for a right of pre-emption. Aggrieved by this rejection, the first Respondent filed a Petition before the Company Law Board (CLB) under Section 111 of the Companies Act. The CLB allowed the Petition and directed rectification of the Register.

4. Proceedings before the Bombay High Court

The contention of the Counsel for the Appellants stated that the CLB has erred in law by treating the transfer of shares under the Scheme of Amalgamation as a case of transmission by operation of law, whereas transfer of assets by a Scheme of Amalgamation is considered as a voluntary transfer between the transferor and the transferee companies. The Counsel also relied on the Articles of Association of the Appellant Company and contended that all voluntary transfers come within the pre-emption clause of the Articles. Since the subject transfer of shares was in breach of the Articles and was thus, rightly rejected by the Appellant Company.

5. Relevant Articles concerning " Transfer of Shares"

5.1 Article 22: Except as hereinafter provided, no shares in the Company shall be transferred unless and until the rights of pre-emption hereinafter conferred shall have been exhausted.

5.2 Article 23: Except where the transfer is made pursuant to Article 29 or Article 38 hereto, the person proposing to transfer any share (hereinafter called "the Proposing Transferor") shall give notice in writing (hereinafter called " a Transfer Notice") to the company, that he desires to transfer the same. Such notice shall specify the sum he fixes as the fair value and shall constitute the Board of Directors his agent for the sale of the share to any member of the company or person approved of selected by the Board of Directors who is willing to purchase the share (hereinafter called " the Purchasing Member") at the price so fixed or at the option of the Purchasing Member at the fair value to the fixed or at the option of the Purchasing Member at the fair value to be fixed by the Auditors of the Company in accordance with Article 25 hereof. A Transfer Notice may include several shares and in such cases shall operate as if it were a separate notice in respect of each. A transfer Notice shall not be revocable except with the sanction of the Directors.

5.3 Article 24: If the Company shall within the space of 28 days after being served with a Transfer Notice find a Purchasing Member and shall give notice thereof to the Proposing Transferor he shall be bound upon payment of the fair value in accordance with Article 25 thereof, to transfer the share to the Purchasing Member.