Under the Indian Companies Act, 2013 (Act), there is no clear and explicit provision dealing with power of directors of a company to refuge to register transfer of shares with respect to both private and public company. However, such a power of discretion can be authorized to directors by the company through its Articles of Association (AoA). Under the act, section 58(2)[1] deals with transferability of securities and provides that securities of a member are freely transferable in case of a public company. But subsection 4 of the section 58 states that a company may not allow and refuse to register a transfer of shares, if it has a sufficient cause. The Act does not define, what constitutes sufficient cause, but many courts have opined that such restriction on transferability of shares should be in good faith and in interest of the company.
If a company decides to reject a share transfer, they are legally obligated to send a written notice to both the person selling the shares (transferor) and the person buying them (transferee) within 30 days of receiving the transfer request. This notice must clearly explain why the transfer was denied. The transferee has the right to challenge the decision of the company. They can file an appeal with a designated tribunal within 30 days of receiving the refusal notice.
Such restriction on transferability of shares is generally provided under the AoA of the company and it is exercised by the directors. Section 58(4)[2] of the present Act is similar to section 111A (2)[3] of the earlier Companies Act, 1956.
In Bajaj Auto Ltd. N.K. Firodia and another[4], the Apex Court laid down that, reasons of the directors to refuse to register have to be examined on three points, Firstly, whether the directors of company have acted in interests of the company; second, whether the directors did act on a wrong principle; and, lastly, whether the directors of company have acted with an oblique motive. The Supreme Court in a decision of, Hari Nagar Sugar Mills Ltd. v. Shyam Sunder Jhunjhunwala said that “the discretion of the Directors would be nullified if it were established that the Directors acted oppressively, capriciously or corruptly or in some other way mala fide.” Hon’ble court further observed in Bajaj Case that the actions of the directors have to be examined as to whether such actions of the directors were for the benefit of the company as a whole.
It is also important to note that the burden of proof to show a mala fide interest on the part of directors is on the aggrieved person[5]. In Bajaj Auto Ltd. v. Company Law Board, the Apex Court held that even if articles give the directors of a company power to restrict transfer of shares, they cannot do so arbitrarily. The acts of the board should be in good faith and in interest of the company[6]. For public companies, free transferability of shares is important. The courts will not interfere in the reasons for refusal but will ensure that the board did not act in bad faith. In Luxmi tea company limited vs. Pradip Kumar sarkar court observed that “If neither a specific nor residuary power of refusal has been so provided, such power cannot be exercised on the basis of the so-called undeclared inherent power to refuse registration on the ground that the company or its directors take the view that in the interest of the Company and the general interest of the shareholders, registration of the transfer of shares should be refused”[7].
In Dale and Kerrington v. P.K Prthapan[8], the Supreme Court addressed the concepts of bona fide and bad faith interests regarding actions of the directors of a company. The Court emphasized a well-established principle that directors have the authority to use their powers in good faith and for the benefit of the company only. As long as directors act with good faith and the company’s interests in mind when assigning shares, their actions are considered proper and legal. Even if the directors have an additional motive, such as personal gain, their decision will not be automatically invalidated as long as their primary motivation aligns with the well-being of the company.
Court further held that the main objective of directors must be to act in interest of company and not for personal gain. Even if directors have the legal right to issue shares to one of themselves, their decision can still be challenged if their primary goal is personal gain, even with some minor benefit to the company. The key is whether they acted in good faith and with the company’s interests at heart. In each case, the specific facts will be considered to determine if the share allotment was bona fide. If it’s found that the directors did not prioritize the company’s well-being, the allotment can be overturned.
The Hon’ble Supreme Court in Sangram Singh P. Gaekwad v. Shanti Devi P. Gaekwad[9] clarified the duties of company directors in relation to the company and its shareholders. The court emphasizes that a company director holds a position of trust (fiduciary capacity) towards the company itself. This means they have a legal and ethical obligation to act in the best interests of the company. The primary responsibility of directors is to prioritize the well-being of the company. Their decisions and actions should be driven by what benefits the company the most. The statute does not explicitly require directors to focus on individual interests of shareholders. This might seem surprising, but the success of a company ultimately benefits all shareholders in the long run. There can be situations where directors might owe a duty to individual shareholders. If there is a specific agreement between the director and shareholders outlining additional obligations, the director must comply. In special circumstances, a director’s actions might directly impact specific shareholders. In such cases, the responsibility of directors towards those shareholders might come into play. The court acknowledges that each situation is unique. When evaluating director actions, the specific facts and circumstances surrounding the case will be considered. This includes determining if any special arrangements or circumstances exist that might influence the duties of directors towards shareholders.
While discussing on the point regarding articles that grant directors the discretion to refuse share transfers. In Shree Krishna Agency Ltd vs Commissioner of Income Tax Central[10], Supreme Court discusses that the articles of a company allow the directors to decide whether to approve a share transfer. This gives them control over who becomes a shareholder of a company. The court emphasizes that this power is a fiduciary one. The directors must exercise it in the best interests of the company. The directors can use this power to prevent someone who could harm the company from becoming a shareholder. Examples could include someone with a history of fraud or someone with a conflict of interest. The court stresses that the decision of directors to refuse to register a transfer must be reasonable and based on a genuine concern for the well-being of the company. They cannot simply reject transfer of shares for their personal reasons. The court assumes the directors will act in good faith and not misuse this power for their own benefit. While the directors have discretion, it should not completely eliminate the ability to freely transfer shares. There needs to be a balance. The court clarifies that simply having the power to refuse transfers does not automatically restrict share transferability. For it to be considered a restriction, there needs to be clear evidence that directors are unreasonably blocking transfers and harming the ability of company to function as a freely trading entity.
In simple words, The Supreme Court ruling clarifies the power some companies grant directors to approve or deny share transfers. This power is meant to be used responsibly, with the company’s best interests in mind. Directors can use it to keep out potentially harmful individuals, but they can’t simply block transfers for no good reason. The court generally assumes directors will act fairly and not prevent shares from being freely traded unless there is strong evidence that such restrictions are necessary to protect the company.
In M.G. Amirthalingam vs Gudiyatham Textiles Pvt. Ltd. And Ors[11]., the court held that the right to refuse transfer is a fiduciary duty and must be exercised in good faith. However, the Court will not interfere when the Board has rejected a transfer as per the interpretation of its articles but only step in where there is proof of bad faith.
The court emphasizes that the power to refuse a transfer by the board of directors is a fiduciary duty. This power must be used with good intentions and for the benefit of the company. The court generally will not get involved when the board rejects a transfer based on their interpretation of the articles of the company regarding share transfers. The court will only intervene if there is clear evidence that the board acted in bad faith. This could include situations where the board rejected a transfer for a reason which is not related to well-being of the company, such as personal animosity towards the person trying to buy the shares.
Supreme Court in the case of Mackintosh Burn Limited v. Sarkar and Chowdhury Enterprises Private Limited[12] held that a company can refuse to register a share transfer, not just if it violates existing laws, but also for other valid reasons. The court introduces the concept of “sufficient cause” as a justification for refusing a transfer. However, the court leaves it up to the Company Law Boards to decide what constitutes “sufficient cause” on a case-by-case basis. This creates some uncertainty as companies and shareholders may not always know for sure if a reason for refusal will be considered valid.
Therefore, the directors of a company do have a discretionary power to refuse to register a transfer of shares through the Articles of Association, but as upheld in above decisions, such power has to be exercised only in interests of the company and not for personal benefits.
CONCLUSION:
The discretionary power of directors to refuse to register transfer of shares in India exists, but with limitations. While the act does not explicitly grant the power, it can be authorized by the articles. Such power must always be act in good faith and in the interest of company only, not for any personal gain. Courts, generally will not interfere but an ensure motive, arbitrariness, and intentions behind the refusal.
The concept of sufficient cause for refusing to register transfer of shares remains undefined. A standardized definition form Act or through a judicial decision will give much clarity. This would also offer a more predictable framework for exercising the power and potentially reduce litigation. The act should also make a balance on the importance of free transferability with need of a company to protect itself from undesirable shareholders. Perhaps a tiered approach could be implemented with stricter scrutiny for larger shareholding or situations where harm to a company is high.
Legislature could also come up few changes regarding clearer communication form directors to transferee when refusing a transfer. Stating the reasons for refusal within a defined timeframe for enhancing transparency.
Authored by Vikas Kumar
Former Intern, H.K. Law Offices
Student, National Law Institute University, Bhopal
[1] The Companies Act, 2013, Sec. 58(2).
[2] The Companies Act, 2013, Sec. 58(4).
[3] The Companies Act, 1956, Sec. 111A (2).
[4] Bajaj Auto Ltd. N.K. Firodia and another 1971 AIR 321, 1971 SCR (2).
[5] Hari Nagar Sugar Mills Ltd. v. Shyam Sunder Jhunjhunwala AIR 1961 SC 1669.
[6] Bajaj Auto Ltd. v. Company Law Board 1998 (6) SCC 218.
[7] Luxmi tea company limited vs. Pradip Kumar sarkar 1989 SCC Supl. (2) 656.
[8] Dale and kerrington v. P.k Prthapan (2005) 1 SCC 212.
[9] Sangram Singh P. Gaekwad v. Shanti Devi P. Gaekwad (2005) 11 SCC 314.
[10] Shree Krishna Agency Ltd vs Commissioner of Income Tax Central,1972 AIR 156.
[11] M.G. Amirthalingam vs Gudiyatham Textiles Pvt. Ltd. And Ors 1970 SCC ONLINE MAD 111.
[12] Mackintosh Burn Limited v. Sarkar and Chowdhury Enterprises Private Limited, (2018) 5 SCC 575.
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