Hybrid Companies and Restrictions on Transferability

We have previously discussed at length the law on the scope of s. 111A(2) of the Companies Act, 1956 [“CA 1956”]. In its recent judgment in Jer Rutton Kavasmanek v Gharda Chemicals, the Bombay High Court has considered this issue, as well as another controversial area in Indian company law – whether “public” and “private” are exhaustive of the types of companies contemplated by the CA 1956.

The case arose out of a long-drawn family dispute between the CMD of Gharda Chemicals Ltd. [“GCL”], Dr. Gharda, and his sister’s family (Mrs. Jer Rutton Kavasmanek). GCL had originally functioned as a partnership to which Mr Rutton Kavasmanek had contributed the bulk of the funds, but in which Dr Gharda held a 40 % share of the profits. Subsequently when the business was in dire straits Dr Gharda had received an injection of capital from the Rebello family, which, however, was eventually allotted less than its promised share in the business. When the partnership was incorporated as a private company, Dr Gharda held 60 % of the share capital, and art 57 of the Articles of Association provided that no member could sell his shares to an outsider if an existing member was willing to offer a fair price. On 17 August, 1988, the company became a deemed public company by virtue of the provisions of s. 43A. Subsequently, after the 2000 amendment to the definition of private company in s. 3(1)(iii)(d), the company proposed to alter its articles to bring them into conformity with the amendment, by providing that it could not accept deposits except as specified in that section. The Kavasmanek group voted against this resolution and it was defeated, after which GCL took the position that it had become a full-fledged public company, and that art 57 had ceased to be binding. Subsequently, there were multiple rounds of litigation between the parties (claims of oppression and mismanagement etc.) and the Kavasmanek group sought an injunction when it appeared that Dr Gharda intended to sell some of his shares to an outsider.

There were thus two important issues of law the single judge had to consider – first, whether s. 111A(2) applied to GCL on account of s. 43A/s. 3(1)(iii)(d) and secondly, if it did, whether art 57 had ceased to be binding. The first of these questions at first sight appears to be a non-issue, since the common assumption is that a company is either private or public. The uncertainty, however, arises from the language the legislature has chosen to use, especially post the 2000 amendment. In the CA 1956 as originally enacted, a public company was simply defined as a company which is “not a private company” – which is now sub-section (a) of s. 3(1)(iv). After the amendment, two additional conditions have been added – the share capital requirement, and s. 3(1)(iv)(c) – “a private company which is a subsidiary of a company which is not a private company”. One view is that a company incorporated as a private company which is then deemed to have become a public company (s. 43A for example, before its effective repeal) or becomes a subsidiary of a company which is a public company (for example on account of a change in shareholding pattern) does not for that reason cease to be a private company, because its “basic characteristics” remain the same. This view was accepted by the Company Law Board in Hillcrest Realty, a decision Mr Umakanth has discussed in more detail in this paper. In Jer Rutton Kavasmanek, this argument (without citing Hillcrest) was put to the single judge, so that there was no question of s. 111A(2) applying. His Lordship rejected it, holding that the legislature in 2000 had intended to entirely dispense with the concept of deemed public company that had been introduced by the 1974 amendment. Dharmadhikari J. observed that “[t]he effect of all this is that the concept of deemed public company under Section 43A and introduced by the Companies (Amendment) Act has now been abolished based on the recommendation of the working group the Companies Act, 1956.” The point was obiter, because the primary basis of Dharmadhikari J.’s conclusion was that the company had become a public company after the resolution in April 2001 to alter the articles was defeated. Nevertheless, the court’s general approach, and its reference to the Working Group, suggest that it is of the view that “public” and “private” are exhaustive.

One may have thought that the second question – s. 111A(2) – was concluded, so far as a single judge of the Bombay High Court is concerned, by the judgment of its Division Bench in Messer Holdings v SM Ruia. Yet, Dharmadhikari J. held that art 57 is void, because the shares of a public company are freely transferable, and that Messer Holdings is distinguishable because in that case the restriction appeared in a private agreement, while in this case it was part of the articles of association. While this distinction does exist, its force is perhaps somewhat undermined by the fact that the fulcrum of Messer was s. 111A(2), which, unlike s. 82, makes no reference to the source of the restriction. Readers may also wish to refer to the recent judgment of the Delhi High Court in Premier Hockey Development v IHF, where Sanghi J., following the judgment in Modi Rubber v Guardian International, has distinguished VB Rangaraj.

Several questions remain unanswered after these decisions – for example, whether s. 111A(2) distinguishes between different sources of a restriction, whether it is directed principally to the Board of Directors (as the Division Bench in Messer held) or to the subject matter of the sale (as Chandrachud J. in Bajaj Auto held), what the nature of a “restriction” is etc.