The ownership pattern of a private limited company is determined by the quantum of shares each individual/organization holds. In order to induce new investors or even transfer the ownership of the company, the shares of the concerned private limited company would have to be transferred.
Share Transfer Restrictions In Articles Of Association
A private limited company is similar to a partnership firm as both are a ‘close corporation of members’. Hence, the transferability of its shares can be restricted by the Articles of Association (AOA) of the company concerned. Therefore, the AOA of the entity must be reviewed prior to the initiation of the share transfer procedure.
There are restrictions on the seller to sell its share to the third party. Before he can do that, it is an obligation upon him to offer his part of shares to the other shareholders in the company. Such a privilege offered to the other shareholders is called the ‘Right of Pre-Emption’. Hence, it is a privilege extended to the other shareholders in the company who have the right to either accept or reject the terms of the shares being offered to them.
There usually are two forms of restrictions on the right of shareholders to transfer their shares and which are mentioned below –
1. Right Of First Refusal
This kind of right is granted to a potential buyer by the transferor/owner of shares by virtue of a contract. In short, this is a contractual right given to an individual by the owner of the shares. Here, the owner gives a right to an individual and/or entity to buy his share of stake as per the same terms and conditions, had it been offered to a third party. If the concerned party agrees to buy the shares, the owner cannot sell his shares, in part or full, to the third party. But in case, if the prospective buyer with whom to whom this right is granted refuses, then the owner can consider to sell it to any third party as he deems fit at a price determined by the Auditors/ Directors of the company, the formula of which is provided in the Articles of Association of the company.
For example, ‘A’ owns 40% of stake in ‘XYZ’ company and has a ‘Right of First Refusal’ agreement with ‘B’. If ‘A’ considers selling his part of share, he has to first offer ‘B’ with the same terms and conditions had it been a third party. But if ‘B’ refuses, then ‘A’ may sell his share to any third party he/she wishes to.
2. Refusal by Directors
The directors of the private limited company may refuse the registration of the transfer of shares under prescribed circumstances which are only mentioned in the Articles of Association of the company. The restrictions contained in the Articles of Association are legally binding. Private agreements are not binding/enforceable either on the company or on the shareholders. However, there cannot be a total prohibition on share transferability.
Rights With Respect To Transferability Of Shares
The following are the contractual terms between shareholders which are usually included in the Articles of Association.
When a majority shareholder intends to sell his share to a potential buyer, the minority shareholder(s) can sell their shares as well subject to an agreement between the minor and major stakeholders, called tag-along rights or ‘co-sale’ rights.
For example, A owns 60% stake in ‘XYZ’ company. B, C, D, E owns 10% each totaling 40% in the same company. The majority (‘A’) and minority shareholders (‘B’, ‘C’, ‘D’, ‘E’) have a tag along rights agreement in place. A found a potential buyer-company which agreed to buy A’s stake at INR 100 per share, which is the best price offered in the market. As the minority shareholders have tag-along rights, they may also offer to sell their shares at the said price (INR 100/share).
Why It Matters?
It would not be wrong to question the ‘relevancy’ of this particular right. As given a tinge of hint earlier, co-sale or tag-along rights are good for the minority shareholders because they give them an opportunity to capitalize on a deal that the majority shareholder has been able to strike with the potential buyer. The majority shareholder may have the contact or access to the potential buyer and may be even able to strike a better deal. This right gives the minority shareholders to capitalize on an opportunity and sell their shares at a price which they probably wouldn’t be able to get if they go solo.
Drag Along Rights
This concept is unique and peculiar and is generally not made. It can be argued that it is an ‘evil’ side of tag along rights, depending on the facts and circumstances. Drag along rights can be defined as a compulsion for the small or minority shareholders in a company to sell their shares to a potential buyer who has already signed a deal of transfer of shares with the majority shareholder.
Therefore, in an event where the majority shareholder strikes a deal with a potential buyer, the former can initiate the sale of the company and ask for other minority shareholders to sell their shares as well on the same terms and conditions as agreed with the majority shareholder.
Initiation Of Transfer Of Shares
The following steps are important to be followed to initiate the transfer of shares –
- The Articles of Association of the private limited company must be reviewed and restrictions contained in it must be addressed.
- The concerned shareholder must give a notice in writing intimating the directors regarding his/her intention to divest his shares from the company.
- If the directors agree to buy the shares of the shareholder willing to divest, the value of the shares will have to be determined either by the directors of the company or by the company’s auditors.
- The company would, in turn, come out with a notice intimating other shareholders regarding the divestment. The details include the quantum of shares available, the last date to purchase, price of the shares, etc.
In case the existing members of the company are not interested in buying the shares, the same can be allotted to outsiders. It is to be noted that, in both the cases (existing members and non-existing members), the same procedure of transfer is to be followed the details of which are ascribed below.
Transferring Shares Of A Private Limited Company: Final Stage
Following steps are to be followed to formalize the transfer of shares of a private limited company:
- The prospective buyer intending to buy the shares of the concerned company has to fill the share transfer deed in form no. SH-4.
- Execute the share transfer deed duly signed by the transferor (old shareholder) and transferee (new shareholder) which should be duly stamped with adequate value.
- A witness must also sign the share transfer deed with his/her signature, name and address.
- Attach the share certificate with the transfer deed and send the same to the company within sixty days from the date of the execution.
- The last stage is the processing of documents by the company which when approved, a new certificate is made in the name of the new shareholder/transferee.
When all the formalities of the transfer like the execution of the transfer deed and handing over of the share certificates are done, then the transfer is said to be complete.
What If The Company Refuses To Transfer Shares? – The Remedies
If a company refuses or fails to register or transfer the shares on the transferor, then the transferor or the transferee can appeal to the National Company Law Tribunal (erstwhile, Company Law Board) within two months of the receipt of refusal to register the transfer the same requesting either to transfer the shares or to send a notice stating the reason for not registering the transfer of shares. In case, the transferor/transferee or both were not intimated the refusal for transfer of shares via notice, then the time limit is increased to four months from the date on which intimation of transmission or the instrument of transmission was delivered to the company concerned by the transferor.
The National Company Law Tribunal or NCLT after hearing such cases, may either reject the appeal or direct the company concerned to register the transfer of shares within ten days of the judgement. The tribunal may also impose pecuniary damages on the company depending on the nature of damage.
The NCLT may also pass interim orders such as injunction, may decide matters pertaining to costs, allotment of bonuses or right shares etc. In case there is a default in the implementation of orders, the NCLT may impose fine of up to INR 10,000 which may further extend to INR 1,000 every day if the order is not complied with.
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