Share transfer: Provision, procedure & valuation for a private company
Transferability of shares in a privately held company is governed by the Articles of Association, which is a document that lays down the rules and regulations.
A private company by definition means a privately held “close corporation” which, in most cases, is owned by a family or closely associated individuals. Share of any member in a company is movable property and is transferable in the manner provided by the Articles of Association (Articles) of the company.
Restriction on transfer
Transferability of shares in a privately held company is governed by the Articles which is a document that lays down the rules and regulations regarding share capital transfer, transmission, board of directors, general meetings and winding up, among others.
Section 2(68) of the Companies Act 2013 provides that the Articles of a private company shall restrict the right to transfer the company’s shares. This restriction is binding upon the company and members thereof. In other words, if the restriction is not mentioned in the Articles and is enforced by way of a private agreement between shareholders, it is not binding either on the company or on the shareholders.
It is important to note that the restriction on transfer is not applicable in the following cases:
- Where the member transfers the shares to his/her representative(s)
- Where the shares have been devolved to the heirs in the event of death of a shareholder
- Where shares are proposed to be allotted on a rights basis and the existing shareholders renounce their shares, these shares will be allotted to the renouncees
The right of pre-emption or first option to buy requires that if a member wishes to sell some or all of his shares, such shares shall first be offered to other existing members of the company at a price determined by the directors or company’s auditors or by using the formula set out in the Articles. If the existing members do not wish to exercise their pre-emptive right, the shares can be transferred by the transferor to the proposed transferee.
The pre-emption provision seeks to restrict the transfer between a member and non-member and does not apply to transfer between members. This implies that a member is not bound to sell his/ her shares to other members under pre-emption clause unless other member(s) agree to buy all the shares proposed to be sold.
Let’s say, Simran and Raj are shareholders in a company and Raj proposes to sell his shares to an outsider. Simran can exercise her pre-emptive right to buy the shares proposed to be sold. However, if Simran fails to agree with the price fixed by the auditors, shares will be sold to the outsider since no member came forward to buy the shares. Hence, the sale of shares in this case cannot be construed as breach of pre-emptive rights guaranteed by the Articles.
Procedure for transfer
The following procedure should be followed by a private company to give effect to the transfer of shares:
- Transferor has to give a notice in writing to convey his intention to transfer his share
- On receipt of such notice, the company has to notify the other members regarding the availability of such shares and the price as determined by the directors or the auditors of the company
- The company has to intimate to the members the time limit within which they should communicate their options to purchase such shares
- If none of the members show interest in purchasing the shares, such shares can be transferred to an outsider and such transfer will be accepted by the company
As per the pre-emption clause in the Articles, shares are to be offered to other members at a price certified by the directors or auditors. The correctness of such valuation cannot be questioned by the Courts, unless there is evidence of inaccurate valuation.
If the valuer has in fact acted negligently and failed to account for all the necessary factors for arriving at the value of shares, the transferor has the right to institute legal proceedings against such valuer for any damages caused due to improper valuation of shares. Ordinarily, the Tribunal does not interfere with the valuation made by experts. Therefore, if the valuation is challenged then there must be sufficient evidence in support to show that the valuation is improper.
Refusal by company
If a private limited company refuses to register the transfer of shares, it shall send a notice of refusal to the transferor and the transferee or to the person giving intimation of such transfer within thirty days from the date on which the instrument of transfer was delivered to the company. The notice should contain reason for such refusal.
If the Articles contain a provision to the effect that the company can refuse to admit an outsider if another member of the private limited company is willing to acquire the shares available for transfer, such member shall have priority over the outsider. The Tribunal supports the view that a company has the right to prefer a member over an outside and such refusal is, therefore, reasonable.
If the Articles allow the directors to refuse transfer of shares without stating the reasons, the Tribunal may assume that the directors acted reasonable and bona fide and those who allege to the contrary would have to prove and establish the same by evidence. However, if the directors provided a reason for refusal, the Tribunal will assess whether such reason was legitimate and justified.
Therefore, while refusing to register transfer of shares, the directors must act in good faith and for the benefit of the company and the shareholders.
(This writer is the Founder and CEO, Insta C.A www.InstaCA.in. Insta C.A. is an online tax and accounting service for SMEs and startups. For more information contact firstname.lastname@example.org or follow them at their twitter handle @InstaCA1)