J Sagar Associates (JSA) managing partner Berjis Desai and Aditya Birla Group GC Ashok Gupta debate whether the Right of First Refusal (ROFR) has now come back to life with the latest Bombay HC judgement in the latest episode.

It looked like the days were numbered for Right of First Refusals (ROFRs), a highly utilised tool of shareholder protection in joint venture and private equity agreements. A Delhi High Court decision in 2005 followed this year by a Bombay High Court ruling made ROFRs illegal under Section 111A of the Companies Act, 1956, which protects free trade of shares by providing that “shares or debentures and any interest therein of a company shall be freely transferable”.
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This month a division bench of the Bombay High Court in the case of Messer Holdings Limited (unreported) has given new life to the use of ROFRs in India by ruling that Section 111A does not prevent a shareholder from entering into a consensual arrangement with a third party in relation to his specific shares.

In analysing the judgment the panelists made the distinction between listed and unlisted companies. Both Desai and Gupta agreed that in the context of private companies ROFRs are fully valid but should also be embedded in the Articles of Association as well as the shareholder agreements.

According to Desai, the same position applies for public unlisted companies. Desai further noted that the more conservative view is “if the ROFRs are reproduced in the articles and not merely in the shareholders agreement then they would be binding on the shareholders and the company”. Gupta disagreed, however, arguing that a legal distinction must be made between public and private companies, regardless of whether the public company is listed or not.

While acknowledging the validity of ROFRs contained in a contract between two shareholders of a public company, Gupta noted that even in a public limited company, ROFR clauses in Articles of Association might call for some issues on free transferability.

Lending support to Gupta’s assessment, Desai noted that during the IPO process, the stock exchanges insist on the deletion of such restrains on transferability contained in Articles of Association.

Therefore, the conclusion among the panellists is that in the case of private companies ROFRs are valid but should be added to the Articles of Association, and with public companies while ROFRs are valid in agreements between shareholders embedding such restrictions in the Articles of Association might give rise to legal challenge.

Gupta and Desai were both in favour of the judgment and thought the decision would prevail in the Supreme Court, though Desai who was first to comment that the division bench judgment is "good law”, cautioned the pending appeal from the Bajaj Auto judgment could theoretically yield a different view.

Still, Desai noted that the notion of free transferability contained in Section 111A is meant to prohibit a board of directions from restricting free transfer and does not speak to the ability of shareholders to do so through contract. The debate on the topic of ROFRs will continue until the Supreme Court voices its opinion.

The question remains, therefore, whether true freedom of transferability allows shareholders themselves the right to determine the manner in which shares are transferred without the intervention of the board of directors or the Courts.