1991 (11) TMI 195 - SC - Companies Law

Memorandum and articles of association Registration of, Articles of association, Shares Allotment of

Issues Involved
1. Validity of the oral agreement between shareholders.
2. Binding nature of the agreement on the company and shareholders.
3. Legality of the sale of shares by the first defendant to defendants Nos. 4 to 6.
4. Authority of the High Court to direct transfer of shares.
5. Applicability of the Articles of Association and relevant statutory provisions.

Issue-Wise Detailed Analysis

1. Validity of the Oral Agreement Between Shareholders
The primary issue was whether an oral agreement between shareholders, which was not incorporated into the Articles of Association, could impose restrictions on the transfer of shares. The plaintiffs alleged that in 1951, there was an oral agreement between Baluswamy Naidu and Guruviah Naidu that each branch of the family would hold an equal number of shares and that any member wishing to sell shares would first offer them to members of his branch. Despite the defendants disputing the existence of such an agreement, the courts below found against the defendants. However, it was undisputed that the Articles of Association were not amended to reflect this agreement.

2. Binding Nature of the Agreement on the Company and Shareholders
The court examined whether the oral agreement could be binding on the company and its shareholders. The legal position, as clarified by the court, is that the Articles of Association are the regulations binding the company and its shareholders. According to Section 36 of the Companies Act, when the memorandum and articles are registered, they bind the company and the members. Therefore, any restriction on the transfer of shares must be specified in the Articles of Association to be enforceable.

3. Legality of the Sale of Shares by the First Defendant to Defendants Nos. 4 to 6
The court held that shares are movable property and their transfer is regulated by the Articles of Association. The only restriction on the transfer of shares is as laid down in the Articles. Since the oral agreement was not incorporated into the Articles, it could not impose additional restrictions on the transfer of shares. Therefore, the sale of shares by the first defendant to defendants Nos. 4 to 6 was not invalid.

4. Authority of the High Court to Direct Transfer of Shares
The High Court had directed the substitution of the plaintiffs as shareholders in place of defendants Nos. 4 to 6, based on its finding that the sale was invalid. However, the Supreme Court found that since the sale was not invalid under the Articles of Association, the High Court's direction was not justified. The High Court could only have declared the sale invalid, not directed the transfer of shares to the plaintiffs.

5. Applicability of the Articles of Association and Relevant Statutory Provisions
The Articles of Association of the third defendant-company, specifically Article 13, were examined. Article 13 allowed for the transfer of shares with the consent of the majority of members and did not impose the restrictions claimed by the plaintiffs. The court referred to several authorities and legal texts, including Shanti Prasad v. Kalinga Tubes Ltd., which reinforced the principle that any restriction on the transfer of shares must be expressly stated in the Articles of Association.

Conclusion
The appeals were allowed, the decree of the High Court was set aside, and the plaintiffs' suit was dismissed with costs. The court concluded that the oral agreement imposing additional restrictions on the transfer of shares was not binding on the shareholders or the company, as it was not incorporated into the Articles of Association.

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