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Understanding The Private Company’s Share Transfer: Provision, Process & Valuation

By definition, a private company means a privately owned close co-operation that, in many cases, is possessed by a family or closely associated people. Any member’s share in a company is the movable property and can be transferred in the manner provided by the AoA (articles of association) of the company.

Limitation on transfer

Shares’ transfer-ability in a business having new company registration as a private entity is regulated by the articles that are a document that specifies the rules and regulations concerning share capital transfer, board of directors, transmission, general meetings and winding up, inter alia.

As per Section 2(68) of the companies act, 2013, mandates that a private company’s articles should limit the right to transfer company’s shares. This limitation is mandatory upon the company and members thereof. And suppose the limitation is not specified in the articles and is imposed by way of a private agreement betwixt shareholders. In that case, it is not binding either on the shareholders or on the company.

There are few cases where the limitation on transfer will not be applicable;

– Where members transfer the shares to their representatives.

– Where shares have been delegated to the successors in the event of shareholder’s demise.

– Where shares are proposed to be allocated based on the right, and the existing shareholders renounce their shares, these shares would be allocated to the renounces.

Pre-emption provisions

The right of pre-emption or first option to purchase needs that if a member wants to sell some or all of his/her shares, such shares will first be provided to other company’s existing members at a decided price by the company’s directors or auditors or by using the formula given in the articles. If the existing members do not want to exercise the said right, the shares are allowed to be transferred to others. 

The pre-emption provision demands to limit the transfer betwixt a member and non-member and does not apply to transfer betwixt members. It suggests that a member is not obliged to sell his/her shares to other members under the pre-emption clause until other members give their nod to purchase all the shares proposed to be sold.

For instance, Anil and Anup are shareholders in a company, and Anil proposes to sell his shares to an outsider. Anup can exercise his pre-emption right to purchase the shares offered to be sold. Nonetheless, if Anup disagrees with auditors’ price, shares would be sold to an outsider since no member intends to buy the shares. Thus, the sale of shares in this scenario cannot be considered a breach of pre-emption rights guaranteed by the articles.

Process for transfer

– Transferor will have to give notice in writing to deliver his/her intention to transfer his/her shares.

– On such receipt’s notice, the company will have to notify the other members concerning the availability of such shares and the price as decided by the company’s directors or auditors.

– Company will have to intimate to the members the stipulated time within which they should communicate their options to buy such shares.

– If none of the members intends to purchase the shares, such shares can be transferred to an outsider, and the company would accept such transfer.

Shares’ valuation

As pre-emption clause specifies, shares have to be offered to other members at a price determined by auditors or directors. The veracity of such valuation cannot be questioned by the court unless there is proof of imprecise valuation.

If there is negligence from the valuer and if he/she failed to account for all the requisite factors for arriving at the shares’ value, the transferor is entitled to institute a legal process against such valuer for any damages caused due to imprecise valuation of shares. The tribunal does not interfere with the valuation made by the professionals. That’s why, if the valuation is challenged, then there has to be enough proof to support the claim.

Rejection by company

Suppose a private limited company rejects registering the transfer of shares. In that case, it should send a rejection notice to the transferor and transferee or the individual providing intimation of such transfer within one month from the date on which transfer’s instrument was conveyed to the company. The notice should include the reason for rejection of share transfer in a private limited company.

If the articles include a provision to the effect that the company can reject to admit an outsider if another member of a private limited company is ready to obtain shares available for transfer, such a member should prioritize the outsider. Tribunal also supports that a company has the right to prefer a member over outside, and such rejection is reasonable.

Suppose the articles permit directors to reject the transfer of shares without notifying the reasons. In that case, the tribunal might assume that the directors acted bona fide and reasonable, and those who assert to the contrary would have to prove and establish the same with proof. Nonetheless, if the directors provided a reason for rejection, the tribunal would evaluate such reason was justified and legitimate.

That’s why, rejection to register the transfer of shares, the directors should act bona fide and benefit the company and shareholders.