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This article has been written by Hritika Jannawar pursuing the Diploma in Global Corporate Practices from LawSikho. This article has been edited by Amitabh Ranjan (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho). 

Introduction

Securities issued by the company are assets and its transfer plays a vital role in the dynamics of the Company management. S.56 of the Companies Act, 2013 and Companies (Share Capital & Debenture) Rules, 2014 prescribes certain procedures for the same. This movement of securities occurs through two processes one being transfer and other transmission. Further the nature of the procedure prescribed for the transfer should be considered as directory or mandatory is a question of importance which has been discussed extensively in the case of Mannalal Khetan & Ors. V. Kedarnath Khetan & Ors. The article discusses the meaning and differences between transfer and transmission of the shares and the case of Mannalal Khetan for its decision regarding the nature of the procedure prescribed for share transfer. The author analyses the reasoning of the Hon’ble Court, whether it was justified and the reasoning behind the same.

Meaning of transmission and transfer of shares

Transmission of shares takes place due to the operation of law and it is not a voluntary act. It could happen by the death of a shareholder, where his heirs inherit his shares or if the deceased bequeath it upon them. Then this process by which the heirs get ownership of the shares is known as ‘transmission’. Transmission also takes place in case if the shareholder has become lunatic or insolvent. On the other hand transfer of shares is a voluntary Act of the transferor and the transferee. Distinction between the transmission and transfer lies in the fact that the transfer in the former is initiated by the receiver or legal representative and the latter the by transferor or transferee. Furthermore, unlike the transfer of shares there is no consideration in case of transmission.  Also, the execution of a transfer deed is not necessary. [Life Insurance Corpn. Of India v. Bokaro & Ramgur Ltd]. In case of transfer of shares, the liabilities on the shares ceases to exist post-transfer and on the other hand original liabilities continue in transmission. S.56 of the Companies Act, 2013 prescrithe bes procedure for transfer of securities such as executing transfer deed and a penalty to the Company and its every officer in default of it.

Mannalal Khetan & Ors. V. Kedarnath Khetan & Ors.

It is pertinent to discuss this judgement extensively as it deals with a very important subject matter in Company law i.e. transfer of shares. The nature of the provision prescribing such transfer whether to be taken as directory or mandatory was the question raised herein. S.56 prescribes the provision for such transfer in the Companies Act, 2013, but the present case has been brought up prior to the enactment of this new companies Act and hence it has been dealt under S.108 of the Companies Act, 1956. If the nature of the aforementioned provision is taken as directory, the company can transfer the shares at its will which will be detrimental to the rights of the shareholders and hence Hon’ble Supreme Court’s observation in said matter built a sound pathway to such transfers and ultimately protected everyone’s right.

Background

In the present case, Appellant group included Mannalal Khetan, Sagarmal Khetan, and Ganeshnarayan Khetan whereas Respondent group included Kedarnath Khetan, Durgaprasad Khetan and a private Company ‘Devi Sugar mills Pvt. Ltd.’ Appellants and Respondents belonged to two branches of the Khetan family. Khetan Family held shares in three companies: the Respondent Company, Maheshwari Khetan Sugar Mills Pvt. Ltd. and Ishwari Khetan Sugar Mills Pvt. Ltd.

On the account of filing the dissolution of the Partnership firm by the appellants, the Bombay High Court appointed a Receiver. There were large income tax arrears outstanding against the Firm as well as the Individual Partners. The Income Tax department issued a notice under Sec. 46(5A) of Indian Income Tax Act, 1922 directing the Respondent Company to pay the department any amount due to Partnership Firm or its individual Partners. The Receiver, so appointed by the Collector of Bombay later took possession of shares in the names of Appellants along with blank transfer deeds signed by them. Subsequently, the Collector of Deoria attached certain shares of the Respondent Company under Order 21 Rule 46 of CPC because of the certificate issued by the Additional Collector of Bombay.

On 31st July 1957, Appellants and the respondents entered into an agreement to exchange the bloc of shares among them i.e. Appellants were to transfer their shares in Respondent Company and Maheshwari Sugar Mills Pvt. Ltd. to the Respondents and in lieu of which Respondents had to transfer their shares in Ishwari Sugar Mills Ltd. These Agreements acknowledged the part that the Appellant shares in the Respondent Company were under attachment under Income Tax Authorities and soon as the transfer of these is permitted the agreement will be fully effective. But, the Respondent Company passed a Board Resolution on 8th April 1958 to transfer the shares in the name of the Appellants to Respondents 1 and 2. 

Subsequently, the Appellant sent two notices on 14th January 1962 to the Respondent Company one notifying them that the shares of the Ishwari  Khetan Sugar Mills Pvt. Ltd. which were attached under income tax Authorities were sold by the Additional Collector of Bombay on 23rd September 1961, it further stated that the aforementioned agreement has become impossible to perform and the consideration for reciprocal promise had disappeared and also revoked power of Attorney in favour of Respondent Company by the Appellants in regards of shares in Maheshwari Khetan Sugar Mills Pvt. Ltd and the Respondent Company Itself. The Second notice stated that the transfer made by the respondent Company on 8th April 1958 is void and illegal as requirements under S.108 of Companies Act, 1956 was not fulfilled and also certain shares among those were in possession of Additional Collector of Bombay. To which the Respondents denied and therefore, the Appellant approached Allahabad High Court where the Single Judge ruled in favour of the Appellants but, when respondents appealed to the Division Bench of Allahabad High Court its decision favoured the Respondents. Later, the appellants approached the Supreme Court where the division bench’s judgement was set aside with no costs.

Issues involved

There are two major issues involved in the present case:

  1. Whether the provisions under S.108 of Companies Act, 1956 are mandatory concerning transfer of shares?
  2. Whether the Company can transfer the shares and make changes in its register of members when it has been informed that he said shares have been attached under the order of attachment?

Rules applied

  1. S.46 (5A) of Indian Income Tax Act, 1922 

Income Tax Officers direct a person by a notice to pay any money which is due to assessee to the Income tax Officer to an extent of the arrears of income tax by the assessee or less than that.

  1. Order 21 Rule 46 CPC

Provisions regarding attachment of debt, share and other property not in possession of judgement debtor.

  1. S.108, Companies Act, 1956.

Prescribes procedure for transfer of shares and debentures.

  1. S.629 A, Companies Act, 1956.

Prescribes a penalty where no specific penalty has been provided for an act prohibited in this Act.

Court’s observations

  • The legality of the transfer of shares was the major concern in the present case and 
  • Appellant contended – 1) that the transfer of shares in the register of Respondent Company was illegal and void as it was contravening mandatory requirements under S.108 of the Companies Act, 1956 because the transfer was without any proper instrument duly stamped and executed by the Appellants or on their behalf was delivered to the Respondent Company. 2)that the legality of this transfer can be questioned on the ground that the shares of the Appellants were surrendered along with the blank share transfer forms to the receiver appointed by the Collector of Bombay in execution of proceedings of tax recovery and the other shares were attached by the collector Deoria under Order 21 Rule 46 of CPC.
  • The Respondents in turn contended that the said case is not of transfer of share but of transmission.
  • The learned Single Judge of Allahabad High Court rejecting the contention of Respondents held that the present case is not a case of transmission as transmission is something which happens by operation of law and the acts of the Parties herein were of voluntary nature so could not be attributed to transmission. It further held that S.108 of the Act is mandatory in nature and when the Appellant divested themselves of power and control over those shares when they executed the power attorney in favour of the Respondent Company it did not mean the divesting of possession and the agreements to which reference is made in present case were not instruments of transfer. Also the shares were attached by Additional collector under Order 21 and Rule 46 of CPC and others were surrendered to the Receiver appointed by Collector of Bombay in Income Tax Proceedings. Thus directing the Respondent Company to restore the name Appellants in the register of the Company.
  • Diametrically opposite view was observed by the Allahabad High Court’s Division Bench, it held that the nature of S.108 of the Act is not mandatory but directory in nature as no penalty has been provided under this provision in the event of non compliance of the Sec. It also held that mere appointment of Receiver does not divest one from its Right to Property and hence said transfer is perfectly valid in the eyes of law.
  • Aggrieved by the decision of the Division Bench the Appellants approached the Supreme Court. The Hon’ble Court pointing out the inconsistency in the Division Bench’s Decision made following observations-
  1. The wording of S.108 of the Act is imperative to take note of, the construction is negative that means prohibitive in nature.

S.108 – “a company shall not register a transfer of shares …….unless a proper instrument of transfer duly stamped and executed by or on behalf of the transferor and by or behalf on behalf of the transferee has been delivered to the company along with the certificate relating to the shares or debentures or if no such certificate is in existence along with the letter of allotment of shares.”

Emphasis on “shall not” usage of negative words is always done to indicate mandatory in nature. In Raza Buland Sugar Co. Ltd. V. Municipal Board Rampur the five Judge bench  that there are various tests to determine whether a provision is directory or mandatory and language is one of them. The Hon’ble Court held that the negative words can rarely be directory and one way to obey the command is by not doing what is forbidden by the provision which in turn provides it a mandatory colour.

  1. The reasoning of the Division Bench that S.108 is not mandatory is flawed in its one more observation that absence of penalty in non -compliance of S.108 makes it directory. The Division Bench was erroneous as S.629 A of the Act prescribes the penalty where no specific penalty is provided elsewhere in the Act. Therefore, when a penalty is provided to prohibit an act, the contract made in violation of it is void without the statute expressly declaring it as there would not be any penalty for a legal act, it will always be intended for an illegal act. Likewise, the transfer made in the present case is void.
  2. According to Order 21 Rule 46 the shares in whose name they are, is prohibited to transfer the same. Also the separate prohibitory order was issued to the Company under Form. No 18 in Appendix E of the first schedule of the CPC.
  • In presence of all these provisions in place entering Respondent’s name in the Register of the Respondent Company and thereby permitting such transfer the Respondent Company has acted in Contravention of law and therefore such transfer was held by the Hon’ble Supreme Court as illegal and void in the eyes of law.

Analysis

In the first instance of the present case, the Single judge Bench Judge of the Allahabad High Court rightly rejected the contention of the Respondent that the said case is of transmission. The Respondent’s contention went wrong on the lines that the ‘transmission’ takes place after the death of the shareholder i.e. the shares are inherited by his/her heirs or bequeathed upon and in another case if the shareholder becomes lunatic or insolvent; the important point here being that transmission occurs by operation of law and the transfer is process that occurs voluntarily by a contract. The Respondents herein tried to acquire the benefit of the proviso prescribed under S.108 that provides an exception to the requirement of delivery of duly stamped and executed share transfer forms by the transferor to the company in case of transmission but failed miserably.

 Furthermore, the three Judge Bench of Supreme Court has thrown light upon the nature of S.108 and had brought in place an aptly correct interpretation while keeping in regards the consequences of it in development of Company Law. The Author regards the decision of the Hon’ble Supreme Court accurate in this present case due to the reason that the transactions related to share transfers have an vital role in the Company’s fate because it may change the management of the company, so the informal way of such type of transactions would necessarily may have an ill impact for both shareholders and the company. To deter the practice of such transfer of shares informally so as to protect the Company from adverse impact to its administration S.108 was brought in first place. 

The Hon’ble Supreme Court held that the S.108 of the Act is  mandatory in nature. The Hon’ble Court attributed this interpretation owing to the negative construction of the provision which made it prohibitory. Emphasis was laid down on the word ‘shall not’ in S.108. The reasoning of the Hon’ble Court that negative construction of provisions give them a mandatory colour irrespective of penalty prescribed in the event of its violation is not an unprecedented one. It is indeed the duty of the Courts to determine the real intention of the legislature by carefully attending to the whole scope of the statute to be construed, as held by Lord Campbell in Liverpool Borough Bank v. Turner 1860. The five Judge Bench of Supreme Court Raza Buland Sugar Co. Ltd. V. Municipal Board Rampur held that one of the tests to determine this intention of the legislature is the language which was rightly pointed out by the Court in the present case. 

It was also held by the Hon’ble Supreme Court in the year 1961 in M.Petiah V. Muddala Veerampala that “negative words are clearly prohibitory and used as a legislative device to make the statute imperative” Thus the decision taken by the Supreme Court was is consonance with the then  Position of law. Also the division Bench of the High Court erred as it overlooked S.629 A of the Act which provided for penalty where the specific penalty was not provided in the Act. Thus with negative construction of S.108 and the penalty present in case of its violation, S.108 is through in through mandatory and not directory. 

This reasoning of the Hon’ble Supreme Court was later upheld in various judgements and to this date it holds a strong ground as seen in the recent decision of the three-Judge Bench of this Court in Asha John Divianathan v. Vikram Malhotra in which they relied on the present case and observed that “prohibited or negative words can rarely be directory and the seeking prior permission from RBI under S.31 of the FERA, is in the nature of the prohibition and hence the permission is mandatory requirement  and where penalty is  provided by statute for doing an act it is not intended that statute would impose penalty for a lawful Act, it only prescribes penalty for unlawful Act, then the thing prohibited if done will be treated as void”

All these Judicial pronouncements of past and present have time and again upheld the reasoning of this Court and thus proving its sound interpretation in the present case. Also, by the fact that the shares in dispute in the present case were attached under Order 21 Rule 46 of CPC and under income tax recovery proceeding there is no way the instrument of the transfer was delivered to the Respondent Company in the Mandatory Procedure prescribed under S.108 and therefore the transfer of shares was rightly held to be void.

Conclusion

The judgement in Manalal Khetan prevented blatant abuse of power to transfer shares by the company. It provided as an important precedent to assign mandatory nature to the clauses constructed in a negative and prohibitory manner. The Hon’ble Supreme Court’s stance in the present case regarding the order of attachment of shares also provides us with a glimpse that sometimes law prevails over individual autonomy.

S.56 of the Companies Act, 2013 is the counterpart of S.108 of the old companies Act. There are few striking differences between them such as S.56 deals with the transfer of an interest in companies with no share capital, transfer of securities wherein the securities have been prescribed wide connotation under the 2013 Act whereas S.108 only provided for the transfer of Securities and Debentures.  Also, S.56(6) prescribes a penalty to the company or every officer of the Company who is/are in default of the prescribed provisions therein, successfully reinforcing the mandatory nature to the procedure of transfer of Shares in the new Act.

References

  1. Difference between Share Transfer and Share transmission, Cleartax, available at https://cleartax.in/s/share-transfer-share-transmission-difference last seen on 06/09/2021
  2. All about Transmission of Shares, TaxGuru, available at https://taxguru.in/company-law/transmission-shares.html last seen on 06/09/2021
  3. Mannalal Khetan & Ors. v. Kedarnath Khetan & Ors. Company Ninja, available at https://thecompany.ninja/mannalal-khetan-and-ors-v-kedar-nath-khetan-and-ors/ last seen on 04/09/2021.

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