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How to sell shares of private and public companies – Understanding share transfers

In the chapter on private placements, we learned about how a company can issue fresh shares to a new set of investors. Similarly, if the company wants to issue shares to the public, it can undertake a public issue (initial public offer, rights issue or follow-on public offer). However, note that during the course of investment and financing transactions, new investors do not always subscribe to fresh shares exclusively (although the subscription aspect is what leads to receipt of money by the company) - they may also purchase shares of prior investors, in which case money is received by the selling shareholders.

Sometimes, founders may sell a portion of their shareholding for various reasons. Most investment transactions in real life are typically a combination of both, share transfer and new share issuances. Share transfers are governed by contract law and certain provisions of the Companies Act (and foreign exchange regulations if the purchaser or seller is a foreigner). This chapter explains share transfer provisions of the Companies Act.

Shares of a private company and their transferability
Private companies by definition are required to impose conditions limiting transfer of shares – as long as these conditions are satisfied, shares of private companies can also be transferred.

Share transfers in private companies must be according to i) the articles of association of the company and shareholder agreements and ii) the Companies Act requirements.

Articles of association and shareholders agreements: Typically, shares are transferred pursuant to a share purchase agreement (SPA). Submission of necessary forms under Companies Act (see below) to the company, passing of board resolutionby the company (to indicate that the company approves the transfer) and entering the name of the purchaser in the register of members are usually ‘closing actions’ under the SPA – these are performed simultaneously on the date of closing.

Where promoter shares are transferred (especially if the promoter wants to exit), the acquirer may conduct extensive diligence to a) identify existence of any financial burden (such as creation of a pledge) on the shares and b) to identify how the business has been conducted and detect any risks that will flow to them as shareholders, because promoters. Such exhaustive diligence is not conducted when other shareholders transfer their shares because they are not responsible for the day-to-day business and operations of the company.
Companies Act aspects: Unlike ordinary products or movable property whose possession is directly transferred (through an invoice or a document evidencing sale), share transfers require a proper instrument of transfer as per Form No SH. 4 (assuming physical share certificates are held).
[See section 56 of Companies Act and Companies (Share Capital and Debentures) Rules, 2014.]

If shares are held in dematerialized format, they can be transferred in accordance with instructions given to the depository participant (depository participants are essentially brokers who have the license to deal in demat shares – they are the ones who hold your shares with the depository and are responsible for effecting transfers through the depository system).

Stamp duty on share transfers: Stamp duty is similar to a tax, which is payable when certain ‘instruments’ are executed. Share transfers are effectedthrough a ‘share purchase agreement’ and a ‘deed of accession’ to the shareholders agreement, and the ‘share transfer form’ (Form SH.4) under the Companies Act, on which stamp duty needs to be paid.

For share transfers, stamp duty is calculated on the value of consideration paid. To determine the rate in any other state, refer to the entry on agreement evidencing transfer of shares in the relevant state stamp act or the Schedule 1A to the Stamp Act in the state (as applicable). The law of the state in which the company has its registered office is applicable.

The rate of stamp duty on share transfers in select metropolitan cities is provided below:
Area Rate (in percent)
Delhi 0.01
Mumbai 0.25
Kolkata 0.01
Bangalore 0.01
Example: Consider 200 shares of Company X of face value INR 100 were issued to Mr. A for a premium of INR 900. Total consideration received by the company for share issuance was INR 1000 per share, that is, INR 200,000. Imagine that they are transferred to Mr. B for INR 1500. A therefore receives total consideration received of INR 300,000. What is the stamp duty payable?
  1. Stamp duty will be payable on INR 300,000.If the transfer is connected with Delhi, stamp duty of INR 30 will be payable (at 0.01 percent).
  2. Where shares are held in dematerialized form, stamp duty need not be paid (see Section 8A of Indian Stamp Act for the exemption).
Timelines for presentation of share transfer form and issue of securities
The form needs to besent to the company within sixty days from the date of execution, along with shares. Share certificates to the purchaser must be delivered within one monthfrom the receipt of the transfer instruments.

Shares of public company and their transferability
Under the Companies Act, shares of a public company are movable property and are generally freely transferable. However, public companies frequently raise finance from large institutional investors and private equity investors, who have a commercial interest in imposing restrictions on transfer of shares by promoters – these were earlier attempted through shareholders agreements and articles of association. The restrictions could be on sale of promoter shares, as follows:
  • There could be right of first refusal clause, where investors must be given the first opportunity to buy shares if promoters want to sell shares. Promoters can sell to third parties only if they receive better terms from them, as compared to existing investors.
  • Onerous conditions such as drag-along rights, through which investors can compel the promoters to sell their shares to a third party if the investors want to exit.
  • Tag-along rights which impose conditions on free sale of shares by promoters. If promoters want to exit, they can only do so if the purchaser of their shares is also willing to purchase investors’ shares.

Restrictions on transferability (ROFR / ROFO, Tag, Drag, options)

Supermajority voting and entrenchment provisions under the new Companies Act

Listed public companies: Shares of listed companies witness frequent transfer as they are freely traded on stock exchanges. Listed company shares are even transferred off-the-exchange (i.e. in private transactions) in certain cases, but these are governed by pricing requirements under securities laws and are required to be reported to the stock exchange.

Changes in Companies Act 2013
Under the old Companies Act, there was significant litigation around whether this is permitted, and courts have consistently held that transfer of public company shares cannot be restricted. However, the Companies Act 2013 carves an exception and states that contracts in relation to transfer of shares will be enforceable as private contracts – thus hinting that it is possible to impose such restrictions by contract.

These clauses were earlier problematic for SEBI and RBI also – however, note that SEBI it has through a recent notification (here) held that these rights are valid if they comply with certain conditions – the shares must have been held for one year prior to exercise of the right, price must be determined as per applicable regulations and the shares must be actually delivered on exercise of the right.

Note that transfer of unlisted public company shares is relatively difficult compared to listed companies due to absence of a ready market of buyers, but shareholders or investors often are able to buy willing buyers through private efforts.

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