Business Partnerships in India Could Change for Ever

The First Right of Refusal is a potent weapon in shareholding deals. And it is dead

Published: Apr 29, 2010

Do you remember the news headlines in India in July 2008? Anil Ambani was pursuing a multi-billion dollar amalgamation deal with South African telecom giant MTN. But hovering above the possibility of creating a 70-billion-dollar entity was a peculiar shadow. The fractious relationship between India’s richest brothers was threatening to scuttle the entire deal (ultimately it did): The elder Ambani pulled a common device used in the corporate world. He claimed his unit had right of first refusal (RoFR) for any deal that would change the control structure of Reliance Communications; to go ahead would be a breach, with severe legal repercussions. Was it posturing or real ammunition? MTN was unsure: The deal died.


Infographics: Malay karmakar

If only the deal was proposed today. The potential legal and regulatory hurdles that proved insurmountable at the time might disappear. In February this year, the Bombay High Court passed a judgment invalidating the right of first refusal, in the case of Western Maharashtra Development Corporation Limited (WMDCL) versus Bajaj Auto Limited, who between them control at least 51 percent of the equity capital of Maharashtra Scooters Limited (MSL). RoFR gives a shareholder or joint venture partner the first right to buy the other shareholder or partner’s stake if it’s up for sale. But he must match the best available price. This in effect restricts a partner’s ability to transfer or sell his stake without the other partner’s consent. So now there is no compulsion on one large shareholder to offer his shares to his partner first. He is free to sell it to anyone he wants.

This legal googly has implications for joint ventures with foreign companies. “The parties to the joint venture agreements should not be permitted to wriggle out of their respective contractual obligations, which would, inter alia, include certain mutually agreed restrictions on the transfer of shares of the joint venture company using the technicality of free transferability of shares and to that extent the principles laid down in the Bombay High Court judgment can be misused by an unscrupulous party,” says Bharat Vasani, group counsel, Tata Sons.

It is particularly worrisome if one of the partners owes the other money. “If the agreement is contrary to law and you don’t want to honour what you sign, off you go! And there’s not a thing anyone can do about it,” says Somasekhar Sundaresan, partner, JSA, Advocates & Solicitors. “People have not really understood the seriousness of what this means. You ought to be very, very worried.”

The Bombay High Court has actually turned the existing logic on its head. Till now most of the legal judgements in this area allow for this preferential clause to be inserted in the Articles of Association of a public company when it is being formed. What the Constitution is to the country, the Articles of Association are to a company and they determine the relationship between various shareholders. And everyone thought putting a prior contract, which an RoFR is, was fine.

Not so, said the Bombay High Court. It checked the Companies Act, which says that shares of a public company must be freely transferable. According to the Bombay High Court, any prior contract on the shares, like an RoFR, prevented the shares from being freely transferable. After all, if one partner has to first offer it to another partner before he can offer to the general public then he/she doesn’t have much of a freedom in transferring the shares! “The court felt that the very presence of a binding contractual agreement was a restriction and in violation of the law,” explains government lawer, Advait Sethna.

The court has said that transfer restrictions cannot be enforced in any circumstances and RoFR clauses if they exist, simply violate the law. “Is it a good law or a bad law…nobody can say if it’s good or bad,” says Jeet Sengupta, associate partner, Economic Laws Practice. “But is it good business? That’s what we need to ask.”

For some, not only is it not good business but it is a violation of an entity’s ability to enter into contracts. “This judgment is actually distorting a free contractual regimen,” says Dr. Shanto Ghosh, senior director and principal economist with Deloitte India. “There should be no legal impediments from striking a contract. This case throws a spoke in the wheel when it comes to this. When two of us get into a JV and you want to exit and there can’t be an exit clause — that’s completely contradictory to how businesses function.”

Very often, RoFR is also given by strategic stakeholders. For instance, private equity firms give RoFR to promoter groups. Under such an agreement, a large shareholder planning to exit the company is obliged to give the promoters an opportunity to buy the shares before they can be sold to a third party. Several corporates, listed as well as unlisted, have such agreements with strategic investors. If the case reaches the Supreme Court and it upholds the Bombay High Court’s ruling, many corporates will have to rework the pre-agreed arrangements with investors. “In some cases, to avoid being held as a ‘promoter’ by SEBI [Securities and Exchange Board of India], some PE funds were already giving up their rights [including share transfer restrictions on the promoters, etc.] in listed public companies. So this may mitigate the impact in those situations,” says Shantanu Surpure, managing attorney at Sandhill India Advisors.

In some cases people are leaving Mumbai to escape the new regime. “I’ve already heard that the foreign MNCs coming in — they’re obviously very high on compliance and conservative of risk capital when coming into other countries — some are already refusing to sign in Mumbai,” says Krishnava Dutt, partner, Argus Partners, a Kolkata-based law firm. “They’re executing contracts in Chennai and Kolkata.”


(This story appears in the 30 April, 2010 issue of Forbes India. You can buy our tablet version from To visit our Archives, click here.)

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