Mannalal Khetan and Ors.v. Kedar Nath Khetan and Ors.

The judgment certainly broadened the horizon of non-obstante clauses and makes them mandatory in nature. Its broad interpretation makes penalty redundant. Now, it is completely valid to assign mandatory meaning to a negatively-worded clause.
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Introduction

The power to transfer shares from one partner to another in a company is one of the areas which are widely discussed under company law. It has the capacity to overhaul the dynamics of the company and the authority of each shareholder. Transferring of shares comes with its responsibilities and repercussions so restrictions are placed upon its exercise either by law or by way of an agreement. This article discusses the scope of power to transfer shares and the restrictions placed on it. It also elucidates on the impact of Section 108 of the Companies Act, 1956[1]on the transfer of shares, its amendments, and its impact on the Companies Act, 2013 through the case- Mannalal Khetan and ors. vs Kedar Nath Khetan and ors.[2] where the same issue was raised in which two different approaches were adopted by the learned single judge of Allahabad High Court and the Division Bench of High Court. However, the Supreme Court analyzed the concept in-depth and agreed with the decision of Learned single judge of the Allahabad High Court.

Facts

The appellant and the respondents were members belonging to two branches of the Khetan family. On account of an application filed for dissolution for partnership in Bombay High Court, a receiver of the properties was appointed. Since there were large income tax liabilities, a notice under Section 46(5) (a) of Indian Income Tax Act, 1922[3] was issued mandating the respondent company to pay any amount due to the firm. In 1953, another Receiver was appointed by Collector of Bombay for execution of certificate. Later, on orders of the High Court the Collector took over all the papers and also the possession of shares in the name of appellants alongwith blank transfer deeds signed by them. Another order was issued by the Additional Collector of Bombay to Collector of  Deoria to attach certain shares held by respondent company under Order 21 Rule 46 of the CPC.

On 31 July, 1957 the members of Khetan family signed an agreement among them for exchange of blocks of shares held by them in the respondent company to settle their dispute. The agreement provided for transfer of shares held by appellants in Maheshwari Khetan Sugar mills Ltd. to respondent in lieu of which the respondents had to transfer their shares in Ishwari Khetan Sugar Mills Ltd. to the appellants. By a resolution dated 8thApril, 1958 the appellants’ shares were transferred to the respondents. However, on 14th January, 1962 the appellant gave notice to respondents informing that the said agreement had become impossible to perform as the shares of the Ishwari Khetan Sugar Mills Ltd. had been sold by the Additional Collector on 23rd Sep, 1961. It concluded by saying that the respondents had no authority over the transferred shares. Subsequently, another notice was issued by the appellants informing that the transfer of shares by the appellant was illegal and void as the requirements under Section 108 of the Companies Act, 1956 weren’t fulfilled. The respondents denied the same. So, the appellant filed a petition in the High Court of Allahabad and subsequently, the Supreme Court decided the case in favour of appellant with no costs.[4]

Issues

The Supreme Court, while dealing with the case had to face two pertaining issueswhich were as follows:

  1. Whether the provisions of Section 108 of the Companies Act, 1956[5] are mandatory in regard to the transfer of shares?
  2. Can a company having been served with the notice of attachment of shares register transfer of shares in contravention of the order of attachment?

Contentions from both the Sides

The appellants presented two arguments:

Firstly, the agreement had become impossible to perform as the Additional Collector has sold the attached shares of respondents in Ishwari Khetan Sugar Mills Ltd. Thus, the respondents had no authority or right to act on behalf of appellants in regard to the said power of attorney.

Secondly, the transfer of shares in the company’s register had been made illegally as no proper instruments of transfer duly stamped by appellant was delivered to the respondents. It was in contravention of the mandatory provisions of Section 108 of Companies Act, 1956. Therefore, the alleged transfer of shares from appellants and subsequent deletion of their names from register is illegal and void.

The Respondents denied the claims made by appellant and contended that the shares had been transmitted and not transferred subject to the orders of Income Tax authorities under Section 46(5)(a) of Indian Income Tax Act[6]. Secondly, the respondents argued that they protested against the selling of shares by Additional Collector but it was in vain. Thirdly, they contended that the transfer of shares was legal and valid.

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Court Decision and Judgment

The petition of the appellant was first heard by the learned Single Judge of Allahabad High Court. He ruled in favour of appellant and ordered the respondent company to mend the register by removing their names and restore it to the original shareholder. The reasoning given by the learned Judge was – firstly, that the case was of transfer of shares and not transmission as the latter only happens through operation of law whereas in the present scenario, it was the result of voluntary act of parties. Secondly, the mere transfer of control doesn’t amount to transfer of possession. Hence, even if the appellant executed an irrevocable instrument it doesn’t mean that respondent has absolute possession of the shares. Thirdly, the agreement in question was not instrument of transfer as it didn’t follow the provisions of Section 108 of the Companies Act, 1956. Therefore, the transfer of shares held by the Receiver and the Additional Collector were illegal and void.

Aggrieved by this decision, the respondents appealed. Subsequently, the division bench of High Court set aside the order passed by the learned Judge and dismissed the application of appellant. The bench based its judgment on the reason that the provisions of the Section 108 of the Act were directory in nature. It also held that the mere appointment of receiver did not deprive the party of his right in the property and thus the transfer is not illegal in the eyes of law.

The appellant in Mannalal Khetan case filed an appeal before the Hon’ble Supreme Court. The Supreme Court set aside the judgment of the High Court and restored the order of the learned Single Judge with no costs. The Court analyzed Section 108 of the Act and held that it is mandatory in nature considering the non-obstante clause in the proviso. It relied on the reason, “Negative words are clearly prohibitory and are ordinarily used as a legislative device to make a statutory provision imperative.” The Court in Mannalal Khetan case also criticized the High Court for failing to consider the provision of Section 629(A) of the Act which prescribes penalty in case no penalty is provided elsewhere in the Act. Thus, the Mannalal Khetan held that the company by registering the transfer of shares was permitting the transfer thus going against the prohibition issued under Order 21 Rule 46 of the CPC and Form No. 18[7] in Appendix E. Since it was contrary to law hence the transfer is illegal and void.

Analysis

This 3-judge bench judgment throws light on significance of interpretation of Section 108 of theCompanies Act of 1956. Section 108 places restriction on the power of company to transfer shares. It acts as a deterrent to informal transfer of shares considering the importance of impact it will have on the overall administration of the company. The judges had to deal with the nature of this section while keeping in regard the repercussions of interpretation on the development of law in the field.

Section 108 was part of the Companies Act, 1956 since its enactment. However, it went through changes because of the inherent abuse of blank transfers.[8] The first amendment to this section was done in the year 1965 by which subsection (1A) was added to curb the said abuse. Subsequently, the Report of the commission[9] suggested to further add sub-sections (1B), (1C) and (1D) in Section 108 of the Act to facilitate the transfer of shares. On this recommendation, the section was again amended in 1966[10], leading to the substitution of sub-section (1A), (1B) and (1C). It also amended sub-section (1D) of section 108 of the Act. The said amendment was introduced as ordinance but later reproduced as the amendment act.[11] The peculiar aspect of these amendments is that all sub-sections are non-obstante clauses. Sub-section (1D) grants power to government in cases of hardship to override sub-sections (1A), (1B) and (1C) by extending the time limit. This goes on to show the importance of adhering to the mandatory requirements provided under Section 108 of the Act.

The decision in Mannalal Khetan relied heavily on the reasoning that negative words or prohibitory clauses are mandatory in nature even if there is no penalty prescribed for their violation. This is the ratio decidendi of the case because the proposition was followed by many High courts afterward. The reasoning goes back to the earlier times and it is not an unprecedented judgment as it relied on previous cases. One of the remarkable cases that had a resemblance to the reasoning is Liverpool Borough Bank v. Turner[12] where Lord Campbell observed- “It is the duty of the courts to try to get at the real intention of the legislature by carefully attending to the whole scope of the statute to be construed.”In the year 1961, the Supreme Court in the case of M. Pentiah v. Muddala Veeramalappa[13] took the same position that negative words are clearly prohibitory and is used as a legislative device to make a statute imperative. The Supreme Court in various cases has taken the same position until it decided the present case.[14]Thus, going through these judgments the stand taken by the 3-judge bench was in consonance with the then position of law. The High Court erred as it overlooked section 629(a) of the Act which provides for penalty in case the provision in the Act doesn’t provide so. Thus, it gives the mandatory color to Section 108 of the Act.

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Conclusion

The judgment in Mannalal Khetan certainly broadened the horizon of non-obstante clauses and makes them mandatory in nature. Its broad interpretation makes penalty redundant. Now, it is completely valid to assign mandatory meaning to a negatively-worded clause. This approach was followed by Supreme Court in cases such as AK Roy v. State of Punjab[15], State of Bihar v. Murad Ali Khan[16], and Karnal Improvement Trust v. Prakash Wanti.[17]The principle became precedent for many such cases. The judgment in Mannalal Khetan was appropriate as it curbed the blatant abuse of power to transfer shares by the company. Also, The Mannalal Khetan Judgment protected the order of attachment and again strengthened the notion that law in certain situations prevails over individual autonomy. Subsequently, the judgment in Mannalal Khetan was also extensively relied on by courts in BharatiHexacom Limited vs. The Union of India and Ors.,[18]Securities and Exchange Board of India vs. Classic Credit Ltd[19] and Anwar Hussain vs. Raja Mohammed Amin and Ors.[20]

Section 56 of the Companies Act, 2013[21] bears huge resemblance with Section 108 of the Act. This itself goes on to portray that nature of section 108 of the Act being mandatory is very important and hence the judgment in present case is significant contribution in development of company law. So, the combined effect of sections 82 and 108[22] is that even if the shares of a company are movable property, unless there is a valid deed of transfer, the transferee cannot claim to have his name entered in the register of members of the company.[23]

However, the judges could have used different form of reasoning such as such as- “So a mandatory statute may be defined as one whose provisions or requirements, if not complied with, will render the proceedings to which it relates illegal and voids, while a directory statute is one where non-compliance will not invalidate the proceedings to which it relates.”[24] Similarly, Maxwell adopted the same reasoning to validate mandatory provisions.[25] The result will be same but the approach will be more inclusive as sometimes a positive clause with no penalty may be mandatory. However, the judgment is undoubtedly correct and in consonance with law. This is the reason it has been followed by the courts while interpreting such clauses and set the precedent that section 108 is mandatory. But a different approach could have made it better. It can be done provided the courts of today try to imbibe the principle prescribed.


[1] The Companies Act 1956, Section 108.

[2]MannalalKhetan and ors.vsKedarNathKhetan and ors., AIR1977SC536.

[3] Indian Income Tax Act 1922, Section 46(5)(a).

[4]MannalalKhetan and ors.vsKedarNathKhetan and ors., AIR1977SC536, para 10.

[5] The Companies Act 1956, Section 108.

[6] Indian Income Tax Act 1922, Section 46(5)(a).

[7] Civil Procedure Code 1908, Order 21 Rule 46.

[8]CR Datta, Company Law (7th Edition, 2016).

[9]CR Datta, Company Law (7th Edition, 2016).

[10]CR Datta, Company Law (7th Edition, 2016).

[11]CR Datta, Company Law (7th Edition, 2016).

[12]Liverpool Borough Bank v. Turner,30 LJ CH 379.

[13]M. Pentiah v. MuddalaVeeramalappa,AIR 1961 SC 1107.

[14] State of Bihar v. Maharajadhiraj Sir Kameshwar Singh of Darbangha (1952) 1 SCR 889.

[15]AK Roy v. State of Punjab,1986 (4) SCC 326.

[16]State of Bihar v. Murad Ali Khan,AIR 1986 SC 1.

[17]Karnal Improvement Trust v. PrakashWanti,1995 (5) SCC 159.

[18]BharatiHexacom Limited vs. The Union of India and Ors.,(2017)1TLR612.

[19] Securities and Exchange Board of India vs. Classic Credit Ltd., 2017 (8) SCJ 512.

[20] Anwar Hussain  vs. Raja Mohammed Amin and Ors., 2018(1)CLJ(CAL)162.

[21]Companies Act 2013, Section 56.

[22] Companies Act 1956, Sections 82 and 108.

[23]CR Datta, Company Law (7th Edition, 2016).

[24]Earl T. Crawford, The Construction of Statutes, ( Pakistan Law House, 2014).

[25]Maxwell, Interpretation of Statutes, (1st Edition, Lexis Nexis, 2010).

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