Sale Of Shares In Spite Of Restriction Under The Articles Of Association

8 October 2018

‘No share shall be transferred to any person whether a member of the company or not, except subject to the following conditions: (i) The person proposing to transfer any share shall give notice in writing to the Company. (ii) If the Company shall, within two months after being served with a transfer notice, find a purchasing member and shall give notice thereof to the proposing transferor, he shall be bound, upon payment of the fair value aforesaid, to transfer such share to the purchasing member. (iii) However, if the Company shall not within two months find a purchasing member, the proposing transferor shall at liberty to sell and transfer the share to any person and at any price.’

The above are standard ‘pre-emption clauses’, or sometimes referred to as ‘anti-dilution provisions’ or ‘subscription privilege clauses’, commonly found in the Articles of Association of private companies, constructed with the intention of protecting the pre-emption rights of the investors and shareholders.

It is a standard commercial practice for private companies to include such pre-emption clauses in the Articles of Association in restricting the transfer of shares to other members or outsiders without any prior notice.

For the most part, the Articles of Association will impose such provision by obliging the seller to first give a notice to the Company of his intention to transfer any of his shares, and thereafter, the Company shall act as his agent to sell his shares to ‘other members of the Company or other persons selected by the Company, at a value fixed by the auditors, and only if the Company fails to find a purchaser, is the seller at liberty to sell his shares to any person at any price.’

However, the problem usually arises when the seller enters into an agreement to sell his shares without complying with the procedures stipulated in the Articles of Association. In such case, shareholders and investors would bring a lawsuit to the Court, wanting to declare that the sale of shares between the seller and the purchaser is void, and all shares shall be returned, or be remained in the name of the seller.

Thanks to the Companies Act 2016, ‘an interest in a share shall not be disregarded by reason only of …the fact that the exercise of a right conferred by the interest is, or is capable of being made subject to restraint or restriction’. Even if shares were transferred without complying with the Articles of Associations, the beneficial interests in shares may, nonetheless, still be passed to the purchaser under the companies law.

‘The law on the issue is well settled that beneficial interest passes to the purchaser of shares upon his full payment and execution of the transfer documents, notwithstanding that the provisions of the Articles of association restricting transfer of shares have not been complied. Those restrictions do not affect and have no application or bearing on the passing of beneficial interest and apply only to restrict the registration of legal interest’, states the Court.

Therefore, so long as the full payment is made, and transfer documents have been duly executed, notwithstanding that there is a complete failure to comply with the Articles of Association, ‘the property in the shares passes at the time the transferor hands over the signed transfer and share certificate. The transferee becomes the beneficial owner as soon as the contract is made. From this time on, the seller holds the shares as trustee for the buyer. The buyer is said to have an equitable interest.’

Despite the fact that it is not necessarily fatal to transfer shares without complying with the Articles of Association, as the beneficial interest may still be transferred to the purchaser, nonetheless, it is a vulnerable legal position that one is advised to avoid.

1. Gan Sin Tuan v. Chew Kian Kor [1957] 1 LNS 24 | 2. Chan Yock Cher @ Chan Yock Kher v. Chan Teong Peng [2004] 1 LNS 465 | 3. Liu, Ren-Shuenn v. Lee, Chiu-Pin [1999] 2 CLJ 35