Justification of the violation of the articles of association by respect for the law: the PNB Housing Finance case – Shareholders


The Securities and Exchange Board of India (SEBI) is investigating Punjab National Bank Housing Finance (PNB Housing Finance), a company founded in 1988 and registered with the National Housing Bank, for its recent preferential issuance of shares.

The Board of Directors of PNB Housing Finance authorized the preferential allocation of shares and warrants to four companies on May 31, 2021: Carlyle Group, General Atlantic, Salisbury Investments and Alpha Investments. Following the sale, Carlyle Group, a US-based private equity firm, would have been the dominant owner, and Punjab National Bank’s stake in the company would have been reduced to 20% from 32.64 % currently. Unfortunately, before the contract could be implemented, he found himself embroiled in a host of issues, drawing attention to the finer points of the deal.

Stakeholders Empowerment Services (SES), a proxy advisory firm, felt the acquisition was unfair and prompted minority shareholders to vote against it, bringing the issue to public attention. They argued that the sale was unfair, claiming that the price set for the shares was unfair and did not reflect the true value of the shares. To make matters worse for PNB Housing Finance, SEBI ordered a halt to the company’s Extraordinary General Meeting (AGE). The notification of the EGM was deemed contrary to the company’s articles of association (AoA) because the mechanism used to calculate the price of the shares was not in accordance with their AoA.

Article from the Association

The most controversial of all the claims against PNB Housing Finance is the process used to fix the share price. These shares were allotted at a price of INR 390 per share, which was lower than the current market price of INR 540 per share. In such a preferential allocation scenario, the share price should be established on the basis of a valuation report from a registered appraiser, in accordance with the AoA of PNB Housing Finance. PNB, on the other hand, chose to do the valuation in accordance with statutory standards, disregarding the approach outlined in its own AoA. According to SEBI, it is ultra-vires the AoA and therefore prohibited.

The price of preference shares is subject to section 62(1)(c) of the Companies Act 2013, rule 13(1) of the Companies (Share Capital and Debentures) Rules 2014 (Share Capital Rules) and the Regulation 164 of the Issue of Capital and Disclosure Requirements (SEBI) Regulations 2018 within the existing legal framework (ICDR). Section 62(1)(c) of the Act authorizes the issuance of additional shares by preferential allotment and directs the procedure to Rule 13 of the Share Capital Rules.

The provision of Rule 13 of the Share Capital Rules states that if a listed company issues preferred shares, the price of the shares does not have to be established by the valuation report of a registered appraiser. In this case, if a valuation report from a licensed appraiser is not required, ICDR Rule 164 defines the procedure for determining the price using the average approach. PNB Housing Finance claims that they followed this approach to arrive at the price of INR 390 per share and they were right to do so as they met all the regulatory criteria, although they did not review the necessary report from a registered appraiser as required by their AoA. They argue that the AoA is essentially a contract between the members of the company and that after fulfilling the statutory criteria, it is up to them to decide whether or not they wish to fulfill the obligations of the AoA. PNB Housing Finance’s explanation for not meeting its AoA was deemed unacceptable by SEBI.

As a result, SEBI issued a letter banning the EGM, which the company appealed to the Securities Appeals Tribunal (SAT). The company received permission to hold the EGM, but the results could not be released until the matter was resolved. Due to a difference of opinion between the two judges, a two-judge panel from the SAT rendered an inconclusive decision on August 9, 2021. The temporary results-release order remained in effect. The Supreme Court will most likely rule on the case immediately.

The Supreme Court will have to decide whether a valuation report from a licensed appraiser under the AoA is necessary for accurate pricing. In other words, the question is whether the company’s AoA is applicable if the statutory criteria are already met.

AoA Violation Analysis

A company’s AoA is a well-established idea that shareholders and directors are bound by it, as the Supreme Court recently upheld in Tata Consultancy Services Limited v. Cyrus Investments Private Limited and others [2021]. The AoA is the “bedrock” of the business, upon which choices must be made, and it represents a shared understanding for all stakeholders in the organization. Accordingly, it cannot be dismissed without careful consideration.

At the same time, if the AoA is determined to be in violation of the law, Section 6 of the Act states that the law prevails over the AoA and the memorandum of association. Accordingly, if any provision of the AoA is ultra vires the Act, the Act will prevail over the provision and compliance will not be required.

PNB Housing Finance invoked the following two reasons to explain its act of non-compliance with its AoA in this case:

  1. That the provision of the AoA dealing with the calculation of a registered appraiser for the future preferential allocation of shares is inconsistent with the Act, and that the Act, as provided in section 6 of the Act, will prevail over the AoA; and

  2. That the AoA is only a contract to be followed at the discretion of the Board, and may or may not be followed if the statutory requirements are met.

We argue that both of these arguments are unsatisfactory and lack legal basis.

In response to the claim that the AoA provision conflicts with the law, we argue that such an interpretation is wrong and that the two should be read together. The Proviso of Rule 13 of the Share Capital Rules [2014] (which governs the procedure for the subsequent allotment of shares) simply clarifies that it is not necessary to obtain a valuation report from a registered valuator. Accordingly, this does not outright prohibit, but rather allows the listed company to choose its preferred valuation method in accordance with the ICDR regulation. When a company specifies in its AoA that the valuation method to be used is valuation by a registered valuer, this means that the company has agreed to the valuation being carried out exclusively by a registered valuer. This finding is also consistent with the concept of harmonious interpretation, according to which, as far as possible, two apparently contradictory clauses should be read in a way that gives effect to both. Therefore, rather than understanding that the two distinct methods contradict each other, the AoA requirement and Rule 13 could be interpreted as suggesting that the AoA imposes additional responsibility regarding valuation technique. The Supreme Court held in VB Rangaraj v. VB Gopalkrishnan and others [1992], a stock transfer matter, that the AoA binds the company and its shareholders. Accordingly, AoA establishes a binding agreement between shareholders on the transfer or allocation of shares. To respect this common understanding as well as a company’s freedom of action when an alternative has been offered, it is essential to read the AoA and the legislation in a harmonious manner wherever there is potential for conflict.

Second, PNB’s argument that AoA is just a contract that the board may or may not follow depending on whether the legal requirements are met is flawed. The AoA is the “bedrock” of the company, as stated in countless decisions and recently confirmed in Tata Consultancy Services Limited v. Cyrus Investments Private Limited and others. It cannot be ignored in a way that adversely affects the rights and position of shareholders.


The Board of Directors of PNB Housing Finance has authorized a value of the preferential issue of shares at a discount of 30% compared to the book price. More importantly, such a problem would eventually lead to Carlyle taking control of the company’s operations. This clearly implies that this preferential issuance has a direct influence on the interests and status of shareholders, and that merely complying with the law without also complying with the AoA would constitute a major violation of the duties of the board of directors.

Author: Abhishek Jena – student at Symbiosis Law School (Hyderabad).

Justification of the violation of the statutes by respect for the law: the PNB Housing Finance case

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