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What is a Shareholder’s Agreement?

A Shareholder’s Agreement (SHA) is contractual arrangement inter-se the shareholders of a company and has gained huge popularity in a way that these agreements are specifically drafted to provide specific rights, impose definite restrictions over and above those provided by the Companies Act, 2013 (2013 Act).

SHA is a private agreement between the shareholders compared to the articles of association of the company, which is a public/ charter document. Rights contained in a SHA are purely contractual and those rights have efficacy only in the course of ownership of shares by the parties.

Generally, SHA is a by-product of transactions involving acquisition of shares of one entity by another, wherein, parties including the Acquirer execute a SHA inter-se to agree upon covenants including but not limited to: (a) Management and Ownership Rights such as appointment or removal of directors; (b) describing how the company should be operated; (c) regulating the sale of shares by shareholders and pre-emptive rights; (d) protection of minority shareholders and other decisions.

Hence, the SHA outlines the rights, obligations of the shareholders and provisions related to the management and the authorities of the company. The purpose of this agreement is to protect the interests of the shareholders; i.e. the ones holding less than half of the equity share capital in the company.

Key Clauses in a Shareholder’s Agreement

Management of company: This clause seeks to provide for the matters relating to day to day management of the company. The parties may agree here to deal with the issues relating to appointment, resignation, and removal of director and their remuneration thereof.

Non-compete: This clause seeks to prevent the existing shareholders from engaging in any business that is similar to the company.

Right of First Refusal: This clause in a SHA is used when one shareholder receives an offer from a third party to purchase his/ her shares.  Before accepting the offer, the shareholder who receives the offer must first offer to sell his/ her shares to the other shareholders on similar terms. If the remaining shareholders do not opt to buy-out, then the sale to the third party must be concluded on the same terms offered to the existing shareholders.

Tag along Right: A tag along clause offers the non-selling shareholders the opportunity to force the purchaser/ third party to acquire not just the majority shareholders’ shares but all of the shares. Such a clause in a SHA will require the third party to buy minority shares as well and that too at the same price and on the same terms as the majority shareholders.  It is pertinent to note here that Tag along clause is used only in cases where the minority shareholders do not wish to continue as shareholders with the third party.

Drag along Right: A drag along clause in a SHA is used by the majority shareholders to compel the minority ones to sell their shares if an offer is given by an acquirer/ a third party for purchase of all the outstanding shares of the Target Company, and the same is acceptable to the majority shareholders. This usually happens when majority shareholders are in favour of a share sale deal, then all of the shareholders (including minority) are required to sell their shares at the price and on the terms contained in the offer.

SHA and Companies Act, 2013

Free transferability of securities in a Public Company & Private Agreements between members

Section 58 of the 2013 Act (i.e. Refusal of registration and appeal against refusal) specifically declares that securities or other interest of a member in a Public Company shall be freely transferable. This declaration is further followed by a proviso which states that “any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract“.

Therefore, by virtue of the aforesaid proviso, SHA is legally recognized wherein, parties in case of a public company contractually agree on terms such as right of first refusal, right of first offer, tag along, call option, put option, etc. and upon execution of the same, the agreed terms become binding on the investors.

A private agreement between two or more members of a public company would be enforceable.

Enforceability of Shareholder’s Agreement – List of noteworthy Rulings

According to the provisions of 2013 Act, any provision which is not consistent or not incorporated in the Articles of Association (“Articles“) is ultra vires and hence void.

It is a common practice to alter the Articles of Association of the investee company to reflect the position in SHA. This helps ensure that none of the provisions of the SHA are rendered inoperative by virtue of them being contrary to the constitutional documents of the investee company.

A breach of SHA which does not breach the articles of association is a valid corporate action but the parties aggrieved can get the remedy under the general law of land for any breach of that agreement.

In India, judges in a number of cases have held that a SHA is said to be void if the same is not embedded into the Articles of a company. Therefore, mere execution of SHA is not sufficient; it is required to be duly incorporated into the Articles so that its enforceability is not put to challenge. Any provision in a SHA, if not incorporated in the Articles will be deemed inconsistent and hence void.

Few important rulings have been discussed here under which one must take into consideration as far as enforceability of SHA is concerned in India:

V.B. Rangaraj v. V.B. Gopalakrishnan

This case is often cited whenever it comes to challenging the enforceability of a shareholder’s agreement.

In this case, Hon’ble Supreme Court held that “a restriction which is not specified in the articles of association is not binding either on the company or on the shareholders.” Further, the Supreme Court accepted the proposition of the parties that an agreement between two shareholders of a private company, by which restrictions are imposed on their ability to transfer the shares, is wholly ineffective unless it is incorporated in the Articles of the company.

Shanti Prasad Jain v Kalinga Tubes Ltd.

In this case, an agreement was entered into between two shareholders of a private company and an outsider relating to allotment of new shares in the Company. The Company was not a party to the said agreement and neither was its terms incorporated in the articles of the Company. The Company was subsequently converted into a public company and its articles were amended. However, the articles still did not reflect the terms of the agreement. As per the terms of the agreement, an allotment of shares was to be made to the outsider. However, the Supreme Court precluded the said outsider from enforcing the allotment as he was not a shareholder of the company at the time of execution of the said agreement and neither was the company party to the agreement. It is to be noted that the judgment did not in any way hold that the transfer of shares agreed to between the shareholders inter se did not bind them.

Western Maharashtra Development Corpn. Ltd. v. Bajaj Auto Ltd

A Single Judge Bench of the Bombay High Court had also pronounced a judgment on the enforceability of a right of first refusal clause in a shareholders’ agreement. The High Court examined Section 111-A read with Section 9 of the earlier Companies Act. Section 9 essentially lays down that the provisions of the Companies Act shall have effect notwithstanding anything to the contrary contained in the memorandum and articles of a company or in any agreement executed by it and any such provision in the memorandum, articles or any agreement shall, to the extent of such repugnance, be void. The High Court held that, “as Section 111-A clearly applies in the case of public companies, any agreement in contradiction with it would be void as per Section 9 of the Companies Act. Therefore, the pre-emptive right contained in the shareholders’ agreement was held to be unenforceable. It must be noted here that agreements covered under Section 9 are only those which are executed by the company. Therefore, this judgment does not deal with a situation where in the agreement is only between the shareholders inter se“.

Concluding remarks

Though, execution of SHA has become a daily practice amongst the corporates, yet the question about its enforceability cannot be ruled out. The underlying question that whether there is any real conflict between the Articles and SHA remains a mystery which has to be cracked after a due examination of the specific clauses of a SHA read in light of the aforesaid cited judgments.

Disclaimer: This write-up is only for academic purposes. Please do not consider this as a professional advice and the same shall not be relied upon for real life facts. We hope that our readers will find this write-up useful in having a better understanding of the concept and need of Shareholder’s Agreement, key clauses therein, rights and obligations of the parties under the contract, provisions under the Companies Act, 2013 and few noteworthy rulings regarding enforceability of such an agreement. Happy Reading!


Author Bio

Deepanshu Gawdi heads the firm's Corporate Laws Practice at Faridabad. He is an Associate Member of the Institute of Companies Secretaries of India (ICSI). He carries with himself the practical exposure of various corporate matters while working in a reputed Law Firm. He is young and energetic Pract View Full Profile

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July 2024