Drafting Shareholders’ Agreement
DRAFTING SHAREHOLDERS’ AGREEMENT
ROHITH KAMATH,
ADVOCATE & CS, REX LAW CHAMBERS, BENGALURU
Shareholder Agreements, a technical document or set of documents that create rights and obligations on the shareholders of a company are the need for any corporate investment activity.
A Shareholder Agreement is an agreement intended to be a re-capsulated Articles of Association for purposes including, the internal management of the company; similar to the latter it tries to govern the relationship between shareholders inter-se, and the company.
The general legal preposition is that all agreements need to be bound and in according to law. Any Agreement to the contrary shall be void ab initio. A corollary of this principle implies that the Memorandum of Association and Articles of association, a creation of the Companies Act, 2013 is also law, and cannot be agreed to the contrary. It is on this basis, a requirement forays that the Shareholder Agreement shall be in line with the Articles of association of a company. The Shareholder Agreement cannot vitiate or state anything to the contrary contained in the Articles of Association and any such stipulation shall be void ab initio.
1.1. CLAUSES IN A SHAREHOLDERS AGREEMENT
This write-up would limit to a few clauses, in the opinion of the author, that are usually covered in a Shareholder Agreements in a Private Limited Company and the diligent practices, based on relevant judicial decisions, to be adhered to while drafting the same.
1.1.1. STRICT RESTRICTIONS THAN STIPULATED UNDER COMPANIES ACT, 2013:
The Companies Act, 2013 vide its provisions allows for the Articles to provide for certain matters. A Shareholder Agreement may be drafted in such manner to include restrictions that are allowed for to be regulated by the Articles of a Company. An illustrative list of matters that can be provided for under a Shareholders Agreement are as follows:
o S. 44: Transfer of Shares;
o S.62: Further Issue of Shares;
o S. 104: Quorum;
o S.114: Chairman;
o S.106: Voting Rights;
o S. 152: Retirement;
“Where the articles are silent on the existence of an affirmative vote, it will not be possible to hold that such a requirement in an agreement between the shareholders would be binding without being incorporated in the AoA.” [1]
1.1.2. RESTRICTIONS ON TRANSFER OF SHARES:
Section 2(68) read with Sections 44 and 56 of the Companies Act, 2013 requires that any restriction on transfer of shares in a private company is to be stipulated in the articles, and any breach thereof by the company and the officer of the company in registering a transfer of share in accordance with Section 56, follows with a penalty of not less than twenty-five thousand rupees, that may extend upto five lakh rupees and not less than ten thousand rupees, that may extend upto one lakh rupees. It is therefore to be noted that any restriction on transfer of shares that is stipulated in the shareholders’ agreement, but is contrary to the articles may make the company liable for any default in registering the transfer of shares, on grounds that the same is not in accordance with the Shareholders Agreement.
1.1.3. PREROGATIVES OR PRE-EMPTIVE RIGHTS:
A prerogative or pre-emptive right may be in the form of the following:
- Right of First-Offer/First Refusal clause: Existing shareholders whereby to sell to a third party must first offer the shares to the holder of the first refusal right and only after the holders of the right of first refusal do not buy the shares, the shareholder can normally sell freely to a third party.
- Drag/Tag-along clause: Drag-Along whereby a shareholder wishing to sell his shares to a third party has the right to drag all the other shareholders and make complete exit from the company. Whereas Tag-alongs are those whereby have a right to tag along with the shareholder wishing to sell his shares to a third party.
- Call option/ Put Option: These options give its holder the right to buy/sell a specified number of shares of the underlying stock at a predetermined price (strike price) on or before the expiration date of the contract.
These prerogatives create a right in favour of one or more shareholders to act or abstain from acting in a given manner in a certain set of pre-determined event.
1.1.4. MATTERS BEYOND COMPANIES ACT, 2013:
It may be often seen that Shareholders Agreement covers matters that are beyond the purview of Companies Act, 2013 such as those relating to the business plan, Intellectual Property Rights, management rights and other non-economic matters. It is advised that any such matter included in a Shareholder agreement only furthers the ambiguity in applying or execution of the same, and is thereof advised to be executed by way of a separate agreement.
1.1.5. ARBITRATION CLAUSE:
The parties in a shareholders’ agreement are free to include an arbitration clause with seat outside India and/or under a law other that of India as long as one of the parties to the shareholders is a non-resident. Any personal or private right can be raised by way of arbitration, and the same is upheld by the Bombay High Court in Messer Holdings Limited v. Shyam Madanmohan Ruia in startling contrast to its decision in Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd.
It must be noted that at certain instances involving oppression and mismanagement, the courts have refrained from interpreting the arbitration clause in a broad manner, and refused to stay the matters from being heard by the Court even though there was a valid arbitration clause between the shareholders.[2]
1.2. DILIGENT PRACTICES
Readers are requested to note that any restriction on the transfer cannot be enforced vide a shareholder Agreement, unless the same is incorporated in the Articles of association, as the companies Act, 2013 seeks to validate any transfer that satisfies the criteria laid down in the Articles. It is a divided opinion on the enforceability of the Share Holder Agreements pertaining to those prerogatives that do not form a restriction on the transfer of shares. In VB Rangaraj vs. VB Gopalakrishnan,[3] the question related to whether the shareholders could enter into an agreement among themselves which is contrary to or inconsistent with the Articles of Association of the company. The Supreme Court took the view that the provisions of a shareholder agreements imposing restrictions on transfer of shares even if found to be in accordance with provisions of the Companies Act, are enforceable only when they are incorporated in the Articles of Association of the Company. Shareholders can enter into any agreement in the best interest of the company, but the only thing is that the provisions in the shareholder agreements shall not go contrary to the Articles of Association.
In light of the decision of the Supreme Court in Vodafone International Holdings v. Union of India,[4] A breach of shareholder agreement which does not breach the Articles of Association is a valid corporate action but, as we have already indicated, the parties aggrieved can get remedies under the general law of the land for any breach of that agreement. But to be remedied in terms of reliefs available under Companies Act, 2013, which is more specific a law for corporate actions, it is essential that all clauses of the Shareholders Agreement be incorporated in the Articles of association.
1.3. ENFORCEABILITY
A Conclusion that the Shareholder Agreement, by itself, cannot be enforced makes the very sanctity of the document, however sceptical, but makes it pertinent to note that the enforceability of the same as a contract under the general law is not kept at abeyance.
However, diligent practices of incorporating the same in the Articles would uphold not just the validity of the agreement, albeit, allow for the same to be enforced against the shareholders and the company by means of the remedies available under Company law, failing which they would be just another commercial agreement open to be contested in the general courts of law.
[1] World Phone India Private Limited & Ors. vs WPI Group Inc., Usa, [2013] 178 Comp Case 173 (Del)
[2] O.P. Gupta v. SFFLV General Finance (P) Ltd., 1977 47 CompCas 279 Delhi
[3] (1992) 1 SCC 160
[4] (2012) 6 SCC 613