The complex relationships in corporate governance call for agreements among the shareholders over and above its constitutional documents of a company. Shareholders’ agreement gained much acceptance as it enumerates the inter se rights of the shareholders of a company. These agreements are entered into with the primary objective of ensuring fair treatment of all shareholders. It is often used as a tool for protecting the interests of minority shareholders of the company. The courts have time and again discussed the issue of enforceability and validity of shareholders’ agreement. The present article examines the enforceability of the Shareholders’ Agreement and its role in protecting the rights of the shareholders. The author also discusses the inter relationship between shareholders’ agreement and the Articles of Association of a company.
INTRODUCTION
Shareholders’ Agreement (hereinafter, “SHA”) is essentially a contract between some or all the shareholders in a company, the purpose of which is to confer rights and impose obligations over and above those provided by the Company Law.[1] These agreements, in most national jurisdictions, are framed complementary to the company law and enables the parties therein in safeguarding their interest in the company. Under the Indian company law jurisprudence, shares are considered as movable properties and are freely transferable with regard to public companies. The transfer of shares in private companies are subject to the restrictions laid down in the Companies Act, 2013 and Article of Association of the company. The shareholder agreements impose rights and obligations on the parties to such agreements over and above those provided in the company law of the land and the constitutional documents of the company namely, the Memorandum of Association (hereinafter, “MOA”) and Articles of Association (hereinafter, “AOA”).
In this article, the author intends to examine the extent of enforceability of shareholder agreements in India. How far does the shareholder agreement be valid in India especially when it contradicts the Articles of Association? And finally, the author attempts to analyse whether the shareholder agreement do really protect the interest of shareholders of the company.
SHA v. AOA
The
Articles of Association is one of the constitutional documents of the company.
By virtue of section 399 of Companies Act, 2013, AOA is a public document.
Unlike AOA, Shareholders’ Agreement is a private confidential contract between
the parties thereto. Confidentiality of the terms and the protection of
minority shareholders are the two major purposes of entering into a shareholders’
agreement.
The
purposes that an SHA may seek to achieve can be mainly classified into four
categories, namely:[2]
(1)
conferring rights on an individual shareholder (such as conferring veto power
on particular matters, power to nominated directors to the board, protection to
such directors from removal);
(2)
governance of the special relationship of the shareholders unconnected to the
administration of the company (such as service as a lawyer or an accountant of
the company);
(3)
protection of the minority shareholders of the company; and
(4)
confidentiality of the terms and conditions.[3]
ENGLISH LAW
Indian company law has been evolved with a heavy reliance on the English company law jurisprudence. The House of Lords, in the case of Russel v. Northern Bank Development Corp. Ltd.[4] considered the question of enforceability of agreement between the company and its shareholders. The agreement in question contained a clause restricting increasing share capital without the consent of the parties to the agreement. Thereafter, a proposal to increase the share capital was put forth by the Board of Directors. The court ruled that an agreement among the shareholders to exercise their voting rights in accordance with the consensus among the parties therein is a personal contract and not an undertaking of the company. The court also held that a shareholders’ agreement is binding only on the parties to the contract and not the future shareholders of the company. However, when a company agrees not to increase the share capital without the consent of the shareholders who are parties to such agreement, the same will have binding effect on the shareholders who are not a party to it.
The
shareholders’ agreement in UK are mostly executed to put a check on the
arbitrary actions and tyranny of the majority shareholders of the company. They
can be executed for both private as well as public companies. The
enforceability of shareholders’ agreements is rarely discussed by the English
courts.[5] While laying the test of
incorporation in the Indian jurisprudence, the Supreme Court of India relied on
the English decisions.
POSITION IN INDIA
Shareholders’ agreements are executed supplementary to the constitutional documents namely, the MoA and AoA. The purpose of Shareholders’ agreements can vary from special voting rights, restriction on transfer of rights, management and control of the company, pre-emption rights, protection of interests of minority shareholders and various others. Specifically, clauses conferring pre-emptive rights in these agreements constitute one of the cardinal methods of regulating the ownership of the shares in the corporation.[6]
The
courts have often held two juxtaposing interpretations on the enforceability of
shareholders’ agreements. On one hand, the courts in India gave foremost
importance to the free transferability of shares by virtue of the provisions of
the Companies Act while on the other, the courts have given primacy to the
freedom of contract of the parties.
Share transferability in Indian Legislative Matrix
The erstwhile Companies Act, 1956 did not have any express provision for the regulation of shareholders’ agreement and their enforceability thereof. However, the Act provided for freedom of transfer of shares in a public company in tune with the provisions of the Articles of Association of the company. Section 82 of the Companies Act 1956 provided that shares are movable property which are transferable subject to the provisions of the AoA[7]. The Articles provides for the manner in which the transfer of shares can be effected. The AoA cannot, however, prohibit transfer of shares in toto. In Sada Shankar Dandige v. Gandhi Seva Samaj Ltd,[8] the court ruled that the right of a shareholder to transfer of shares cannot be absolutely prohibited by the articles of association. In such cases, the AoA shall be void to the extend to which it is in contravention to the Act.
In
the Companies Act, 2013, section 58 is pari materia to the section 111A
in the erstwhile Act, 1956. The section provides for Refusal of registration
and appeal against refusal[9] and it expressly states
that the shares and other securities of a public company shall be freely transferable. The section also recognises the legality of
an agreement with respect of transfer of securities between 2 or more persons.[10] Therefore, the parties
can execute legally binding contracts enumerating right to first refusal, right
to first offer, put option, call option etc.
Further,
section 6 of the Companies Act, 2013 states that “any provisions contained
in the memorandum, articles, agreement or resolution shall, to the extent to
which it is repugnant to the provisions of this Act, becomes or be void, as the
case may be”[11].
In case of private companies, even though the Act, 2013 restricts
transferability of shares to certain extend. However, absolute restriction on
transfer of shares is violative of the Act.
One of the earliest landmark decisions where the court discussed the issue of enforceability of shareholders’ agreement is the apex court’s judgment in V B Rangraj v. V B Gopalakrishnan[12]. In this case there was an oral agreement between two brothers who were the sole shareholders of the private company. The agreement mandated equal distribution of the shareholding among the two branches of the family at all times. It was also agreed that in an event where any member of either branch desires to sell their shareholding, the members of their branch will have the right of pre-emption. Only if the member of same branch refuses to buy, can the shares be sold to others. In violation of this agreement, one of the shareholders sold his shareholding to the member of other branch directly. The other members of his branch approached the court contending that the sale is null and void. This is identified as the first case challenging the legality of shareholders’ agreement in India. The court observed that “The main question that falls for consideration … is whether the shareholders can among themselves enter into an agreement which is contrary to or inconsistent with the Articles of Association of the company.”[13] The court ruled that articles of association of a company is the regulations and is binding on both the company and its shareholders. The court also observed that the shareholders’ agreement inconsistent with the articles shall be void and hence, would not be binding on the parties. The only restriction under the articles was that a new member shall be admitted only with the assent of majority of the shareholders. The shareholders’ agreement in question laid out further restriction over and above those provided in the articles and hence, shall be void.
Thus, the Rangaraj Case[14] elevated the articles of a company to the status of law in relation to simple contracts. Although the judgment cited English cases and textbooks on the transfer of shares, it left out the body of case law, from both the jurisdictions, that the articles are only contracts with a narrow scope of applicability inter se.[15]
In Gujarat Bottling Co. v. Coco-Cola Co.[16], the question before the court was regarding the enforceability of shareholders’ agreement in public companies. The apex court observed that the restriction imposed by a franchise agreement between the appellant and respondent thereof would not divest the shareholder’s right to transfer the shareholding owned by them. The court, however, distinguished the decision in the Rangraj case[17] on the ground that the agreement in the instant case was between two companies as against the shareholders’ agreement in the former.
In Mafatlal Industries v. Gujarat Gas Co. Ltd.[18] the letter establishing the right to pre-emption was held unenforceable on the ground that the same was not incorporated into the articles of association. The court decided on the enforceability of pre-emption rights by relying on the test of incorporation laid down in the Rangraj case[19].
However, courts tended to deviate from the test of incorporation laid down in Rangraj[20] with respect to public companies.[21] The High Court of Delhi rejected the legality of shareholders’ agreement with respect to public companies as they curtailed the right to free transferability of shares. The court held that pre-emptive rights with respect to the shares of a public company cannot be created as it would be violative of section 111A of the Companies Act, 1956 (corresponding section in Act, 2013 – sections 58 and 59). In a later case, the test of incorporation with regard to public companies was abolished on the ground that such agreements are ultra vires to the Companies Act which provides for free transferability of shares.[22]
Freedom of Contract
In the landmark case of M S Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd.[23], the honourable apex court brought in an alternative approach in the question of enforceability of shareholders’ agreement. The dispute in this case arose from an agreement between four brothers and their mother who held shares of a private company. By virtue of the agreement, the appellant shall be entitled to shares of one of the brothers to a total of 50% of the total shareholding of the company. It also provided for delineation of control over the company. The appellant filed for specific performance to which the respondent contended that the agreement is not enforceable by virtue of the judgment in Ragraj case[24]. The court held that the agreement would not be unenforceable as it pertains to “particular” shareholders with respect to the transfer of “specific” shares that are inherited from the parents of the appellant and his three brothers. The case upheld the freedom of contract available to the parties.
The
scope of the decision in M S Madhusoodhanan was extended to public companies by
the High Court of Bombay in Messers Holdings v. Shyam Ruia[25]. The court was of the
view that if the right of free transferability is to be understood to be the
genus, the right of pre-emption is the specie.[26]
In Vodafone International Holdings v. Union of India, the honourable apex court disagreed the position in the Rangraj case and held that:
“The nature of SHA was considered by a two Judge Bench of this Court in V. B. Rangaraj v. V. B. Gopalakrishnan and Ors. In that case, an agreement was entered into between shareholders of a private company wherein a restriction was imposed on a living member of the company to transfer his shares only to a member of his own branch of the family, such restrictions were, however, not envisaged or provided for within the Articles of Association. This Court has taken the view that provisions of the Shareholders’ Agreement imposing restrictions even when consistent with Company legislation, are to be authorized only when they are incorporated in the Articles of Association, a view we do not subscribe. (Therefore) the shareholders can enter into any agreement in the best interest of the company, but the only thing is that the provision in the SHA shall not go contrary to the AOA. It can visualize the best interest of the company on diverse issues and can also find different ways not only for the best interest of the shareholders, but also for the company.”[27]
The
court identified that the primary purpose of shareholder agreement is to
protect the best interest of the company and any contravention therein with the
AOA shall be void.
ROLE OF SHAREHOLDERS’ AGREEMENT IN PROTECTING INTERESTS OF SHAREHOLDERS
The Shareholders’ agreement is an optional document executed between all or some of the shareholders of the company enumerating the rights and obligations and their relationships inter se. These agreements can have a huge impact on the protection of the rights of minority shareholders who otherwise would have very minimal control over the management of the affairs of the company. The expression “minority shareholder” is not defined in the Companies Act, 2013. However, it is often perceived as those shareholders who own less than 50% of the total equity shareholding of the company. The protection afforded to such shareholders under the various provisions of the Act can be limited.
Many shareholders’ agreement provides for specific clauses for the protection of minority shareholders. It may mandate for unanimous approval in case of certain decisions regarding the management of the company and such decisions cannot be made unless every shareholder agrees to it. Such provisions are generally made in case of creation of new securities (shares or bonds), significant decisions on the operation of business, appointment or removal of directors, change in the capital structure of the company etc.
Usually, shareholders’ agreements provide for affirmative voting rights as a protective safeguard towards minority shareholders. However, it is pertinent that the Articles of Association of the company to have enabling provisions regarding affirmative voting rights. In the case of World Phone India Pvt. Ltd. v. WPI Group Inc. USA[28]the SHA granted affirmative action to the parties therein. However, the directors of the company passed a resolution approving the right to issue shares even without securing affirmative votes as provided by the agreement. The court found the provision in the shareholders’ agreement unenforceable as no such provision was provided for in the articles of association of the company. A similar view was taken by the Delhi High Court in HTA Employees Union (Regd.) v. Hindustan Thompson Associates Ltd. and Ors.[29] wherein the ratio of shareholding as agreed in the shareholders’ agreement was not maintained. The court held the SHA to be unenforceable as the AOA has already been amended. The court further held that any alleged breach in shareholders’ agreement could be challenged under the provisions of the Indian Contract Act for damages or injunction rather than under Company law. However, this view would dilute the very essence of executing SHAs as a means to protect the rights of shareholders. The courts in these decisions ignored the judgment in the Vodafone case[30]. This has caused an ambiguity in respect of the jurisprudence of Shareholders’ agreements.
The Bombay High Court while balancing interest of minority and majority shareholders[31]upheld the validity of the shareholders’ agreement and held that the clauses that are not in contravention to the Companies Act and Articles of Association shall be enforceable. The court upheld the initiation of proceeding against the Indian Hockey Federation for breach of shareholders’ agreement between ESPN and the Indian Hockey Federation for creating a new company for promotion and organizing hockey tournaments.
Shareholders’ agreement may also often contain tags along and drag along provisions. This is a classic instance of balancing the interest of the majority and minority in a company. These rights are purely contractual as it is not provided for under the Act. The Vodafone case[32] discussed the same while stating “inter-alia tag along and drag along rights are contractual which are biding no matter whether they are mentioned in the AoA of the company or not. The only precaution that needs to be taken is to make sure that shareholders’ agreement is not violative of anything in the AoA”.[33]
CONCLUSION
In view of the growing instances of joint ventures and mergers, execution of shareholders’ agreement to impose rights and obligations over and above those provided in the articles of association and those in the Companies Act are becoming unavoidable. This has led to increasing instances of friction between the provisions of the AOA and the SHA. However, the question of enforceability of shareholders’ agreement in case of conflict between the provisions therein and the Articles of Association of the company is still debated. The courts in India, in various decisions, has ruled that the provisions of articles of association will prevail over those of shareholders’ agreement. However, holding shareholders’ agreement to be unenforceable if not incorporated to the AOA makes the whole execution of SHA pointless. This ambiguity needs to be cleared by an authoritative precedent by the apex court as well as through adequate legislative actions. Until such clarity is obtained incorporation of clauses of the SHA to the AOA will ensure its validity. The proviso to section 58(2) of the Companies Act, 2013 legally recognized the shareholders’ agreement. It can be inferred from the proviso that a shareholders’ agreement can be legally executed on matters where the articles of association are silent. This position is applicable only to public companies as it is silent about private companies. The said provision, however, talks only about conferring pre-emption rights and other aspects concerning the shareholders’ agreement are still in the dark as the Act, 2013 is silent about them.
*The Author is a student of LL.M at Gujarat National Law University.
Disclaimer: The views, thoughts, and opinions expressed in the text belong solely to the Authors and not to the Jurisedge Academy.
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[1]Vodafone International Holdings B.V v.
Union of India (2012) 341 ITR 1 (SC) 154
[21]Pushpa Katoch v. Manu Maharani Hotels
Ltd. (2006) 151 Comp Cas. 42 Del; Western Maharastra Development v.
Bajaj Auto (2010) 154 Comp. Cas. 593 Bom.
[22]Western Maharastra Development v.
Bajaj Auto (2010) 154 Comp. Cas. 593 Bom.
[23]M S Madhusoodhanan v. Kerala Kaumudi
Pvt. Ltd. AIR 2004 SC 909
Saurabh Kumar
Share post:
Author- Dharmya M S*
ABSTRACT
The complex relationships in corporate governance call for agreements among the shareholders over and above its constitutional documents of a company. Shareholders’ agreement gained much acceptance as it enumerates the inter se rights of the shareholders of a company. These agreements are entered into with the primary objective of ensuring fair treatment of all shareholders. It is often used as a tool for protecting the interests of minority shareholders of the company. The courts have time and again discussed the issue of enforceability and validity of shareholders’ agreement. The present article examines the enforceability of the Shareholders’ Agreement and its role in protecting the rights of the shareholders. The author also discusses the inter relationship between shareholders’ agreement and the Articles of Association of a company.
INTRODUCTION
Shareholders’ Agreement (hereinafter, “SHA”) is essentially a contract between some or all the shareholders in a company, the purpose of which is to confer rights and impose obligations over and above those provided by the Company Law.[1] These agreements, in most national jurisdictions, are framed complementary to the company law and enables the parties therein in safeguarding their interest in the company. Under the Indian company law jurisprudence, shares are considered as movable properties and are freely transferable with regard to public companies. The transfer of shares in private companies are subject to the restrictions laid down in the Companies Act, 2013 and Article of Association of the company. The shareholder agreements impose rights and obligations on the parties to such agreements over and above those provided in the company law of the land and the constitutional documents of the company namely, the Memorandum of Association (hereinafter, “MOA”) and Articles of Association (hereinafter, “AOA”).
In this article, the author intends to examine the extent of enforceability of shareholder agreements in India. How far does the shareholder agreement be valid in India especially when it contradicts the Articles of Association? And finally, the author attempts to analyse whether the shareholder agreement do really protect the interest of shareholders of the company.
SHA v. AOA
The Articles of Association is one of the constitutional documents of the company. By virtue of section 399 of Companies Act, 2013, AOA is a public document. Unlike AOA, Shareholders’ Agreement is a private confidential contract between the parties thereto. Confidentiality of the terms and the protection of minority shareholders are the two major purposes of entering into a shareholders’ agreement.
The purposes that an SHA may seek to achieve can be mainly classified into four categories, namely:[2]
(1) conferring rights on an individual shareholder (such as conferring veto power on particular matters, power to nominated directors to the board, protection to such directors from removal);
(2) governance of the special relationship of the shareholders unconnected to the administration of the company (such as service as a lawyer or an accountant of the company);
(3) protection of the minority shareholders of the company; and
(4) confidentiality of the terms and conditions.[3]
ENGLISH LAW
Indian company law has been evolved with a heavy reliance on the English company law jurisprudence. The House of Lords, in the case of Russel v. Northern Bank Development Corp. Ltd.[4] considered the question of enforceability of agreement between the company and its shareholders. The agreement in question contained a clause restricting increasing share capital without the consent of the parties to the agreement. Thereafter, a proposal to increase the share capital was put forth by the Board of Directors. The court ruled that an agreement among the shareholders to exercise their voting rights in accordance with the consensus among the parties therein is a personal contract and not an undertaking of the company. The court also held that a shareholders’ agreement is binding only on the parties to the contract and not the future shareholders of the company. However, when a company agrees not to increase the share capital without the consent of the shareholders who are parties to such agreement, the same will have binding effect on the shareholders who are not a party to it.
The shareholders’ agreement in UK are mostly executed to put a check on the arbitrary actions and tyranny of the majority shareholders of the company. They can be executed for both private as well as public companies. The enforceability of shareholders’ agreements is rarely discussed by the English courts.[5] While laying the test of incorporation in the Indian jurisprudence, the Supreme Court of India relied on the English decisions.
POSITION IN INDIA
Shareholders’ agreements are executed supplementary to the constitutional documents namely, the MoA and AoA. The purpose of Shareholders’ agreements can vary from special voting rights, restriction on transfer of rights, management and control of the company, pre-emption rights, protection of interests of minority shareholders and various others. Specifically, clauses conferring pre-emptive rights in these agreements constitute one of the cardinal methods of regulating the ownership of the shares in the corporation.[6]
The courts have often held two juxtaposing interpretations on the enforceability of shareholders’ agreements. On one hand, the courts in India gave foremost importance to the free transferability of shares by virtue of the provisions of the Companies Act while on the other, the courts have given primacy to the freedom of contract of the parties.
Share transferability in Indian Legislative Matrix
The erstwhile Companies Act, 1956 did not have any express provision for the regulation of shareholders’ agreement and their enforceability thereof. However, the Act provided for freedom of transfer of shares in a public company in tune with the provisions of the Articles of Association of the company. Section 82 of the Companies Act 1956 provided that shares are movable property which are transferable subject to the provisions of the AoA[7]. The Articles provides for the manner in which the transfer of shares can be effected. The AoA cannot, however, prohibit transfer of shares in toto. In Sada Shankar Dandige v. Gandhi Seva Samaj Ltd,[8] the court ruled that the right of a shareholder to transfer of shares cannot be absolutely prohibited by the articles of association. In such cases, the AoA shall be void to the extend to which it is in contravention to the Act.
In the Companies Act, 2013, section 58 is pari materia to the section 111A in the erstwhile Act, 1956. The section provides for Refusal of registration and appeal against refusal[9] and it expressly states that the shares and other securities of a public company shall be freely transferable. The section also recognises the legality of an agreement with respect of transfer of securities between 2 or more persons.[10] Therefore, the parties can execute legally binding contracts enumerating right to first refusal, right to first offer, put option, call option etc.
Further, section 6 of the Companies Act, 2013 states that “any provisions contained in the memorandum, articles, agreement or resolution shall, to the extent to which it is repugnant to the provisions of this Act, becomes or be void, as the case may be”[11]. In case of private companies, even though the Act, 2013 restricts transferability of shares to certain extend. However, absolute restriction on transfer of shares is violative of the Act.
One of the earliest landmark decisions where the court discussed the issue of enforceability of shareholders’ agreement is the apex court’s judgment in V B Rangraj v. V B Gopalakrishnan[12]. In this case there was an oral agreement between two brothers who were the sole shareholders of the private company. The agreement mandated equal distribution of the shareholding among the two branches of the family at all times. It was also agreed that in an event where any member of either branch desires to sell their shareholding, the members of their branch will have the right of pre-emption. Only if the member of same branch refuses to buy, can the shares be sold to others. In violation of this agreement, one of the shareholders sold his shareholding to the member of other branch directly. The other members of his branch approached the court contending that the sale is null and void. This is identified as the first case challenging the legality of shareholders’ agreement in India. The court observed that “The main question that falls for consideration … is whether the shareholders can among themselves enter into an agreement which is contrary to or inconsistent with the Articles of Association of the company.”[13] The court ruled that articles of association of a company is the regulations and is binding on both the company and its shareholders. The court also observed that the shareholders’ agreement inconsistent with the articles shall be void and hence, would not be binding on the parties. The only restriction under the articles was that a new member shall be admitted only with the assent of majority of the shareholders. The shareholders’ agreement in question laid out further restriction over and above those provided in the articles and hence, shall be void.
Thus, the Rangaraj Case[14] elevated the articles of a company to the status of law in relation to simple contracts. Although the judgment cited English cases and textbooks on the transfer of shares, it left out the body of case law, from both the jurisdictions, that the articles are only contracts with a narrow scope of applicability inter se.[15]
In Gujarat Bottling Co. v. Coco-Cola Co.[16], the question before the court was regarding the enforceability of shareholders’ agreement in public companies. The apex court observed that the restriction imposed by a franchise agreement between the appellant and respondent thereof would not divest the shareholder’s right to transfer the shareholding owned by them. The court, however, distinguished the decision in the Rangraj case[17] on the ground that the agreement in the instant case was between two companies as against the shareholders’ agreement in the former.
In Mafatlal Industries v. Gujarat Gas Co. Ltd.[18] the letter establishing the right to pre-emption was held unenforceable on the ground that the same was not incorporated into the articles of association. The court decided on the enforceability of pre-emption rights by relying on the test of incorporation laid down in the Rangraj case[19].
However, courts tended to deviate from the test of incorporation laid down in Rangraj[20] with respect to public companies.[21] The High Court of Delhi rejected the legality of shareholders’ agreement with respect to public companies as they curtailed the right to free transferability of shares. The court held that pre-emptive rights with respect to the shares of a public company cannot be created as it would be violative of section 111A of the Companies Act, 1956 (corresponding section in Act, 2013 – sections 58 and 59). In a later case, the test of incorporation with regard to public companies was abolished on the ground that such agreements are ultra vires to the Companies Act which provides for free transferability of shares.[22]
Freedom of Contract
In the landmark case of M S Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd.[23], the honourable apex court brought in an alternative approach in the question of enforceability of shareholders’ agreement. The dispute in this case arose from an agreement between four brothers and their mother who held shares of a private company. By virtue of the agreement, the appellant shall be entitled to shares of one of the brothers to a total of 50% of the total shareholding of the company. It also provided for delineation of control over the company. The appellant filed for specific performance to which the respondent contended that the agreement is not enforceable by virtue of the judgment in Ragraj case[24]. The court held that the agreement would not be unenforceable as it pertains to “particular” shareholders with respect to the transfer of “specific” shares that are inherited from the parents of the appellant and his three brothers. The case upheld the freedom of contract available to the parties.
The scope of the decision in M S Madhusoodhanan was extended to public companies by the High Court of Bombay in Messers Holdings v. Shyam Ruia[25]. The court was of the view that if the right of free transferability is to be understood to be the genus, the right of pre-emption is the specie.[26]
In Vodafone International Holdings v. Union of India, the honourable apex court disagreed the position in the Rangraj case and held that:
“The nature of SHA was considered by a two Judge Bench of this Court in V. B. Rangaraj v. V. B. Gopalakrishnan and Ors. In that case, an agreement was entered into between shareholders of a private company wherein a restriction was imposed on a living member of the company to transfer his shares only to a member of his own branch of the family, such restrictions were, however, not envisaged or provided for within the Articles of Association. This Court has taken the view that provisions of the Shareholders’ Agreement imposing restrictions even when consistent with Company legislation, are to be authorized only when they are incorporated in the Articles of Association, a view we do not subscribe. (Therefore) the shareholders can enter into any agreement in the best interest of the company, but the only thing is that the provision in the SHA shall not go contrary to the AOA. It can visualize the best interest of the company on diverse issues and can also find different ways not only for the best interest of the shareholders, but also for the company.”[27]
The court identified that the primary purpose of shareholder agreement is to protect the best interest of the company and any contravention therein with the AOA shall be void.
ROLE OF SHAREHOLDERS’ AGREEMENT IN PROTECTING INTERESTS OF SHAREHOLDERS
The Shareholders’ agreement is an optional document executed between all or some of the shareholders of the company enumerating the rights and obligations and their relationships inter se. These agreements can have a huge impact on the protection of the rights of minority shareholders who otherwise would have very minimal control over the management of the affairs of the company. The expression “minority shareholder” is not defined in the Companies Act, 2013. However, it is often perceived as those shareholders who own less than 50% of the total equity shareholding of the company. The protection afforded to such shareholders under the various provisions of the Act can be limited.
Many shareholders’ agreement provides for specific clauses for the protection of minority shareholders. It may mandate for unanimous approval in case of certain decisions regarding the management of the company and such decisions cannot be made unless every shareholder agrees to it. Such provisions are generally made in case of creation of new securities (shares or bonds), significant decisions on the operation of business, appointment or removal of directors, change in the capital structure of the company etc.
Usually, shareholders’ agreements provide for affirmative voting rights as a protective safeguard towards minority shareholders. However, it is pertinent that the Articles of Association of the company to have enabling provisions regarding affirmative voting rights. In the case of World Phone India Pvt. Ltd. v. WPI Group Inc. USA[28] the SHA granted affirmative action to the parties therein. However, the directors of the company passed a resolution approving the right to issue shares even without securing affirmative votes as provided by the agreement. The court found the provision in the shareholders’ agreement unenforceable as no such provision was provided for in the articles of association of the company. A similar view was taken by the Delhi High Court in HTA Employees Union (Regd.) v. Hindustan Thompson Associates Ltd. and Ors.[29] wherein the ratio of shareholding as agreed in the shareholders’ agreement was not maintained. The court held the SHA to be unenforceable as the AOA has already been amended. The court further held that any alleged breach in shareholders’ agreement could be challenged under the provisions of the Indian Contract Act for damages or injunction rather than under Company law. However, this view would dilute the very essence of executing SHAs as a means to protect the rights of shareholders. The courts in these decisions ignored the judgment in the Vodafone case[30]. This has caused an ambiguity in respect of the jurisprudence of Shareholders’ agreements.
The Bombay High Court while balancing interest of minority and majority shareholders[31]upheld the validity of the shareholders’ agreement and held that the clauses that are not in contravention to the Companies Act and Articles of Association shall be enforceable. The court upheld the initiation of proceeding against the Indian Hockey Federation for breach of shareholders’ agreement between ESPN and the Indian Hockey Federation for creating a new company for promotion and organizing hockey tournaments.
Shareholders’ agreement may also often contain tags along and drag along provisions. This is a classic instance of balancing the interest of the majority and minority in a company. These rights are purely contractual as it is not provided for under the Act. The Vodafone case[32] discussed the same while stating “inter-alia tag along and drag along rights are contractual which are biding no matter whether they are mentioned in the AoA of the company or not. The only precaution that needs to be taken is to make sure that shareholders’ agreement is not violative of anything in the AoA”.[33]
CONCLUSION
In view of the growing instances of joint ventures and mergers, execution of shareholders’ agreement to impose rights and obligations over and above those provided in the articles of association and those in the Companies Act are becoming unavoidable. This has led to increasing instances of friction between the provisions of the AOA and the SHA. However, the question of enforceability of shareholders’ agreement in case of conflict between the provisions therein and the Articles of Association of the company is still debated. The courts in India, in various decisions, has ruled that the provisions of articles of association will prevail over those of shareholders’ agreement. However, holding shareholders’ agreement to be unenforceable if not incorporated to the AOA makes the whole execution of SHA pointless. This ambiguity needs to be cleared by an authoritative precedent by the apex court as well as through adequate legislative actions. Until such clarity is obtained incorporation of clauses of the SHA to the AOA will ensure its validity. The proviso to section 58(2) of the Companies Act, 2013 legally recognized the shareholders’ agreement. It can be inferred from the proviso that a shareholders’ agreement can be legally executed on matters where the articles of association are silent. This position is applicable only to public companies as it is silent about private companies. The said provision, however, talks only about conferring pre-emption rights and other aspects concerning the shareholders’ agreement are still in the dark as the Act, 2013 is silent about them.
*The Author is a student of LL.M at Gujarat National Law University.
Disclaimer: The views, thoughts, and opinions expressed in the text belong solely to the Authors and not to the Jurisedge Academy.
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[1] Vodafone International Holdings B.V v. Union of India (2012) 341 ITR 1 (SC) 154
[2] Varghese George Thekkel (n 4)
[3] ibid
[4] Russell v Northern Bank Development Corp Ltd [1992] BCC 578 HL
[5] J. Freeman ‘Small Businesses and the Corporate Form: Burden or Privilege?’ (1994) 57 Mod. LR 555, 576
[6] Vasudha Anil Kumar (n 2)
[7] Companies Act, 1956 s 82
[8] Sada Shankar Dandige v. Gandhi Seva Samaj Ltd. (1958) 28 Comp. Cas. 137 Bom
[9] Companies Act, 2013 s 58
[10] ibid
[11] Companies Act, 2013 s 6
[12] V B Rangraj v. V B Gopalakrishnan AIR 1990 SC 453
[13] ibid
[14] ibid
[15] Prof Akhileshwar Pathak (n 1)
[16] Gujarat Bottling Co. v. Coco Cola Co. AIR 1995 SC 2372
[17] Rangraj (n 16)
[18] Mafatlal Industries v. Gujarat Gas Co. Ltd. (1999) 97 Comp 301 Guj
[19] Rangraj (n 16)
[20] ibid
[21] Pushpa Katoch v. Manu Maharani Hotels Ltd. (2006) 151 Comp Cas. 42 Del; Western Maharastra Development v. Bajaj Auto (2010) 154 Comp. Cas. 593 Bom.
[22] Western Maharastra Development v. Bajaj Auto (2010) 154 Comp. Cas. 593 Bom.
[23] M S Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd. AIR 2004 SC 909
[24] Rangraj (n 16)
[25] Messers Holdings v. Shyam Ruia (2010) 159 Comp. Cas. 29 Bom.
[26] Vasudha Anil Kumar (n 2)
[27] Vodafone (n 5)
[28] World Phone India Pvt. Ltd. v. WPI Group Inc. USA [2013] 178 Comp Case 173 (Del)
[29] HTA Employees Union (Regd.) v. Hindustan Thompson Associates Ltd. and Ors RFA 247/2004
[30] Vodafone (n 5)
[31] Premier Hockey Development Private Limited v. Indian Hockey Federation O.M.P. 92/2011 & O.M.P. 52/2011.
[32] Vodafone (n 5)
[33] ibid
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