In this article, Anupam discusses Enforceability of Shareholders Agreements.
Introduction
A company is an artificial legal entity and incorporated association formed by voluntary association of many persons coming together in order to carry out their commercial business and to earn profit or to carry out function with charitable object. According to the Companies Act, 2013 a company will be regarded as a “company” only if it was or will be incorporated under this or any previous company acts. A company can either be a private, public or one person company. A company may be formed under section 8 of the act in the promotion of commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment or any such other object with non profit purpose.[1]
What is Shareholders agreement?
Shareholders are individuals who invest money in the company’s share and become owners of that share of the company. Agreement can be defined as a consensus between the parties on certain terms and conditions pertaining to their work or any article and they are bound by such agreement and can be enforced against the parties agreeing to it. Shareholders agreement (SHA) after amalgamating both the definitions shareholders agreement can be defined as a consensus arrived by the shareholders of a company for managing the working of the company, division of shares, company related or non-company related matter. “A shareholders’ agreement is an agreement entered into between all or some of the shareholders in a company. It regulates the relationship between the shareholders, the management of the company, ownership of the shares and the protection of the shareholders. They also govern the way in which the company is run.”[2]
SHA is not regulated by any specific law in India and thus it is not mandatory for shareholders to make and enter into SHA. There is no confinement to the number of shareholders who can enter into an agreement as per any rules and regulations.
Motive for framing an SHA
The motive behind framing of the shareholders agreement is to provide an extensive remedy to the shareholder to enforce his rights mentioned in the agreement other than those mentioned in the Articles of Association of a company. In order to enforce the conditions prevailing in the agreement, terms and conditions of the agreement are to be mentioned in the articles of a company.
Contents to be included in the SHA
Shareholders can include both company and non-company related clauses in the agreement but it is advisable to include the clauses which are pertinent to the company and not in violation of articles of a company and company Act, 2013. The agreement can include clauses related to
1) The appointment of directors,
2) Quorum requirements,
3) The matters related to special resolution or providing veto rights to certain shareholders (more in case of private equity and venture capital partners), 3) financial needs of a company,
4) Restrictions on right to transfer shares,
5) Defining the rights and duties of each of the shareholder towards the company.
Articles of Association
Articles of association of a company contain the rules, regulation and guidelines to the management of the company[3]. It defines the rights and duties of management in relation to its internal affairs. Articles should not contain any element which is in ultra vires to memorandum, the companies act or oppose to public policy. Articles are auxiliary to the memorandum.
A company is incorporated under the company act, 2013 after framing and submitting its articles and memorandum of association.
Legal Validity and Enforceability of SHA
There is no specific statutory act to govern the shareholders agreement and in addition to it there is no consistent case law to govern the agreement. There is no legal formality prescribed by law for its creation. However it is partially guided by the contract act and other legal principles.
In order to claim remedy under company act, 2013 often the clauses of the shareholders agreement are made in conformity to the articles of a company or the articles are altered after the shareholders enter into the agreement.
Agreement cannot be enforced against the third party to the SHA. However, in order to enforce the agreement against the third person in the matter concerning to the non- company related issue, it has to be first incorporated in the articles of the company. Articles of a company are public in nature i.e. it is easily accessible to the third party and thus he would be legally bound to read the articles before entering into any transaction.
Important case laws related to the SHA
V.B.Rangaraj v. V.B Gopalakrishnan was the first case instituted in the Supreme Court related to the shareholder’s agreement. The defendant is a private limited company which from the start had an aggregate shareholding of 50. Prior to the joint family of the plaintiff and defendant came to hold all the 50 shares of the company, the family was a minority investor holding 13 shares, the rest 37 shares being held by outsiders. In course of time, the family procured the rest 37 shares and turned into the sole shareholder of the organization. The family comprised of Baluswamy Naidu and Guruviah Naidu who were siblings, and every one of the siblings held 25 partakes in the organization. The plaintiffs and defendant 1 and 2 and one Selvaraj are the children of Baluswamy Naidu and defendants 4 to 6 are the children of Guruviah Naidu. Baluswamy Naidu kicked the bucket on February 5, 1963 and Guruviah Naidu passed on January 10, 1970. The plaintiffs claimed that in 1951 there was an oral agreement between Baluswamy Naidu and Guruviah Naidu that each of the branches of the family would dependably keep on holding equal number of shares, viz., 25 and that if any part in both of the branches wished to offer his shares, he would give the primary choice of procurement to the individuals from that branch and just if the offer so made was not acknowledged, the offers would be sold to others. In spite of the fact that for the benefit of defendants, it was questioned that there was any such agreement between the two siblings, the finding recorded by every one of the courts underneath is against defendant. It isn’t in question that the Articles of Association of the organization were not altered to acquire them congruity with the said understanding.
The fundamental question which was considered in the case was related to the dominance of article of association of a company over shareholders agreement. The court held that the restrictions to the transferability of shares are to be mentioned in the articles of association and since in this case it was not mentioned in articles but in shareholder’s agreement made it unenforceable against the defendants.
Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd – the Gujarat High Court enforceability of the SHAs regarding granting of pre-emption rights in a public company was decided. In tha SHA there was a clause granting the pre- emption rights to the Mafatlal Industries but it was dishonoured by the defendants which initiated this suit. The defendants contended that in view of the provisions of Section 82 and 111A of the Companies Act, the Supreme Court had already declared that shares are freely transferable with no restriction on the shares.
The defendants contended the reasoning of the case V B Rangaraj v. V B Gopalakrishnan. In retaliation it was contended by the plaintiffs that the judgement of the case would not be applied as it was concerned to the private company and the concerned company was a public company. The Gujarat High Court inclined its judgement towards the plaintiff and declared that the pre-emption agreement which is not incorporated in the Articles of Association was held to be unenforceable.
In Premier Hockey Development Private Limited v. Indian Hockey Federation, the Indian Hockey federation and the petitioner company entered into a shareholders agreement. Court held that the agreement was enforceable against both i.e. the shareholders and the company both of them were a a party to the Shareholders Agreement and were legally bound by it.
Enforceability of SHA against the company
Two conditions which could be propounded after considering above judgements are:
- When company is not a part of the shareholders’ agreement –
There are two sub categories under this a) Private company, and b) Public company
In case of private company the clauses related to the shareholders agreement should be mentioned in the articles of association. This condition is mostly prominent in the cases related to restrictions imposed on transferability of shares of the members of the company.
In case of public company if the terms and conditions in the shareholders agreement is not in contravention to the provisions of the company act and the articles of association then it would be enforceable against the members. Albeit, no obligations can be imposed on the statutory powers of the company.
- When company is a part of shareholders’ agreement
In the scenario where the company itself is a party to the shareholders agreement, the agreement can be enforced against the company according to the enshrined contractual principles.
Conclusion
The articles of association constitute a statutory contract between the shareholders and the company[4]. The articles tend to bind each and every member of the company even though there is no individual contract between the members.
The agreement which is inconsistent with the provisions of the act would be considered to be void as per Section 6 of the company act,2013.
To fill the void provision in the company act about the shareholders agreement and its enforceability various landmark judgements have been passed by supreme court and high courts. The judgement in the case of V.B.Rangaraj v. V.B Gopalakrishnan is considered pertinent even today in many cases related to the difference of private and public company in relation to shareholders agreement. The case of Premier Hockey Development Private Limited v. Indian Hockey Federation is relied and considered in the cases where the company is party to the agreement. However, considering the recent judgements of the Delhi High Court and Bombay High Court it can be concluded that incorporation of the Shareholder Agreements in the Articles of Association of the company is not a mandatory clause for its enforceability against company. The condition for its enforceability is that the Shareholder Agreements should not curtail the statutory powers of the company and should not bind future shareholders, then they can be enforced against the company even if they are not incorporated in the Articles of Association of the company.
[1] COMPANY ACT, 2013
[2] https://www.stephensons.co.uk/cms/document/Shareholders_agreements.pdf
[3] http://www.mca.gov.in/SearchableActs/Schedule1.html
[4] Borland Trustee v. Steel Bros & Co. (1901) 1 Ch. 279.
