This article is written by Mithi Jaiswal pursuing Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.
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An agreement executed between all the co-founders of a company that lays down the ownership pattern, rights, responsibilities, dispute resolution, and other terms and conditions of the business that is to be carried out by the co-founders is called a co-founder’s agreement.
A co-founder’s agreement is a mandate before starting any business or company involving more than one founder. Similarly, an airline company with more than one co-founder will require the agreement to safeguard the rights and liabilities of each other co-founder involved.
Reasons to execute a co-founder’s agreement
Let’s have a close look at some of the important clauses we should keep in mind while drafting a co-founder’s agreement for an airline company:
- Firstly, the co-founder’s agreement demarcates the responsibilities and duties of each of the founders which aid in the decision-making process. Based on the strengths and weaknesses of the individuals, each of them is assigned certain roles and responsibilities.
- Secondly, this agreement helps in framing the strategies and also helps the founders to plan the actions that are required to be taken when any member desires to quit the company.
- Thirdly, this agreement helps in safeguarding the intellectual property under the name of the company and to avoid any errors that may happen while assigning the ownership of copyright to an individual.
- Fourthly, this agreement eases the carrying on of future transactions which further improves the performance of the business.
Essential clauses under a co-founder’s agreement
This clause lays down the determined proportion of equity ownership of each other co-founders. This equity ownership is determined by taking into consideration various factors such as experience, technical know-how, network in the industry, and financial investment. This also determines the voting rights that can be exercised by the co-founders.
Demarcation of the roles and responsibilities
This clause is very vital as it lays down the responsibilities and duties of each of the co-founders which are to be duly performed by them. In case of any action and non-action on the part of any co-founder, the same shall be accountable and subjected to certain legal implications as mentioned in this agreement.
Restriction on transfer of shares
The rights and restrictions of the founders to transfer their shares in the company are mentioned under this clause.
- There should be a lock-in clause prescribing the number of years upon expiry of which the co-founders can transfer the shares held by them in the company. The co-founders are strictly prohibited to transfer the shares owned by them before the expiry of the number of years mentioned in this clause.
- A transparent mechanism shall be laid down to deal with situations where the co-founders desire to leave or exit from the company before the expiry of the lock-in periods. It is mandatory to throw light upon the method of valuation and dilution of rights attached to shares that are to be transferred.
Bajaj Auto Ltd v. Western Maharashtra Development Corporation Limited in this case it was held by the Bombay High Court that the restrictions on the transfer of shares will be enforceable even on a public company provided the agreement lays down the restrictions on transferring of shares.
Intellectual property assignment
- Any idea, invention, and other intellectual property developed by any particular individual is entirely owned and all rights over the same are enjoyed by the particular individual in general business but while drafting a co-founder’s agreement the lawyer shall take utmost care to assign the intellectual property to the company and that the same does not remain in the same of any individual.
- In this clause, it is extremely important to mention that any intellectual property which has been initially purchased in the name of any of the co-founder will be later transferred to the company after a definite time period mentioned in the agreement.
- Any idea, invention and other intellectual property developed by any co-founder in the course of their association with the company shall always be owned by the company.
This clause prohibits the co-founders from engaging in activities that are in conflict with the objectives of the company during their association and for a period of a certain number of years after the termination of the agreement.
Taprogge Gesellschaft MBH v. IAEC India Ltd, in this case, it was held by the Bombay High Court that after the termination of a contract, the party exiting the contract is restrained from associating with any similar business to secure freedom from the competition was void. The court refused to enforce the negative covenant and held that, even if such a covenant was valid under German law, it could not be enforced in India.
The founders while working together and very closely with the company get very well aware of all the minute details and the secret or confidential information of the company. This clause prohibits the co-founders from misusing the same and also deals with how shall the confidential information be protected and disposed of in case any of the co-founders exits the company.
In the famous case of Fairfest Media Ltd. v. ITE Group, it was held by the Calcutta High Court that all the cost and pricing, projected capital investments, inventory, marketing strategies, and customer lists, and all such business information included but not limited to the above mentioned may qualify as trade secrets. An injunction was passed prohibiting the respondent from sharing any information falling within the ambit of business information received from the petitioner for a period of 2 (two) years from the date of termination of the non-disclosure agreement thereby enforcing the non-disclosure agreement post-termination.
The details of the additional finances required to be contributed by the co-founders for the growth of the company are to be clearly stated in this clause. This clause shall lay down the method in which these additional finances are to be rendered such as in equity or debt. If the financing is through equity, then the method of valuation of equity and the rate of interest to be paid by the company in case the financing is debt financing.
Winding up of business
In case of winding up, the rights and liabilities of each of the founders shall be clearly laid down in the co-founder’s agreement. This clause shall also include the distribution of all the assets and liabilities of the business.
In the day-to-day functioning of the business, the company may be required to make complex decisions. The agreement shall clearly state the manner of exercise of simple as well as substantial decisions. Further, the structure of the board of directors of the company shall be determined. The day-to-day decision-making is allocated to the chief executive officer who is appointed by the board of directors of the company. The agreement is also required to prescribe the procedure which is to be adopted by the company in the event that there is a deadlock in decision making.
Termination and dispute resolution
The co-founder’s agreement should clearly state the circumstances in which this agreement can be terminated and the rights of the company or the co-founder to terminate the same. This agreement may be terminated for a cause or without any cause by any of the parties individually or by mutual consent. In case there is an occurrence of a dispute between the parties then this clause shall state the clear mechanism for resolution of disputes between the company and the co-founders with respect to the matters stated in the agreement. The methods of dispute resolution undertaken by the parties can be mediation, conciliation, or arbitration in order to settle the disputes amicably. The parties shall agree on the governing law of the agreement and the exclusive jurisdiction of the courts to which the disputes under the agreement may be referred to.
Advantages of making a co-founder’s agreement
By entering into a co-founder’s agreement, the co-founders give their consent to the terms and conditions laid down in the agreement. This further makes the relationship between the co-founders clear, strong, and less complicated.
This agreement clearly lays down the roles and responsibilities hence bifurcating the duties and activities to be performed by the founders clear. This bifurcation of roles and responsibilities improves the individual performance of the co-founders hence improving the business of the airline company.
Factors that are to be kept in mind while framing a co-founder’s agreement
- Prior to signing the agreement, there should be a thorough discussion among all the co-founders in relation to the ownership, capital, investment, and other important aspects.
- Each and every party entering into the co-founder relationship shall have clarity.
- While drafting the agreement we should always avoid all sorts of ambiguities.
Hence, we can conclude that the co-founder’s agreement is executed for the following:
- To avoid any kind of ambiguity in the future in respect to the business between the parties.
- To avoid any kind of loss arising out of certain unforeseen situations which might, in the long run, affect the business of the company.
- To safeguard the business and the parties from any unnecessary liabilities.
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