This article is written by Ibapynhun S Mukhim, pursuing Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).
Table of Contents
A shareholder is a member of the company according to Section 2(55)(iii) of the Companies Act 2013. A shareholder holds Shares of the company and their name is entered as a beneficial owner in the records of a depository. Becoming a shareholder does not mean that it is only to receive advantages, like dividends. However, they also have responsibilities to carry on. Some of the responsibilities of the shareholders include the appointment of directors, changing the Articles of Association, Memorandum of Association, making changes and amendments when it comes to the financial statements of the company. The shareholder is entitled to appoint one person to the Board, and if wishes to remove them, they can take such action.
The purpose of an agreement or a contract is to provide legal safeguards in our transaction, we will feel safer if we get some kind of guarantee that we are being protected. A shareholder agreement is an arrangement that defines the relationship between shareholders and the company. The agreement safeguards the rights and obligations of the majority and minority shareholders, and it ensures all shareholders are treated fairly. When the minorities receive favour and protection, it should not be at the cost of the majority. Therefore, the protection of rights and obligations should be a balance between the both.
How does one become a shareholder?
There are different methods by which a person can become a shareholder. First, he can purchase shares, second by the allotment of shares, and lastly by subscribing to the memorandum. The same person also ceases to be a shareholder when he transfers his shares, surrenders shares, when he forfeits his Shares, when he dies and when the trustee goes bankrupt.
Who are the minority and majority shareholders?
A majority shareholder is someone that holds more than 50% of shares in the company. As a majority shareholder, a person or operating entity has a significant amount of influence over the company, especially if their shares are voting shares. This presents an opportunity for the majority Shareholder to take part in significant decisions of the company. For example, to make corporate decisions, appointing directors, etc. In this way, they can direct the company in the way they desire since they can do so through voting power.
So a minority holder, on the other hand, is someone who holds less than 50% shares in the company. A minority holder will not enjoy all the privileges enjoyed by a majority holder. Minority shareholders have limited rights to benefit from the operations of a company, including receiving dividends and being able to sell the company’s stock for a profit. The minority holder may not have voting rights and does not have control over the company.
Let us imagine a simple scenario to portray a majority shareholder. In a parallel universe, there is Mr Stark who owns about 55% of shares in the Galaxy Company. Mr Thor owns 7% share, Mr Star Lord owns 8% share, Miss Black Widow owns 9% of the share, and Mr Roger owns 13% of the share and the rest of the shares is owned by Miss Pott.
In this scenario, we can see that Mr Stark has majority shares as compared to others. He can have a major influence on the company. Whereas the rest own less than 50% share in the company and therefore they are the minority shareholders. Therefore, we can conclude that the Galaxy Company is mainly run by Mr Stark as he might have a significant amount of influence over the company, especially if his shares are voting shares. .
What is a Shareholder Agreement?
Put simply, a Shareholder Agreement is a legally binding contract that defines the relationship between the shareholders and the company. So basically, the rights and the obligations of shareholders are given in the said Shareholder Agreement and are protected by them. The Shareholder Agreement also protects the existing shareholder from situations when the company’s management changes, or/and when the company is sold off to another and the same shareholders remain, their rights are protected.
After learning that there are two types of shareholders- majority and minority, we found that the minority holder is in a vulnerable position. Letting the majority shareholder dictate the decisions of the company without realizing that their action may not sync with the desire of the minority shareholders can lead to disputes. A Shareholder Agreement can be used as an instrument to protect the minority as well as the majority shareholders alike.
How does Shareholder Agreement protect the Minority Shareholders?
The presence of the Shareholder Agreement helps the minority Shareholders to influence the function of a company. One can argue that the presence of Article of Association will protect the Minority Shareholders too but since it can be easily amended by the Majority Shareholders, there is no guarantee that they will not be abused.
The Companies Act 2013(to be known as the Act) has made efforts to safeguard the rights of the minority shareholders. Let us mention in brief these rights that are mentioned in the Act to protect the rights of the Minority Shareholders below:
- Section 151 of the Act reserves the right to appoint Minority Shareholders Directors: A Minority Shareholder Director is an independent director, and an individual elected by the Minority Shareholders representing them. He/She will be on the Board of their listed company. He will hold office for a term of three years and cannot be re-appointed.
- Section 241 and 242 of the Act reserve the right to apply to NCLT for oppression and mismanagement: Oppression and mismanagement may come from the Board, promoters, or the management team. Whenever Minority Shareholders face any problems of being oppressed or/and mismanagement they can approach the National Company Law Tribunal for expedient action.
- Section 235 and 236 of the Act reserve the right to reconstruction and amalgamation of companies: There is a fear amongst the Minority Shareholders that during the process of amalgamation or reconstruction of companies, the interest of Minority Shareholders may not be taken into consideration. However, the addition of these provisions has helped to safeguard and assure the Minority Shareholders that they are in safe hands.
- Section 108 of the Act mandates certain companies to offer e-voting facilities to shareholders to vote on shareholder meetings: We are familiar with the concept of virtual/online work and online shopping, etc. This section provides a similar notion for Minority Shareholders to attend the meetings and exercise their voting rights without being physically present in meetings. So, even if they cannot be present in meetings, they can still access their voting rights.
- Section 188 of the Act talks about accepting mandates from the majority only which talks about related party transactions, mandates companies to undertake such transactions only after receiving approval from the majority of non-interested parties.
- Right to file a Class Action Suit: A class action suit is a suit where one person or number of plaintiffs come together and file a suit against another party or person. They will represent the entire interested group. In this case, the Companies Act, 2013 allows a group of Minority Shareholders (can include Majority Shareholders too) combining with the lenders to approach the National Company Law Tribunal. The suit may be against the operations of the company, or the management, or the board.
- Adoption of Fair Mechanism: Shares need to be evaluated accordingly. To avoid unfair valuation, a fair mechanism needs to be adopted. The Act of 2013 provides for an independent Valuation Mechanism to protect the interest of the Minority Shareholders. The Minority Shareholders can approach the NCLT should there be any unfair means.
These provisions attach power to the Minority shareholders and protect them from being abused. The Shareholder Agreement can add all these provisions. If at any point in time, the Majority of Shareholders abuses them, they can use the said Shareholder Agreement so that they can protect themselves.
How does Shareholder Agreement protect the Majority Shareholder?
In any event, we are well familiar with the concept of majority rules. Whether in a political election or any class of election or agreement. We are also aware that, to some extent, the majority experiences supremacy over the minority. Then why does the majority shareholder need protection in the Shareholder Agreement? After familiarising ourselves with the minority rights and obligations, we are conscious that they are protected not only by the Shareholder Agreements but also the provisions mentioned in the Companies Act, 2013. With this, it becomes difficult for the Majority Shareholder to tell or stop the minority shareholder from doing certain things. There are situations when decisions taken by Majority Shareholders are in the interest of the company, but the Minority Shareholders may not be on board with it. In this case, the majority Shareholders can add a provision that drags the minority shareholders to cooperate with them in the best interest of the company.
There may also be a situation when the minority shareholders will want to sell their shares, however, the interested party, maybe a party that the Majority Shareholder may not want to get involved with, such a situation like this case, the majority shareholders can stop the minority shareholders from selling their share to the forbidden party.
The hypothetical situation of minority and majority shareholders protected by Shareholder Agreement
In the given example here we found that Mr. Stark was the majority shareholder, whereas Mr. Star Lord, Miss Black Widow, Miss Potts, Mr. Rogers and Mr. Thor are the minority shareholders. They have done what was required, which is to formulate a Shareholder Agreement. So, both parties’ rights are well protected and secured. The Majority Shareholders will not abuse the Minority Shareholders.
Mr Star Lord wanted to sell his shares to Mr Thanos, Mr. Stark did not want this transaction to go forward. However, Mr Star Lord is persistent in selling his shares and justified that selling his shares will earn him the money he needs, and on top of that, the market is not doing well. Mr Star Lord sees that selling his Shares is the best corporate decision that he could make at the moment. Mr Thanos is the only person who is willing to buy the said shares from Mr Star Lord. Having a legitimate reason, the other minority shareholders protest that Mr Star Lord can do whatever he wants with his Shares. The Majority of Shareholders have had their hands tied, which leads them to the only resolution, that is, by going to the Shareholder Agreement. In doing so, there will be a clause allowing the Majority Shareholders to stop the Minority Shareholders from selling their shares to their competitors or the interested party they do not want to work with as co-shareholders.
We can see the importance of the Shareholder Agreement. It protects the rights of both the Majority and Minority Shareholders. If anyone takes a decision that will hamper the interest of the company, such actions can be regulated, and taken care of by going through the Shareholders Agreement. Just like any contract, before entering into one, it is important to have every discussion laid on the table to avoid problems later on. Shareholders Agreement is not a one-sided Agreement but it is an agreement that works in favour of both parties and the Company.
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