In this blog post, Naveen K. Jain, a student at Jindal Global Law School, Haryana, describes tag along and drag along rights and their enforceability in India.
Tag along and Drag along rights are contractual that do not find any mention in Companies Act in India. Tag along and Drag along rights are considered to be an important part of any term sheet/shareholders agreement that involves the transfer of equity shares.[1]
Tag along rights are simply those rights which mostly benefit the minority shareholders. When the promoters or Majority shareholders transfer their shares to incoming investors, the existing minority shareholders can tag along. 
It means that they can bind the selling shareholders to allow the minority shareholders to sell their shares along with them on the same terms and conditions [that also includes pre-determined agreed price of shares].
On the other hand drag along rights benefit the majority shareholders cum promoters. An incoming investor might wish to acquire full control over the company. Minority shareholders may not wish to tag along and wish to stay with the limited ownership in the hope that share prices may rise. Majority shareholders/Promoters, therefore, include “drag along rights” provision in the term sheet/shareholders agreement that gives them the power to compel the minority shareholders to sell off their shares at a price determined for majority selling shareholders on the same terms and conditions.
India’s position
India’s position has not been clear with pre-emptive rights, RoFA, Tag along, Drag along and Put and Call options until recently.
In the case of V.B. Rangaraj v. V.B. Gopalkrishnan (1992) 1 SCC 160, it was settled that the terms in the shareholders’ agreement cannot contradict the Articles of Association. But the main questions raised were; as what would happen when “Article of Association “only just not mention a right which on the other hand a shareholder’s agreement does? Can a right which has been provided in SHA be enforced when AoA is silent on the issue? The two-Judge Bench at Supreme Court in V.B. Rangaraj while discussing the above two questions said:-
“This Court has taken the view that provisions of the shareholders’ agreement imposing restrictions even when consistent with company legislation, are to be authorised only when they are incorporated in the articles of association[2].”
Subsequent judgements had either followed the above reasoning or made an attempt to distinguish the facts of the cases from existing precedent of V.B. Rangaraj. In the case of Messer Holdings Limited v. Shyam Madanmohan Ruia and Ors. 2010(5) Bom CR 589, the divisional bench of Bombay High Court distinguished the case from V.B. Rangaraj. The Court further referred to Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd., (2010) 154 Company Cases 593 (Bom) where a single judge had observed that the V.B. Rangaraj case only deals with a matter involving a private company, and therefore the said judgement and its ruling shall not be applicable in a matter involving public Ltd. company.
Three-Judge Bench of Supreme Court of India dealt with the ratio of V.B. Rangaraj again in Vodafone International Holdings BV v. The Union of India, (2012) 6 SCC 613 and specifically disagreed with the reasoning. The Hon’ble Court said:
“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…… (64) Shareholders can enter into any agreement in the best interest of the company, but the only … (66) SHA, therefore, regulate the ownership and voting rights of shares in the company including ROFR, TARs, DARs, Preemption Rights, Call Options, Put Options, Subscription Option etc. in relation to any shares issued by the company, restriction of transfer of shares or granting securities interest over shares, provision for minority protection, lock-down or for the interest of the shareholders and the company.[3]”
The Hon’ble Court directly did not overrule V.B. Rangaraj but clearly expressed its disagreement with the reasoning therein. The court said that 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. Vodafone International Holdings case is one of the most recent cases from the apex court that precisely talks about Tag along and Drag along rights[4].
Clearly, Rights mentioned above are rights which if not mentioned specifically in AoA, would come under the ambit of Contract laws of India. Section 111A of Companies Act, 1956 states that the shares in the public company must freely be transferable. Which means that there cannot and should not be any restriction on transfer of shares to one party to another. Section 58 of new Companies Act, 2013 follows the same line of reasoning but also additionally came with the clause that states:-
“Provided that any contract or arrangement between two or more persons in respect of the transfer of securities shall be enforceable as a contract[5].”
Section 111A of old companies act was implicit about the separate contractual arrangement of parties whereas Section 58 of new Companies Act has made it very explicit that parties may individually enter into separate contractual arrangements. Additionally, Sale of Goods Act, 1930 or section 23 of Indian Contract Act, 1872[6] may govern certain contractual arrangements that are not mentioned anywhere. Section 23 broadly set the grounds on which an agreement can be held to be unlawful. Public policy and immorality are the two main grounds on which a court may declare a contract invalid.
After the Vodafone International Holdings case it was felt that the issue has been settled but in 2013 in another case which was decided by Delhi High Court created ripples in the water. In re World Phone India Pvt. Ltd v. WPI Group, [2013] 178 Comp Cas 173 (Del), the issue involved a resolution passed by the board of directors of a private company relating to the rights issue. But such resolution required an affirmative vote of the appellant as per shareholders’ agreement. The same was not exercised. The court said since such right is not mentioned in the AoA, it is not enforceable solely based on shareholders’ agreement. The Hon’ble court probably tried to set a different precedent for private companies by avoiding Vodafone International Holdings case. Vodafone could not even find a mention in the Word Phone case[7].
In the same year, a SLP was filed against the World Phone case, but Hon’ble Supreme Court had refused to admit it stating the reason that the H.C.’s order was only regarded to interim relief and it will be Company Law Board which would decide the matter[8].
Most recent development
SEBI- Notification No. SO 184(E) dated 1 March 2000[2][9]: – under this SEBI did not permit pre-emptive rights such as put/ call or tag along or drag along rights until recently when a new notification came into effect. In the year 2011 where a matter was before SEBI to seek permission for Put/Call options and companies were listed, SEBI opined that put and call options are invalid and unenforceable, and thus cannot be given effect by it. In the ruling related to the public takeover of Cairn India Limited[10]. The put option and call option arrangements and the right of first refusal were held not to be conforming to the requirements of a spot delivery contract nor with that of a contract of derivatives as provided under Section 18A of the SCRA and, therefore, held illegal. Simultaneously, in an informal guidance issued by SEBI to Vulcan Engineers Limited, it was explained that a pre-agreed buy-back of shares through put/call option would not be valid in view of the provisions of SCRA and the Notification No. SO 184(E)[11].
3rd Oct 2013 SEBI Notification
In furtherance to making section 58 of the newly introduced Companies Act, 2013 clearer, SEBI has passed SEBI notification no. LAD-NRO/GN/2013-14/26/6667 on 3rd Oct. 2013. Via this notification SEBI rescinded the previous notification of the year 2000.
SEBI surprisingly took a complete shift from its previous notification. In the new notification, it has specified the different set of contracts in which one would not be required to take permission from SEBI in advance. The clause (c) also includes tag-along and drag-along rights. Clause (c) states:-
(c) contracts for pre-emption including the right of first refusal, or tag-along or drag-along rights contained in shareholders agreements or articles of association of companies or another body corporate[12];
Although the notification rescinded the earlier notification no. SO 184(E), it seems that the notification is not retrospective and would only be beneficial for the shareholding-contract entered after its effect.
It is a very appreciable development since the position of the SEBI was not very clear on Put/Call options, Tag along, Drag along rights and RoFR. SEBI under previous notification had vested powers to itself where it could decide whether such rights are enforceable on case to case basis.
Bajaj Auto Ltd v. Western Maharashtra Development Corporation Ltd, 2015(4) Bom CR 499
The previous single-Judge judgement of this case had been discussed by a division-Judge Bench of Hon’ble High Court in Messer Holdings Limited in the year 2010. The same has been discussed above on page no. 2.
It is important to note that this case was decided by a single-Judge in the year 2010 when neither 2013 notification of SEBI nor Section 58 proviso was in place. In this case, the main contention revolved around clause 7 of shareholders’ agreement which had created a right of pre-emption between the parties with regards to the purchase of each other’s shares in a company where both the parties were promoters. The single-Judge said that since both the parties are shareholders in a Public company, they could not have a pre-emption clause inter-se between themselves as the same was violative of section 111A (2) of the Companies Act. On that count alone the Single-Judge set-aside the arbitral award.
Bajaj Auto case was further decided by a divisional bench recently in 2015 after an appeal. The court had looked into all the possible aspect related to issue involving AoA and special rights granted to shareholders under shareholders’ agreement.
In this case, court referred to the 57th report of a parliamentary standing committee on Companies Bill, 2011. The introduction of Section 58 itself was to simply codify the various judgements made by various courts in India holding that contracts relating to transferability of shares of a entered into by one or more shareholders of a company (which may include promoter or promoter group as a shareholder) shall be enforceable in India. The court observed that SEBI followed the line with proviso to section 58 (2) of the companies act 2013 and thus issued a notification dated 3rd Oct. 2013 (already discussed above in detail) and shifted from its previous position[13].
Respondent in this case also referred to section 22A of Securities Contracts (Regulation) Act, 1956 which was inserted by Securities Contracts (Regulation) (Amendment) Bill, 1985. Hon’ble Supreme Court observed that this very section was the predecessor to Section 111A of the Companies Act, 1956. The said section stated:-
“22-A. Free transferability and registration of transfers of listed securities of companies.
- In this section, unless the context otherwise requires,-
- “company” means a company whose securities are listed on a recognised stock exchange;
- **
- **
- Subject to the provisions of this section, securities of companies shall be freely transferable.”
On para 25 the Hon’ble Supreme Court observed “we do not read section 22A (2) to mean that it would affect the right of individual shareholders to deal with their own shares on such terms and conditions as they deem fit or to enter into any consensual arrangement / agreement regarding their own shares by way of sale, pledge, pre-emption or otherwise.[14]”
On 27th para of the judgement, the Court said that shares of a company are movable property and therefore right of the shareholder to enter into separate contracts with regards to his shares (either by way of sale, pledge, or pre-emption, etc.) is nothing but a shareholder exercising his property rights. Thus contracts of such nature voluntarily entered into by a shareholder or his shares giving rights of pre-emption to a third party/ another shareholder, cannot constitute a restriction on free transferability as contemplated under section 22A.
Hon’ble Court also dealt with the issue concerning a situation where a Private company is involved. Court pushed the reasoning that “shares are movable properties and are transferable” little too far. According to the Court under Section 10 of Specific Performance Act, 1877 which corresponds to Section 12, on exceptional situations transfer of a share can be granted to a third party on the basis of separate/ individual contractual agreements. Court stated:-
“It has been held by a long line of authority that shares in a private limited company would come within the phrase “not easily obtainable in the market[15]””
In this case, Court also referred to Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613 (extensively discussed above). Relying on the observation, Court refused to place its faith on V.B. Rangaraj.
Conclusion
It is clear that Pre-emptive rights, Tag-along, Drag along, Put/call options and RoFR are enforceable rights in India. Even if the AoA of a Public limited company does not mention of such rights, they are very much enforceable under Shareholders’ agreement. Only in those situations where such rights are explicitly stated as unenforceable under AoA, there might be a possibility to contest otherwise.
References:
[1] Chemla G, Ljungqvist A and Habib M, ‘An Analysis Of Shareholder Agreements’ (Papers.ssrn.com, 2002) accessed 10 May 2016
[2] of V.B. Rangaraj v. V.B. Gopalkrishnan, (1992) 1 SCC 160
[3] Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613
[4] Ibid
[5] Section 58 proviso, Companies Act 2013, Universal Company law Bare Act 3rd edition
[6] Section 23 states: What consideration and objects are lawful, and what not.—The consideration or object of an agreement is lawful, unlessThe consideration or object of an agreement is lawful, unless—” it is forbidden by law; 14 or is of such a nature that, if permitted, it would defeat the provisions of any law; or is fraudulent; or involves or implies, injury to the person or property of another; or the Court regards it as immoral, or opposed to public policy. In each of these cases, the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful is void. Illustrations.
[7] World Phone India Pvt. Ltd v. WPI Group Inc USA, [2013] 178 Comp Cas 173 (Del)
[8] Aditya Swarup, ‘INDIAN CORPORATE LAW: Conflicts Between Shareholders Agreements And Articles Of A Company’ (Indiacorplaw.blogspot.in, 2013) <http://indiacorplaw.blogspot.in/2013/06/conflicts-between-shareholders.html> accessed 10 May 2016.
[9] Shikha Bansal, ‘INDIAN CORPORATE LAW: Analysis Of SEBI Notification On Pre-Emption Rights And Options – Part 1’ (Indiacorplaw.blogspot.in, 2013) accessed 10 May 2016.
[10] ‘Letter of Offer’ (SEBI, 2010) <http://www.sebi.gov.in/takeover/cairnlof.pdf> accessed 10 May 2016.
[11] Supra note 8.
[12] ‘SEBI Notification No. LAD-NRO/GN/2013-14/26/’ (SEBI, 2013) accessed 10 May 2016.
[13] Bajaj Auto Ltd V. Western Maharashtra Development Corporation Ltd, 2015(4) Bom Cr 499
[14] Ibid
[15] Ibid
