Introduction
In India, the Companies Act 2013 is a statute governing the functioning of the companies incorporated under the said Act. The Companies Act 2013 also contains various provisions pertaining to the rights of the shareholders of the company, including the rights to receive dividends, voting rights, rights to receive information, and various other aspects. Absent any specific agreement for governing the rights of the shareholders, the rights of the shareholders/members of a particular company incorporated under the Act will be governed by the provisions of said Act. The Shareholder Agreements normally are an attempt to have contractualise shareholders relationship inter se and with the company beyond what is provided under the Companies Act, 2013.
The matters dealt with under the Shareholders Agreement
The Shareholder Agreements are normally a requirement when a private unlisted company is seeking investment in the form of equity funding in furtherance of the needs for funding for expansion of its business, especially at a time when the business has not grown to the extent of being able to afford the expenditure and other resources required for flotation of the initial public offer.
Such unlisted companies normally seek to obtain investment from institutional private equity investors or other private investors and at the time of making such investment, for protection of their investment and for keeping checks on the enthusiasm of the promoters of the company as also for taking care of certain other aspects, these investors seek to execute a Shareholders Agreement for having various specific rights and obligations imposed upon the parties in addition to or in derogation of what are provided by the company law. They seek to prescribe for the clauses of right of first refusal, right of first offer, drag along rights, veto requirement for certain matters, etc. These agreements may contain provisions for buyout options and modalities, maintenance of status quo regarding certain matters connected to the company, including the constitution of the board of directors and key managerial persons, compulsory acquisition of shares in certain eventualities, dealing with deadlocks, dealing with exit mechanisms, valuation related issues and procedures, etc.
Analysis of Special Rights under Shareholders Agreement viz a viz provisions of Indian Law and Enforceability thereof
While above are examples of different kind of special rights, in addition to what is provided under the Companies Act, it is important to understand whether and to what extent such special rights granted to shareholders under the Shareholders Agreement are enforceable.
Indian courts, on the subject matter are in agreement that while the parties have freedom of contract, Indian law does not provide for complete freedom in connection with the contracts pertaining to shares and different rights of the shareholders.
Supreme Court of India and different High Courts have dealt with different peculiar situations/clauses including the veto rights, drag along rights, ROFR clauses, etc. While have dealt with enforceability requirements for different specific rights under Shareholders Agreement which could be found at https://rdlawchambers.com/research-articles/ , in this article we seek to deal with general requirements for enforceability of Shareholders Agreement and with enforceability of clauses imposing restrictions on transferability of shares e.g. ROFR, Right of First Offer, drag/drag along rights etc.
All these types of clauses providing certain rights to a party to the shareholder’s agreement resulting in direct or indirect restrictions on free transferability of the shares of the privately held company would be required to be considered in light of the decisions of the Supreme Court in this regard.
Generally speaking, there cannot be any restriction on the free transferability of shares of the public limited companies. However, in the case of a privately held company, restrictions could be imposed on the free transferability of the shares of the company.
In the case of V.B. Rangaraj vs V.B. Gopalakrishnan and Others[i]. an agreement was entered between the shareholders of a private company whereunder, a restriction was imposed on a living member of the company to transfer his shares only to a member of his branch of the family. Such restrictions were, however, not envisaged or provided for within the articles of association of the company and therefore, the Supreme Court took the view that provisions of the shareholder’s agreement imposing restrictions (even those consistent with the Company law) are to be considered to be enforceable only when they are incorporated in the articles of association.
In the case of Vodafone International Holdings B.V vs Union of India & Anr[ii]. The Supreme Court of India, while dealing with the issue of tax liability, had to consider the restrictions on transferability in the shareholder’s agreement and the Supreme Court, while not expressly overturning the decision of V.B. Rangaraj vs V.B. Gopalakrishnan and Others[iii], observed that the view was not being countenanced by the bench which considered the case of Vodafone and further observed that shareholders can enter into any agreement in the best interest of the company but the provisions of the shareholder’s agreement shall not go contrary to the articles of association and that as laid down in the case of S. P. Jain vs Kalinga Tubes Ltd[iv] the agreements between non-members and members of the company will not bind the company but there is nothing unlawful in entering into an agreement relating to transfer of shares and restrictions regarding the same.
What the Supreme Court emphasized in this case was that a breach of the shareholders agreement which did not breach the articles of association was a valid corporate action and nothing much could be done to bring action under the Companies Act to bind the company or to seek any kind of reliefs against the company in connection with breach of such shareholders agreement which is not contrary to the articles of association. However, the aggrieved parties will definitely have the remedies and the general law of the land for any breach of such agreement.
There are various other decisions from different high courts, e.g. Messer Holdings Ltd vs Shyam Madanmohan Ruia[v], (Premier Hockey Development Private vs Indian Hockey Federation) [vi]and Il and Fs Trust Co. Ltd. vs Birla Perucchini Ltd[vii], Bajaj Auto Ltd vs Western Maharashtra Development[viii], Rolta India Ltd vs. Venire Industries Ltd & Others[ix], etc. However, we do not intend to go into the details of the facts and ratio of these judgments.
The position of the restrictions on the transferability of the shares as also the position of shareholders agreements generally, as could be deduced from the decisions of the Supreme Court of India as discussed above is that: –
- The shareholder will always have a right of action against the company as well as the party committing breach, in case of breach of shareholders agreement till so far as it doesn’t contravene the provisions of the article of association of the company.
- If such restrictions or other clauses provided for in the shareholder’s agreement are not specifically incorporated in the article of association, remedy for shareholder in such a case will be a private remedy against the other party /parties to the contract and not against the company. This is also in line with the decision of the House of Lords in the case of Russell v Northern Bank Development Corp Ltd.
- In case the restrictions are specifically incorporated in the articles of association, the aggrieved party can have a remedy against the company as well as the individual parties in connection with the breach of the shareholder’s agreement and the remedies could include the remedies under the Indian Contract Act as well as under the Companies Act 2013.
Conclusion and Recommendations
It is suggested and recommended that:-
- Necessary corporate actions for amendment of the articles of association.
- Shareholder’s agreement provisions may be duly incorporated in the articles of association of the company;
for the aggrieved party to have rights both against the individual opposite party to the shareholder’s agreement as well as against the company in which the share is held.
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