Enforceability of private arrangements entered into by shareholders often become a bone of contention in corporate disputes. Following is an attempted analysis of the judicial trend in that regard in this country. While referring to the judgments, it is important to look into the factual matrix of the cases, as the reasoning would vary depending upon the nature of the company (private or public) and the status of the agreements (whether or not incorporated in the Article). Rhodes scholar and subsequently Vinerian scholar designate V. Niranjan did a brilliant and elaborate analysis of this issue in the Indian Corporate Law Blog (http://indiacorplaw.blogspot.in/2010/09/rangaraj-madhusoodhanan-conflict-and.html). I've reproduced the article below with some minor alterations and additions.
1. Introduction
Contracts among
shareholders of a company are termed as “shareholders agreements” (SHA). Usually,
the company is also a party to these agreements (but this may not always be the
case) which confer rights and impose obligations over and above those provided
by company law. The agreements provide for matters such as restrictions on transfer of
shares (right of first refusal,
right of first offer), forced
transfers of shares (tag-along rights, drag-along rights), nomination of directors for representation
on boards, quorum requirements and veto or supermajority rights available to
certain shareholders at board level or shareholder level. Hence,
broadly, Shareholders Agreements provide stipulations either for
transferability of shares (restriction, forced transfer, etc) or they provide
conditions which govern the administration of the company.
2. Judicial Trend on Enforceability of Shareholders
Agreements.
2.1.
Shareholders Agreements dealing with Transferability of Shares.
As mentioned earlier,
Shareholders Agreements may either contain provisions on transferability of
shares or deal with aspects of corporate governance (voting rights, quorum,
etc). However, most of the judgments delivered by the courts in India are on
situations wherein SHAs have dealt with transferability of shares under Section
111A of the Indian Companies Act.
2.1.1. Stage 1: Non
Enforcement due to absence of provisions in Articles.
Initially, the Indian
courts did not favour complete freedom of contract in the case of shareholders
agreements. Courts either refused to recognize clauses in shareholders
agreements or, even when consistent with company legislation, enforced such
clauses only if they were incorporated in the articles of association.
(Niranjan's analysis extracted from his post in the Indian Corporate Law Blog link to which is mentioned above)
"The
landmark judgment in this regard is V.B.
Rangaraj v. V.B. Gopalakrishnan,
AIR 1992 SC 453, [1992] 73 Comp. Cas. 201, often cited in the context of shareholders’
agreements. The
defendant in that case was a private limited company, and in time, its sole
shareholder came to be a family that consisted of two branches. The principals
of each branch orally agreed in 1951 that the proportion of shareholding of
their respective branches would not change, and provided, for this purpose,
that any member of a branch who wished to sell his shares must first offer the
shares to his own branch. After referring to the decision of the Supreme Court
in Kalinga Tubes, common law decisions and scholarly opinion, Sawant J. held
that shares are “freely transferable” and that “a private agreement that
imposes … restrictions not stipulated in the articles of association…” is “not
binding either on the shareholders or on the company. Hence, in this judgment,
the Apex Court refused to enforce shareholders agreement which provided for
restriction in transferability, as it had not been stipulated in the Articles. The
statutory ground of the decision was S 82 which provides that shares in a
company constitute movable property “transferable in the manner provided by the
articles of association”.
The Rangaraj rule was reiterated in Mafatlal.
(Niranjan's analysis extracted from his post in the Indian Corporate Law Blog link to which is mentioned above)
Ø "Mafatlal Industries Ltd.
v. Gujarat Gas Co. Ltd., [1999] 97
Comp. Cas. 301 (Gujarat High Court)
In 1999, an eminent judge of the
Gujarat High Court heard Mafatlal, where the defendant was a public limited
company. The plaintiff had sold 3.87 % of the equity in that company to an FII
with a pre-emption right, who later disposed of a part of those, shares in the
open market. The plaintiff relied on the right of pre-emption to invalidate the
subsequent sale by the FII, and argued, interestingly, that “free
transferability of shares refers to absence of restrictions which may be
imposed by third parties, but it cannot exclude the right of a shareholder to
impose restrictions on himself in the matter of transfer of shares to another
person.” This argument was rejected by M.B. Shah J., who pointed out that the
“ratio in the case of V.B. Rangaraj will apply with much greater force to the
case of a public company”."
2.1.2. Stage 2: Enforcement despite absence of provisions in
Articles.
Subsequently, the courts moved on from taking the Rangaraj
rule as a blanket provision on enforcement of shareholders agreement, to applying
it on given factual scenarios. The judgments which distinguished Rangaraj are
the following:
(Niranjan's analysis extracted from his post in the Indian Corporate Law Blog link to which is mentioned above)
Ø "M.S.
Madhusoodhanan and Anr.
v. Kerala Kaumudi (P) Ltd. and Ors.
2004) 9 SCC 204
In 2002, the Supreme Court decided
Madhusoodhanan. The case arose out of a complex family dispute in Kerala, and
specifically out of a karar (agreement) that provided in Clause 2 that “there
would be no change in the existing share structure” (among the family) of a
private company. Clause 2 also provided that the shares of two members would
pass to Madhusoodhanan in a certain percentage on their death. Ruma Pal J.
distinguished Rangaraj and Kalinga Tubes on the basis that this restriction was
not on a share as a class, but on specific, identified shares between specific,
identified members, to which the company need not be a party. Whether the
decision is consistent in its entirety with Rangaraj is a matter of
disagreement, especially as to the clause that there would be no change in the
existing share structure – a provision similar to the requirement in Rangaraj
that the shareholding pattern of the two branches would remain constant. Therefore,
even if the company is not a party to the shareholders agreement, that by itself
does not prevent the shareholders, inter se, from enforcing their agreement in
relation to the transfer of shareholding.
However, it is clear that it is not authority for the
general proposition that a private arrangement is legal under existing Indian
law, but at best for the proposition that a transaction between identified
members imposing a restriction on identified shares is legal.
Ø This brings us to the two Bombay High
Court decisions. In Western
Maharashtra Development Corpn. Ltd. v. Bajaj Auto Limited, [2010] 154 Comp. Cas. 593 Chandrachud J. noted that the karar
in Madhusoodhanan had dealt with specific, identified shares between identified
members, followed Rangaraj, and declared that a right of pre-emption is
contrary to s. 111A. That has now been overruled in Messer Holdings [2004] 121 Comp. Cas. 335. In Messer, Khanwilkar J. makes three points –
first, that the legislative history of s. 111A shows that the intention of the
legislature was to fetter the actions of the Board of Directors, not individual
shareholders; secondly, that Madhusoodhanan is authority for the general
proposition that “consensual arrangements between particular shareholders
relating to their specific shares do not impose restriction on the
transferability of shares”; and thirdly, that “freely transferable” in s. 111A
only means that “both seller and purchaser must agree to the terms of the
sale”. It was further held that this need not be embodied in the articles of
association.
In paragraph 55, Khanwilkar J. held as follows:
…“freely transferable” in Section 111A
does not mean that the shareholder cannot enter into consensual
arrangement/agreement with the third party (proposed transferee) in relation to
his specific shares If the company wants to even prohibit that right of the
shareholders, may have to provide for an express condition in the Articles of
Association or in the Act and Rules, as the case may be, in that behalf.
The rule in Rangaraj was that a
restriction on the transfer of shares is “unenforceable unless contained” in
the Articles of Association. If Messer Holdings is good law, the rule is that a
restriction on the transfer of shares is “enforceable unless barred” by the
Articles."
It is important to note that Messer is at present in appeal before the Apex Court.
2.2. Shareholders
Agreements dealing with issues of Corporate Governance.
These agreements have acquired popularity in the Indian
context only over the last two decades or so. Therefore, courts have not been
presented with sufficient opportunities to decide upon the enforceability of
their provisions. Where courts have indeed ruled on such agreements, it has
often been in relation to agreements merely stipulating transferability of
shares and not on issues of governance. However, there have been three
judgments of the Delhi High Court which have dealt with the issue of
enforceability of agreements in relation to issues other than transferability.
Ø
Spectrum
Technologies USA v. Spectrum Power Generation Company. 2000(56)DRJ405
In this case the Respondent Company
contended that they would not be bound by the Promoters Agreement as they were
not a party to it. The Delhi High Court refused to entertain the plea because
the company had passed a board resolution to implement it in the Articles and
taken such steps which were required of the Agreement, hence expressing their
intent to abide by its terms. The provisions of the Agreement were also not
inconsistent with the Articles or memorandum although the provisions of the promoters’
agreement were never incorporated in the Articles.
Para 22.
“We are unable to
agree with the submission advanced on behalf of SPGL that adoption and
revocation of the said promoters’ agreement by SPGL are irrelevant to the issue
on hand. As regards the three decisions referred to above, in none of these
decisions the company had agreed to amend its Articles of Association to bring
them in conformity with the promoters’ agreement and, Therefore, they being
distinguishable are inapplicable to the facts of the present case. “
Ø
Modi
Rubber Ltd. v. Guardian International
Corp. 2007(2)ARBLR133(Delhi)
In this case the Petitioner and
Respondent entered into a shareholders’ agreement to collaborate and promote a
joint venture company for the production and marketing of float glass. Subsequently
the financial status of the petitioner company drastically deteriorated and it
was declared to be a ‘sick company’ by the BIFR. As a result, the respondent
proposed to set up a wholly owned subsidiary, without the consent of the
petitioner, in breach of clause 14 of the Shareholders Agreement. The Respondent
argued that since the said clause was not incorporated in the Articles of the joint
venture company, they were not to abide by it. The Delhi High Court negating
the argument ruled in favour of the petitioners and prevented the respondent
from proceeding towards setting up of the said subsidiary. However, it seems
from the order, that the Shareholders Agreement was enforced despite not being
incorporated in the Articles because the said clause was merely a non
compete clause and had nothing to do with the administration of the company.
In fact, Sr. Arun Jaitley, senior counsel for the appellant, sought
enforceability of the agreement on the aforementioned ground.
Para 61.
“Mr. Arun jaitley,
learned senior counsel for the petitioner, has urged that clause 14 of the SHA
did not relate to a matter effecting the affairs of the joint venture.”
Para 68.
“The instant case
is certainly not concerned with any restriction or stipulation relating to
management of the affairs of GGL, the joint venture. The agreement between the
parties relates to an agreement not to enter into such business which is the
same as or similar to the business of GGL, the company that is the joint
venture. There is a fundamental difference between such an agreement as against
an agreement relating to restriction on transfer of share holding or
functioning as directors of a company which would be governed by the Companies
Act and the Articles of Association of the company.”
Hence, According to the
judgment, the demarcation of shareholders agreement on the basis of what they
ought to achieve is irrelevant and whether they deal strictly with
transferability or governance, they must not be in conflict with the Articles.
Ø
Premier
Hockey Development v. Indian Hockey
Federation 2011(2)ARBLR492(Delhi)
The Shareholders Agreement required a minimum quorum
requirement which was not met. The petitioner contended that such requirement
was invalid since the said provision was not incorporated in the Articles. Reliance
was placed on the Rangaraj judgment
by the petitioners. The court negating the contention held in favour of the Respondents
while distinguishing Rangaraj on the following grounds:
a. The petitioner company, unlike in Rangaraj, was a party to
the agreement.
Para 36.
“Pertinently, the
position in the case in hand is materially different from that before the
Supreme Court in Rangaraj (supra). The Petitioner company is a party to the
Subscription and Shareholders Agreement dated 31.12.2004.”
b. the petitioners could not show any clause in the SHA which
were in conflict with the articles.
Para 39.
“In the present
case as well, there is no Article pointed out by the Petitioner, in the
Articles of Association of the Petitioner company, which conflicts with
Articles 10.3.2 and 10.3.3 of the Subscription and Shareholders Agreement.”
However, as mentioned
earlier, the relevance of the above judgments may be limited to the extent that
it is only a High Court decision and the extensiveness of the principle cannot
be taken for granted unless the Supreme Court echoes that view.
3. Analysis of the
judgements.
An analysis of the
above judgements on the issue of shareholders agreement seem to be that they
shall be enforced, even if not incorporated in the Articles, provided
they are not in conflict with it.
As regards
enforceability against the company:
a.
they shall be enforced if the company is a party to it.
b.
they shall not be enforced if the company isn’t a party (Rangaraj hasn’t been
overruled), provided the company hadn’t expressed its willingness to amend its
articles to implement it in its Articles (such as passed a Board Resolution).
This follows from the Spectrum ruling.
As regards
enforceability against the parties:
they
shall be enforced even if the company isn’t a party to it or even if it is not
incorporated in the Articles, provided they are not in conflict with the Articles
or any statutory provision. (Modi Rubber, Messers Holdings).
The Present Position in light of the Vodafone Verdict:
The Supreme Court’s
judgment in Vodafone (2012) is of enormous importance to a number of branches
of Indian law. The relevant para in context of shareholders agreement is
reproduced below:
SHAREHOLDERS'
AGREEMENT
154. shareholders'
Agreement ( for short SHA) is essentially a contract between some or all other
shareholders in a company, the purpose of which is to confer rights and impose
obligations over and above those provided by the Company Law. SHA is a private
contract between the shareholders compared to Articles of Association of the
Company, which is a public document. Being a private document it binds parties
thereof and not the other remaining Advantage of SHA is that it gives greater
flexibility, unlike Articles of Association. It also makes provisions for
resolution of any dispute between the shareholders and also how the future
capital contributions have to be made. Provisions of the SHA may also go contrary to the
provisions of the Articles of Association, in that event, naturally provisions
of the Articles of Association would govern and not the provisions made in the
SHA.
155. The nature of SHA was considered by a two Judges Bench
of this Court in V.B. Rangaraj v. V.B. Gopalakrishnan and Ors.
MANU/SC/0076/1992 : (1992) 1 SCC 160. 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.
Conclusion:
To guarantee
enforcement, while it is not necessary that
the provisions of the shareholders agreement are to be incorporated in the
Articles, it is certainly to be ensured that such provisions are not in conflict with the Articles.
