‘One Person Company’ and ‘Small Company’ under Companies Act, 2013

The Companies Act, 2013 (“Act”), which received the assent of the President of India last year, has introduced two important concepts in (Indian) Company Law Jurisprudence – Small Company and One Person Company (“OPC”). As can be understood from the reply of Sachin Pilot, Minister of State (I/C) Corporate Affairs, to Starred Question no. 507 (2^nd May, 2013, Lok Sabha) and Unstarred Question no. 90 (5^th Dec., 2013, Lok Sabha), the concept of ‘small company’, along with ‘one person company’, have been introduced to allow new entrepreneurs to take advantage of corporate form of business. In the Companies Act, 1956 (“1956 Act”), there were no such concept(s) and those, intending to incorporate a business entity under the 1956 Act, had the option to incorporate companies in other forms.

Both Small Company and OPC are special form of private companies. While existence of the former company is determined in accordance with the value of share capital or turnover, existence of the latter company is determined in accordance with the number of members. There can also be a possibility where both the forms of companies may overlap. For instance, consider a situation where an OPC also satisfies the definition of a Small Company. These companies are different from other companies because of the simplified procedure available for them, both in terms of administration and responsibilities.

The 21^st Report [Companies Bill, 2009 (“2009 Bill”)] of the Standing Committee on Finance noticed that the 2009 Bill contained scattered provisions for providing exemptions to OPC and Small Companies [see: clause 421, 2009 Bill – it was later removed]. While Ministry of Corporate Affairs (“MCA”) was of the opinion that further exemptions, if any, could be provided vide notifications, the Standing Committee opined that such exemptions should be provided in the bill itself. In fact, Standing Committee recommended that such exemptions should be provided by way of a schedule or be appended to the main Act. Once again in its 57^th Report [Companies Bill, 2011 (“2011 Bill”), the Standing Committee reiterated that exemptions available to different classes of companies should be clearly specified.

Companies Act, 2013: Independent Directors

In this post, important changes relating to introduction of Independent Directors (IDs) in the new Companies Act, 2013 would be discussed. [For an analysis & discussion of M&A and Corporate Restructuring in the ‘new act’, kindly click here].

Now, the primary role of corporate governance is always to ensure the independence of the board of directors (BOD) in a company. Independent directors on the board predominantly enhance the monitoring and supervising of the management and the promoters of a company. Thus is turning immensely helps in protecting and safeguarding the interests of the public shareholders. The new Companies Act, 2013 on one hand bestows independent directors with greater say in corporate governance & on the other hand places greater demand from them. Now, the relevant provisions concerning IDs in the new act are Section 149, 150 and Schedule IV. The primary features concerning Independent directors (IDs) in the new Companies Act, 2013 are as follows-

Number of Independent Directors

The new Companies Act, 2013 requires all the listed companies to have at least 1/3rd independent directors on their board. But this provision of the Act is a slight departure from clause 49 of the listing agreement. Clause 49 of the Listing agreement issued by SEBI requires that at least 50% of the Board of Directors (BOD) must comprise of Independent Directors in case the chairperson is in an executive capacity or a promoter or related to a promoter. Now, one thing which must be noted is that the listed companies will be required to comply with the more onerous of the two requirements, while others can merely comply with the company law. The consequences of violation may also be different under company law and securities regulation i.e. under clause 49 of the listing agreement.

Companies Act, 2013: What's in the box for Mergers & Amalgamations (M&A) and Corporate Restructuring?

The Companies Bill, 2012 has finally become the Companies Act, 2013. See the official Gazette Notification here. Further, we already had an overview of the Companies Bill, 2012 here. But it must be noted that all the substantive sections are yet to be notified in due course of time by the Central Government. Only section 1 of the Act has come into effect, and section 1(3) provides:-

This section shall come into force at one and the remaining provisions of this Act shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint and different dates may be appointed for different provisions of this Act and any reference in any provision to the commencement of the Act shall be construed as a reference to the coming into force of that provision.

Thus, the substantive sections would be notified by the Government later. Now, I would be delineating, in this post, the key provisions relating to Mergers & Acquisitions in the new Companies Act, 2013. The new Companies Act, 2013 has sought to streamline and make M&A more smooth and transparent. The newly added provisions have made it easier for companies to implement ‘Schemes of Arrangement’ (mergers & acquisitions (M&A), de-merger, corporate debt restructuring etc) and at the same time impose checks & balances to prevent abuse of these provisions.

Now, the key provisions relating to M & A transactions and corporate restructuring are as follows-

The new Companies Bill, 2012: An Overview

[Note: Author and Contributor of this blog post is Risabh A. Gupta, 3rd Year Student, B.B.A. LL.B. (Hons.), National Law University, Odisha. He can be contacted at rishabh.a.09@gmail.com]

The much awaited Companies Bill, 2012 has been finally approved by Rajya Sabha on 8^th August, 2013. The bill was passed in Lok Sabha in December 2012 after detailed deliberations and discussions. It is now on the verge of becoming an act post presidential assent and notification in the Gazette of India.

The new Companies Bill, 2012, once effective, would replace the fifty-six year old legislation, the Companies Act, 1956, the primary legislation for incorporation, governance and operation of the corporate bodies in India. Further, the Bill envisages to create a simplified and effective framework for regulation and functioning of corporate bodies in India.

The new companies Bill, 2012 is a very welcome step as it has brought in numerous positive steps in streamlining the overall framework pertaining to corporate law. While the existing Companies Act, 1956 has 658 sections, the new Companies Bill, 2012 would have 470 clauses which are divided into twenty-three (23) chapters and has seven (7) schedules. Thus, in this post, an overview of the important and substantial changes as well as introduction of new provisions would be discussed like One-Person Company, new compliance regime for private companies, Corporate Social Responsibility, Mergers & Acquisitions (M&A), Corporate Governance and Class Action Suits.

1.                  MERGERS &ACQUISITIONS (M&A)

Numerous changes have been proposed in the new Companies Bill, 2012 to make the procedure for mergers and amalgamations (M&A) simpler and efficient. The approval of the National Company Law Tribunal (NCLT) for the fast-track mergers has been done away with in the new bill if it is a merger between two small companies, between a holding and subsidiary company, or between any other companies as may be prescribed.

Further, the new Companies Bill, 2012 says any contract or arrangement between two or more persons on transfer of securities shall be enforceable as a contract. Private equity (PE) investors, who until now have been unable to enforce strict conditions in their agreements with promoters, will be able to use clauses such as 'tag along' and 'drag along' mentioned in the shareholder agreement. A 'tag along' clause helps protect a minority shareholder as he can sell his stake along with the majority shareholder, while a 'drag along' clause gives right to a majority shareholder to force a minority shareholder to sell stake[1].

The new law also allows an Indian company to merge with a foreign company, making cross-border mergers and acquisitions easier. Earlier, only foreign companies were allowed to merge with Indian companies. Also, the bill will make it easier for promoters to restructure, merge or acquire companies because only those shareholders who own more than 10% stake or have more than 5% of the total debt will have the power to oppose any scheme of arrangement[2].

Taking a closer look at the new Minimum Public Shareholding regime in Listed Companies

[Note: Author and Contributor of this blog post is Risabh A. Gupta, 3rd Year Student, B.B.A. LL.B. (Hons.), National Law University, Odisha]

Recently, the new minimum public shareholding of 25 % in all the private sector listed companies has kicked in thus, mandating all the private sector held listed companies to mandatorily offering at least 25% of the shares to the public. Thus a number of companies notably Tata Communications and Wipro have taken steps to increase their public stake using methods such as offering existing shares to the public, selling promoter shareholding, and issuing fresh shares to the public. But in the backdrop of this, around 105 listed companies failed to comply with the minimum public shareholding norm of 25% as mandated under the Securities Contracts Regulations (Rules), 1957 ("SCR Rules") within the stipulated deadline of June 3, 2013. Therefore, the current scenario pertaining to enforcement of minimum shareholding regime would be discussed and lastly a brief analysis of Gillette case would be provided in order to comprehend why SEBI rejected the Gillette’s scheme/plan to offload its share to meet the new minimum shareholding requirement.

All listed companies in India are regulated through three securities acts/rules which are-

a.       The Securities and Exchange Board of India Act, 1992 (‘SEBI Act’)

b.      The Securities Contracts (Regulation) Act, 1956 (‘SCRA Act’)

c.       The Securities Contracts (Regulation) Rules, 1957 (‘SCR Rules’)

BACKGROUND

The requirement to maintain a minimum public shareholding of 25% of each class or kind of equity shares or convertible debentures issued by a listed company was always provided under Rule 19(2) (b) of “Securities Contract Regulation Rules (SCCR)”[1]. Regulators have always been advocating for introduction of minimum public shareholding in listed companies for the reason that it aids in ensuring liquidity in the market and discovery of fair price. Further, the availability of requisite floating stock ensures reasonable market depth and trims down susceptibility of listed securities to market manipulation.

Therefore, in furtherance of the aforementioned objectives, SEBI amended Rule 19(2)(b) of SCR Rules and added Rule 19(A)[2] to the SCR Rules vide the Securities Contracts (Regulation) (Amendment) Rules, 2010 thereby expressly obligating all listed companies to maintain at all times at least 25% of minimum public shareholding. SEBI also obligated all non-compliant listed companies to increase their public shareholding to 25% by June 3, 2013 through any of the following methods prescribed by SEBI:

1. Issuance of shares to the public through prospectus.

2. Offer of sale of shares held by promoters through prospectus.

3. Offer for sale by promoters on the floor of stock exchanges.

4. Institutional Placement Programme ("IPP")

5. Rights issue/bonus issue to public shareholders, with promoters and promoter group shareholders forgoing their rights entitlement/bonus entitlement.

6. Any other method as approved by SEBI on a case to case basis

Now, based on the information provided by the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), 105 listed companies have still not complied with minimum public shareholding requirement as required under the provisions of Regulation 19(A) and Regulation 19 (2) (b) of the Securities Contract (Regulation) Rules, 1957. SEBI has primarily attributed the non-compliance to the promoters and directors of the defaulting listed companies. Also, according to SEBI, the promoters and directors often take advantage of their excess shareholding to the disadvantage of the public shareholder as quite often only promoters and directors’ interests are taken into account thus excluding the interest of the public shareholders. Further, such non-compliance by some companies puts the promoters/promoter groups of compliant companies at a disadvantageous position in comparison to the promoters/ promoter group of the non-compliant companies.

 PENALTIES FOR NON-COMPLAINT LISTED COMPANIES

Thus pertaining to the current situation prevailing, concerning the minimum shareholding requirement, and with an aim to restore the balance between the public and non-public shareholding and removing the disproportionate advantage arising out of the non-compliance, the SEBI has directed the following actions[3]-

1.      Voting rights and corporate benefits like dividend, bonus shares, split, etc. in respect of the excess of the proportionate promoter/promoter group shareholding would be frozen till compliance with the minimum public shareholding requirement is achieved.

2.      The promoters/promoter group and directors of non-compliant companies are barred and prohibited from dealing in securities of such companies, whether directly or indirectly. However, they are allowed to deal in securities for the sole purpose of complying with the minimum public shareholding requirement.

3.      The shareholders forming part of the promoter/ promoter group and directors of non-compliant companies are prohibited from holding any new position as director in any listed company, till the minimum public shareholding requirements have been complied.

It is worth mentioning here that not only does the SEBI’s order restrict the promoter/ promoter group/ directors from holding new positions in the non-compliant companies, but it also extends to any company listed on any stock exchanges in India.

SEBI has also clarified that the Order is without prejudice to its right to take any other action which it deems apt and befitting against the promoters of non-compliant companies including the following:

1. Levying monetary penalties under adjudication proceedings;

2. Initiating criminal proceedings;

3. Moving scrip to trade-to-trade segment; and

4. Excluding scrip from F&O segment.

Brief analysis of Gillette case- Why SEBI rejected its method of meeting minimum shareholding requirement

The facts are such that Procter & Gamble India Holdings BV (P&G) is a promoter of Gillette having 75.9% voting rights. The Poddar group is the Indian promoter of Gillette with 12.9% voting rights. The total promoter holding is in excess of the 75% permitted by the public shareholding norms. Therefore, Gillette’s proposed that Poddar group would first transfer 4% of its shares to P&G. Thereafter, the Poddar group would be categorized as an ordinary public shareholder as it would lose all its rights as a promoter (including by virtue of termination of rights under the shareholders agreement and articles of association). This approach was opposed by SEBI on the ground that it violates the spirit of the public shareholding norms in that the promoter holding would, in fact, be increased rather than diluted in the process.

Thus, it basically involved reclassification of a top company executive as non-promoter entity and the proposed scheme of shareholding arrangement to meet the norms was rejected by the SEBI and further on appeal rejected by the SAT (Securities Appellate Tribunal).

Further, taking action against promoters of Gillette India for non-compliance to minimum public holding norms, the Securities and Exchange Board of India's (‘SEBI’) ordered freezing of all corporate benefits arising out of their stake in the company. Also, it has restrained the promoters and directors from taking up any new position as director in any listed company.

Thus, given that stringent penalties have been imposed on the Gillette, it would be very interesting to see what scheme the company comes up with to meet the new mandatory minimum requirement. Also, the Gillette case would serve as a reprimand for the non-complaint listed companies to soon prune out their shareholding. So, lastly sooner rather than later, all the listed companies would cut down their shareholding to the minimum 25% public shareholding.

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[1] Rule 19(2)(b) of SCR Rules:

(i) At least twenty five per cent of each class or kind of equity shares or debentures convertible into equity shares issued by the company was offered and allotted to public in terms of an offer document; or

(ii) At least ten per cent of each class or kind of equity shares or debentures convertible into equity shares issued by the company was offered and allotted to public in terms of an offer document if the post issue capital of the company calculated at offer price is more than four thousand crore rupees:

Provided that the requirement of post issue capital being more than four thousand crore rupees shall not apply to a company whose draft offer document is pending with the Securities and Exchange Board of India on or before the commencement of the Securities Contracts (Regulation) (Amendment) Rules, 2010, if it satisfies the conditions prescribed in clause (b) of sub-rule 2 of rule 19 of the Securities Contracts (Regulation) Rules, 1956 as existed prior to the date of such commencement:

Provided further that the company, referred to in sub clause (ii), shall increase its public shareholding to at least twenty five per cent, within a period of three years from the date of listing of the securities, in the manner specified by the Securities and Exchange Board of India.

[2] Rules 19(A) of SCRR:

(1) Every listed company [other than public sector company] shall maintain public shareholding of at least twenty five per cent: Provided that any listed company which has public shareholding below twenty five per cent, on the commencement of the Securities Contracts (Regulation) (Amendment) Rules, 2010, shall increase its public shareholding to at least twenty five per cent, within a period of three years from the date of such commencement, in the manner specified by the Securities and Exchange Board of India.

[3] http://www.sebi.gov.in/sebiweb/home/detail/25897/yes/PR-Interim-Order-in-the-matter-of-Non-Compliance-of-the-requirement-of-Minimum-Public-Shareholding-by-the-Listed-Companies-in-Private-Sector

Strengthening Corporate Governance vis-à-vis Companies Bill, 2012

[Note: Author and Contributor of this blog post is Risabh A. Gupta, 3rd Year Student, B.B.A. LL.B. (Hons.), National Law University, Odisha]

I.                   INTRODUCTION

Corporate governance basically means an entire system of rights, processes and controls which are established internally and externally over the management of a business entity. Its prime objective is to protect the interests of the stakeholders. This is achieved by the process of auditing, proper functioning of the board of directors and apt regulatory and legal framework. Before moving on, it is pertinent to briefly discuss the infamous Satyam scam and the recent Reebok scam in order to aptly comprehend the flaws currently prevailing concerning corporate governance. 

II.                THE SAYTAM AND THE REEBOK SCAM

The Satyam fraud in 2009 had perfectly exposed the inadequacies in India’s legal and regulatory systems to tackle corporate wrongdoing of such unprecedented dimensions. There was confirmed falsification of books of accounts and inflation of the company’s financial position to the extent of over Rs.5, 000-6,000 crore.

Recently, Reebok Scam to the tune of Rs 870 crore has once again portrayed the flimsy legal and regulatory regime concerning corporate governance. The subsequent audit carried out had found fake transactions with unauthorized customers, allegedly concocted to exaggerate the company’s revenue. Thus, it calls for a closer look at the current legal and regulatory regime prevailing in India and what needs to be done in order to plug in the loopholes.

III.             ROLE OF DIRECTORS  & FAILURE TO REGULATE

In the Satyam scam, the Satyam board, including its five independent directors, had approved the acquisition of Maytas Infra and Maytas Properties given the fact that acquisition was on a totally unrelated business. The fact that independent directors are quite often friends or associates of the management or controlling shareholders has become one of the major weakness of corporate governance in India.

The Directors have to be nominated to the Board. This is done de jure by the shareholders but in reality it is done by other Directors. The shareholders merely confirm the nomination, thereby, making it possible for people who are known to the Directors to get elected. Therefore, the independence of the directors and shareholders’ interest gets diluted.

IV.             THE INDEPENDENCE OF THE DIRECTORS & THE BOARD UNDER COMPANIES BILL, 2012

The new Companies Bill, 2012 tries to bring in various correctives measures. Concept of Independent directors has been introduced for the first time in Company Law. All listed companies are mandatorily required to appoint independent directors. Atleast 1/3 of the Board should comprise of independent directors. Term of an independent director shall be 5 years, with a further extension of 5 years. After two consecutive terms, an independent director shall not be eligible for reappointment for 3 years. An independent director is not entitled to any remuneration other than sitting fee, reimbursement of expenses for participation in the meeting. An Independent director is not entitled for any stock options. Thus, these provisions would aid immensely in keeping the independence of the board.

Further, the new bill also mandates constitution of Stakeholders’ Relationship Committee where the combined membership of the shareholders, debenture holders and other security holders exceeds 1000 at any time during the financial year with the chairman of the committee being a non-executive director to aptly take rational decisions considering all the stakeholders.

V.                FAILURE TO REGULATE AUDITORS & AUDITS

The Satyam Scam posed serious questions about systematic regulatory efficacy, predominantly pertaining to auditing and audit firm oversight. The statutory auditor of Satyam, Price Waterhouse, one of the ‘big four’ international accounting firms failed to check the auditing fraud for 8 consecutive years. Even months after Satyam boss R. Raju had confessed to fudging the accounts, the institute was still to take action against the two auditors who had signed the Satyam accounts. Further, there are instances where the statutory auditors have been the de facto internal auditors as well.

VI.             REGULATING AUDITORS & AUDITS UNDER THE COMPANIES BILL, 2012

The new Companies Bill, 2012 tries to plug in the loopholes and streamlines the auditing process of the companies.

It mandates compulsory rotation of individual auditors in every 5 years and of audit firm every 10 years in every listed company. Rotation of auditing partner and his team at specific interval could be done by the members of the company. Auditing standards have been made mandatory in addition to accounting standards and an auditor is liable to be disqualified if he has indebtedness to holding/subsidiary company. Further, a person cannot be appointed as an auditor for more than 20 companies.

VII.          INADEQUATE POWER GIVEN TO SFIO (SERIOUS FRAUDS INVESTIGATION OFFICE)

Serious Frauds Investigation Office (SFIO) is the investigative arm of Ministry of Corporate Affairs which is primarily concerned with investigation of corporate scams. But in reality, SFIO has been an utmost failure. 

Since its inception in the year 2003, the SFIO still hasn’t made much success. Contrast to this, its counterparts in UK and US have successfully convicted multiple corporate scams and frauds with much wider success.

Lacunae in SFIO

The biggest drawback with the SFIO is that it operates within the Companies Act, 1956 and is just an investigative arm of the Ministry of Corporate Affairs. The only statutory powers SFIO enjoys are under the Companies Act, 1956, even though the frauds investigated by it were criminal offences. There is absence of clearly defined criteria for referring cases to the SFIO in statute. Rather, the charter for SFIO provides that it shall take up cases that have complexity, inter-departmental and multi-disciplinary ramifications, or has substantial involvement of public interest in terms of monetary misappropriation.

Comparison with UK SFO (Serious Fraud Office)

Contrary to this, UK SFO (Serious Frauds Office) has the power to investigate and prosecute and can independently summon people and conduct raids. It has also clearly defined criteria for speedy and timely investigation. In addition to this, SFO functioning is governed by the Criminal Justice Act, 1987. Thus in all essence, any case like Satyam in UK would most certainly be referred to SFO. But in the absence of any such powers in India, the SFIO had to wait for its turn to interrogate Raju brothers and seize documents. Further, all it can do is to file a compliant with local police and the minister-in-charge has the discretion to accept or reject the SFIO’s final report.

Overlapping of investigating agencies & absence of a Nodal agency

The recent Reebok scam and the Satyam Scam has aptly demonstrated that several other regulators and investigating agencies, including SEBI, the ROC, Income Tax and the CID often leads to multiplicity of regulators (sometimes operating at cross-purposes) which almost never produce optimal results. Pertaining to the Reebok Scam, investigation by both the Gurgaon Police and the SFIO has clearly created a very messy situation. Further in Satyam case:-

a.       SEBI was initially only investigating insider trading charges.

b.      RoC’s investigation covered only violation of Companies Act, Section 372A in particular.

c.       The Income Tax department had to send the report to the Central Board of Direct Taxes.

This multiplicity of agencies leads to coordination problems, which results in delaying the case and confusing issues. Thus, a single regulator and a nodal agency will result in a unified approach.

VIII.       STRENGTHENING OF SFIO IN COMPANIES BILL, 2012

The bill has accorded the statutory recognition to the SFIO, in line with the UK SFO. The SFIO will have the power to carry out arrests under Section 212(8). It also bars investigation by any other agency if the case has been assigned to SFIO under Section 212(2) thus creating a single nodal agency for investigation.  It will also have the power to arrest in respect of certain offences of the Bill which attract the punishment for fraud. These offences shall be cognisable and the persons accused of any such offence shall be released on bail subject to certain conditions provided in the relevant clause in the Bill.

Drawbacks in Companies Bill, 2012 concerning SFIO

Notwithstanding the substantial steps taken by the Companies Bill, 2012 to give significant powers to SFIO, still it fails to address the two issues of immense importance. Firstly, the bill still doesn’t give the search and seizure power without the prior approval of the Judicial Magistrate or as the case may be. Contrary to this, other investigating agencies like Enforcement Directorate, Income Tax authorities have all been accorded with search & seizure.

Secondly, the SFIO cannot take a case suo mottu. It needs to get prior approval of the Central govt. in order to start investigation.

Lastly, while the Companies Bill, 2012 has been passed in Lok Sabha, it is still languishing in Raj Sabha. It is expected that the bill would be passed in this monsoon session at the earliest. Further, the new Companies Bill, 2012 is a very welcome step concerning strengthening of corporate governance and making India more conducive to all the stakeholders concerned.

Enforceability of Shareholders Agreements: In Relation to Articles of the Company

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.