ENFORCEABILITY OF SHAREHOLDERS AGREEMENT

Various agreements are entered into by and between companies or its shareholders with others regarding transfer of shares, restrictions on voting,  and other rights attached to the shares of a company. These agreements are  of various kinds like shareholders agreement, share subscription agreement, pledge agreement, investment agreement, etc.  This article deals with couple of Supreme court judgments,  that discuss the legality of those agreements.

Any company established in India has its functions regulated by Articles of Association.  The Articles regulate the rights attached to shares, lien; transfer, transmission, and forfeiture of shares, alteration of capital; company meetings;  resolutions, etc. of the company and all other relevant aspects of governance of a company.

In case of a private company, transfer shares are restricted as per the articles of Association. Section 3(1)(iii) of The Indian Companies Act 1956 mandates the restrictions required.  This section is quoted hereunder:

3(1)(iii) ” private company” means a company which, by its articles,-

(a)restricts the right to transfer its shares, if any;

(b)limits the number of its members to fifty not including-

(i)persons who are in the employment of the company, and

(ii)persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased; and

(c)prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company: Provided that where two or more persons hold one or more shares, in a company jointly, they shall, for the purposes of this definition, be treated as a single member;

Section 3(1)(iii)(a) clarifies that Articles of a private company restricts the right to transfer its shares, if any.  Articles not only restricts transfer of shares but also prohibits invitations to general public to subscribe.  Thereby any transfer of shares of the private company should have to qualify the necessary restrictions in the Articles.  Section 82 of The Indian Companies Act 1956 further states that the transfer of shares or debentures should be considered as that of transfer of movable property and in the manner provided by Articles.  Section 82 is reproduced hereunder:

Section 82:  The shares or debentures or other interest of any member in a company shall be movable property, transferrable in a manner provided by the articles of the company.

 

Hence, it is clear from these sections that for any transfer of shares or debentures has to follow the rule book of Articles for it to be considered a valid transfer.

On the other hand Agreements such as shareholder agreement, share subscription agreement, pledge agreement, investment agreement, share purchase and cooperation agreement, etc., are signed by and between companies and shareholders or between two shareholders or between shareholders and outsiders as the case may be.  These agreements creates contractual obligations in relation to transfer of shares or enjoyment of shares or exercise of rights attached to the shares Viz. voting etc. What is the validity of  such agreements, if the provisions of the said agreements are a) not incorporated in the Articles of association of the company or b) if the provisions of the said agreements are contradictory to the Articles of Association.

The supreme court in V.B. Rangaraj vs. V.B. Gopalakrishanan & Others 1992 AIR (SC) 453  considered on whether the shareholders can among themselves enter into an agreement which is contrary to or inconsistent with the Articles of the company.  It is a case of a private  agreement whereunder there is a restriction on a member for transfer of his shares only to members of the company who belongs to a branch of family to which he belongs.  The agreement obviously therefore imposes some additional restrictions on the members right to transfer the shares other than those prescribed in the articles of the company. Court opined that such  additional restrictions are not binding on the company.

The only restriction on the transfer of shares of a company is as laid down in its Articles, if any.  A restriction which is not specified in the Articles is, therefore, not binding either on the company or on the shareholders.  The vendee of the shares cannot be denied registration of the shares purchased by him on a ground other than that stated in the Articles.”

 

A private agreement, the terms of which are not incorporated into the Articles, is only valid to the extent the Articles permit.

However, Supreme Court in the recent case of Vodafone International Holdings v Union of India & Another CDJ 2012 SC 068, this judgment was reconsidered by Justice Radhakrishnan.  Quoting another judgment of the Supreme Court in Gherulal Parekh v. Mahadeo Das Maiya (1959) SCR supp (2) 406 which states that freedom of contract can be restricted by law only in cases where it is for some good for the community.  Companies Act 1956, FERA 1973, RBI regulations or I.T. Act do not explicitly or impliedly forbid shareholders of a company to enter into agreements as to how they should exercise voting rights attached to their shares.  The court viewed shareholders can enter into any agreement in the best interest of the company but the only thing is that the provisions in the Shareholders Agreement shall not go contrary to Articles of Association.  The essential purpose of a shareholders agreement is to make provisions for proper and effective internal management of the company.  The court summarized the position very clearly.  A breach of Shareholders agreement which does not breach the Articles of Association is a valid corporate action and parties can get remdies under the general law of the land.

Earlier Supreme court In  Supreme Court in S.P. Jain v Kalinga Cables Ltd. (1965) 2 SCR 720 considered the validity of shareholdres agreement.  In this judgement supreme court distinguished between the shareholders agreement for issuance of new shares and agreement for transfer of already issued shares. In cases where agreement offering issuance of new shares, court viewed that it is imperative to have company a  party. On the otherhand  it is not mandatory to make company a party in cases where the agreement is relating to already issued shares of a company.

Hence, the position of law is very clear that agreement between two shareholders of a company or between shareholders and outsider of company in relation to rights attached to the shares of the company is valid & legally enforceable provided the provisions of the said agreement are not in breach of the Articles of Association.  In order to bind the company it should be made party to the agreement. Inroder, to bind all the stake holders of a company, all agreements imposing restrictions relating to rights attached to a shares are to be incorporated in the Articles of Association of the company.

Rajesh Vellakkat

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