Conflict Between Shareholders Agreement And Articles Of Association
With Businesses in India on the rise, it is important to discuss an important element in the business world that often prevents and dissolves conflicts. It ensures that the company runs smoothly, avoids legal issues due to miscommunication, serves to validate in situations of chaos or mistrust. Two or more people who are starting a small business together as friends, may not prioritize or find the need for a shareholders agreement and thus find difficulty splitting profits as they evolve. Or on a larger scale, minority shareholders of a multi-national company may always be overruled by the majority and have no way of voicing their opinions. Both of these situations call for a Shareholders Agreement. It is advisable to take the time out to draft a proper Shareholders Agreement for businesses of all scales, as long as two or more people are involved.
There have always been conflicting views with regard to Articles of Association of a company and provisions in the shareholder’s agreement in India. Every business and shareholder must know the meaning and function of a shareholders agreement as well as the articles associated with it.
- Shareholders Agreement: This is an agreement between the shareholders of a company that outlines the rights, duties, operational control and liabilities of the shareholders. Generally, new businesses or startups, as well as large corporations undertake shareholder agreements, though it is not mandatory to get a shareholders agreement. A shareholder agreement is not enforceable either. In order to enforce agreements against third parties, it is necessary to include the same clauses in an agreement in the by-laws of the company.
- Articles Of Association: This is an internal document of a company that categorically specifies – a company’s purpose of business, the process for appointment of directors, bookkeeping system that the company will maintain, regulations in company operations and voting rights. It serves as a go-to guide for a company to fulfill its day-to-day obligations. A company must compulsorily submit the articles of association at the time of incorporation of a company in India.
The conflicts between shareholders agreement and articles of association are mainly of two types:
- Conflict in Management of the company (accounts of a company, board of directors, votes)
- Conflict in transferability of shares
Applicability To Private Companies (Section 10 Of Companies Act, 2013)
Anything contradictory provided in the articles of association, memorandum of association or any agreement done by the company will come under the effect of the Companies Act limited to Public companies. Only company meetings and the issue of share capital do not apply to private limited companies. Apart from this, private companies also come under the effect of the Companies Act.
Transferability Of Shares
Shares of Public Limited companies are freely transferable and the shares of private companies can be transferred based on the by-laws of the company. A shareholder has the right to transfer his shares to any other person unless this right has been taken away by the articles of association. When there is a restriction on transfer of shares, courts generally accept the less restrictive interpretation when the word ‘restrictive’ is open to more than one interpretation in the articles of association. This means, if the provision in the articles is ambiguous, the courts generally rule in favour of the shareholder wishing to transfer his shares.
Case Example: VB Rangaraj Vs. VB GopalaKrishnan And Others (1992)
This landmark case dealt with whether the shareholders can enter into an agreement which is inconsistent with the articles of association. VB Rangaraj was restricted to transfer his shares only to existing members and only to branch family members. This was an obvious restriction on VB Rangaraj’s right to transfer his shares which were contrary to the provisions stated in the articles of association. The contract was, therefore, not binding on the company nor its shareholders.
In the case stated, the Supreme Court ruled that any conflict with transferability of shares, even if the shareholders agreement is valid and consistent with the Companies Act, can impose restrictions on transferability of shares only when those restrictions are incorporated in the articles of association. In other words, a company can only follow and implement what is stated in the articles of association, if there is a conflict between the articles and shareholders agreement. From the decision, we can gauge that the law gives the articles of association priority over shareholders agreement and the shareholders agreement cannot go beyond the articles of association.
Case Example: Vodafone International Holdings BV vs Union of India (2012)
The Supreme Court ruled that shareholders can enter into any agreement deemed best for the company, except for the provisions in the shareholders agreement shall not be contrary to the articles of association. The main purpose of a shareholders agreement is to maintain effective and proper operations as well as the internal management of a company.
Additionally, breach of shareholders agreement, that does not breach the articles of association, is a valid corporate action. The parties that agreed to the agreement can avail of remedies for breach of an agreement.
Affirmative Votes
Affirmative voting rights are generally required to protect minority investors. A majority resolution on a decision cannot be passed without the consent of the minority shareholder. When the Articles of Association does not mention anything regarding the existence of an affirmative vote, it is not possible to uphold any clauses in an agreement that binds a stockholder unless it is incorporated into the articles of association.
An example; a company wants to issue shares and it can rightly do so as stated in the Companies Act. The company has made no mention in its articles of association about affirmative votes. For example, minority shareholder X is not happy with the new issue, but cannot voice his concern because of a majority vote. Such an action will be in breach of the shareholders agreement and the aggrieved stockholder can file a case.
Case Example: World Phone India Pvt. Ltd. vs WPI Group Inc. USA (2013)
The directors of World Phone passed a resolution approving the right to issue shares without obtaining the affirmative votes required for such issue. Though the articles were silent on affirmative votes, the company could not enforce the shareholders agreement.
We get it now!
There are no fixed laws in place to govern shareholders agreements but is judged on a case to case basis. There is no fixed inclination in the direction of the law either, unlike in most economically dominant countries, where shareholders agreements are lawfully accepted. Freedom to Contract as individuals is what gives us freedom to choose our terms of a contract, whether to contract or not and whom to contract with. This very same freedom is directly opposed in the face of a shareholder agreement which affects their enforceability.
Courts in India tend to favour shareholders agreements if there is already a mention of the same in the by-laws of the company and the agreement does not conflict with company legislation.
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