SHAREHOLDER’S AGREEMENT AND IT’S BINDING EFFECT ON

THE COMPANY

NAME- PRITI GUIDE

ROLL NUMBER-1953

COURSE- B.A., LL.B. (Hons.) [7th Semester]

SYBMITTED TO- MS. NANDITA S. JHA

DATE OF SUBMISSION- 26-09-2021

FINAL DRAFT SUBMITTED IN PARTIAL FULFILMENT OF THE COURSE

TITLED CORPORATE LAW-I FOR OBTAINING THE DEGREE B.A., LL.B.
(HONS.) DURING THE ACADEMIC YEAR 2020-21.

September, 2021

CHANAKYA NATIONAL LAW UNIVERSITY

NYAYA NAGAR, MITHAPUR, PATNA – 800001
DECLARATION BY CANDIDATE

I, Priti Guide, student of Chanakya National Law University hereby declare that the work
reported in the B.A., LL. B. (Honrs.) project report titled “Shareholder’s agreement and it’s
binding effect on the company” submitted at Chanakya National Law University, Patna is
an authentic record of my work carried out under the supervision of Ms. Nandita S Jha. I
have not submitted this work elsewhere for any other degree or diploma. I am responsible
for the contents of my Project Report.

Signature of the

candidate Name-Priti

Guide

Roll-1953

Course- B.A., LL. B Hons.,

7th semester

Session-2018-2023

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 TABLE OF CONTENTS

TABLE OF CASES..................................................................................................................3

LISTS OF ABBREVIATIONS...............................................................................................4

I. INTRODUCTION............................................................................................................5

II. ENFORCEABILITY OF SHAREHOLDER’S AGREEMENT IN INDIA..............12

III. AN ANALYSIS OF THE CURRENT POSITION..................................................15

IV. CONCLUSION AND SUGGESTIONS....................................................................19

V. BIBLIOGRAPHY...........................................................................................................21

2
 TABLE OF CASES

Bajaj Auto Ltd. v. Western Maharashtra Development Corporation Ltd....................................18

IL & FS Trust Co. Ltd v. Birla Perucchini Ltd.........................................................................13, 15

Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd..............................................................................13

Madras stock Exchange Ltd v SSR RajKumar.................................................................................6

Messer Holdings Limited v Shyam Madanmohan Ruia and Ors..................................................13

Rolta India Ltd. & Another vs Venire Industries Ltd. & Others..................................................14

Russell v. Northern Bank Development Corp Ltd..........................................................................16

Southern Foundries Ltd v. Shirlaw..................................................................................................17

VB Rangaraj v. VB Gopalakrishnan................................................................................................15

Vodafone International Holdings BV v. Union of India.................................................................17

Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd.................................13

Wood v Odessa Waterworks Co.........................................................................................................7

World Phone India Pvt. Ltd. v. Wpi Group Inc........................................................................16, 17

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 LISTS OF ABBREVIATIONS

AOA - Articles of Association

BOD - Board of Directors

HC - High Court

MOA - Memorandum of Association

ROFL - Right of First Refusal

SC - Supreme Court

SHA - Shareholders Agreement

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 INTRODUCTION

A shareholder agreement typically grants rights to those shareholders who are party to the
agreement that are above and beyond the rights that are inherited in the shares that they own,
and is intended to ensure that those shareholders obtain the benefits of the additional rights that
they bargained for when making the transaction.1 It would be trite to state that the enforceability
of any contract is taken for granted. This may however, always hold good enforceability of
shareh0lder’s agreement in such instance. These kinds of agreements have, sometimes,clause
that go against the company’s legislation like drag along rights, tagalong rights, rights of first
refusal (ROFR), composition of board of directors, maintaining a particular structure of the
company.2 Thus it can be seen that shareholder’s agreement restricts the right of the company
over and above those provided by the Companies Act. Since the shareholder’s agreement is an
agreement outside the Article of Association, the question of validity is a vexed question .
Essentially AOA constitute an agreement between the company and it’s members as well as the
members inter se and is binding on all members whether he was a member originally or became
a member later on. The Memorandum of Association and Articles of Association of the
company bind the company and the members to the same extent as if they had been signed by
each of them.3 The term „member‟ includes any person who has subscribed to the
Memorandum of the company and any member holding equity shares of the company whose
name has been entered in the register of members or depositors records. 4 The purpose of the
research is to evaluate the condition under which Shareholder’s agreement (SHA) would be
permissible vis-a-vis the AOA of the company.
Shareholders are individuals who invest money in the company’s share and become owners of
that share of the company. Agreement can be defined as a consensus between the parties on
certain terms and conditions pertaining to their work or any article and they are bound by such
agreement and can be enforced against the parties agreeing to it. Shareholders agreement (SHA)
after amalgamating both the definitions shareholder’s agreement can be defined as a consensus
arrived by the shareholders of a company for managing the working of the company, division of

1
Corporation Law Committee of the Association of the Bar of the City of New York, The Enforceability and
Effectiveness of Typical Shareholders Agreement Provisions, available at
[Link]
[Link] . last accessed on 03- 09-
2021
2
Nidhi Ladha, Legality of a Shareholders Agreement: Can Shareholders agree outside the Articles?, available at
[Link] Last accessed on 07-10-2019
3
Section 36(1), Indian Companies Act, 1956
4
Section 41, Indian Companies Act, 1956
5
shares, company related or non-company related matter. “A shareholders’ agreement is an
agreement entered into between all or some of the shareholders in a company. It regulates the
relationship between the shareholders, the management of the company, ownership of the
shares and the protection of the shareholders. They also govern the way in which the company
is run.”5

5
Available at [Link] Last accessed on 03-
09-2021
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RESEARCH METHODOLOGY

Issues and Proposal:

The researcher proposes in this research work to delve into the concept of shareholders
agreement and its binding effect on the company and also to look into the varioius
approach of courts in dealing with cases where there is a situation of conflict between
Articles of a Company and Shareholder’s Agreement.

Importance of the study:

The study will help us to understand the importance of Article of company as the
governing and constitutional document and the stance taken by courts in preferring AOA
over SHA through case commentaries and judicial decision. It will also help us to know the
current judicial trends along with applicability of well established principle of non-
enforceability of shareholder’s agreement when they are in conflict with Articles of a
company

Review of Literature:

The research methodology used in this project is doctrinal or non-empirical research, it is

descriptive and analytical in nature. Secondary and electronic Resources are the major
resources used here Chanakya National Law University online sources has been used for
research purpose. Various books, articles and websites have been referred for the same.
Secondary and electronic resources have been largely used to gather information and data
about the topic. Books and other references have been primarily helpful in giving this project
a firm structure. Websites, dictionaries and articles have also been referred.

SINGH, AVTAR; COMPANY LAW (17th Edition, 2019, EBC Publications)

The new edition of this book is written simple and lucid style and is designed to provide
introductory knowledge of company law. The book explains the provisions of the Act Topic-
Such as Articles of Association, its importance as a constitutional document of the company
and its overriding effect over shareholders agreement and other private arrangements. The
book avoids a section-wise narration; however, as far as possible, statutory sequence of
provisions has been adhered to within the framework of a topic-wise treatment. The current
edition has been thoroughly revised and updated with all the statutory and case law
developments. The work includes all the important legal rulings in the field of company law.

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Method of Research

The researcher has adopted a purely doctrinal method of research. The researcher has made
extensive use of the on-line sources of the Chanakya National Law University and also other
relevant internet sources.

Sources of Data

The following Primary and secondary sources of data have been used in the project-

a) Primary Sources- Bare Act (Companies Act 2013), Case laws.

b) Secondary Sources-Articles, Books Internet.

Method of Writing

The method of writing followed in the course of this research paper is primarily analytical.

Mode of Citation

The researcher has followed a uniform SILC Mode of citation.

Research Questions

The researcher has formulated following research questions:

1. What is shareholder’s agreement?
2. What is the extent of enforceability of shareholder’s agreement in India?
3. What does Article of Association signifies?

Aims and Objectives

1. The researcher aims to descriptively provide a critical overview of the topic arising.
2. The main goal of this research is to understand the legal position in Indian context.

Hypothesis
The researcher presumes that supremacy of the Article of association over shareholder’s
agreement never denies shareholder’s right to sue and they can claim a remedy in case of
breach caused by other.

Limitation of the Project

The researcher has time and territorial constraint in completing this project.

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 SHAREHOLDER’S AGREEMENT

ADVANTAGES OF A SHAREHOLDERS' AGREEMENT

Privacy
The predominant reason for using a shareholders’ agreement is that it is a private document between the
parties thereto which can be made subject to express confidentiality restrictions. By contrast the articles
of association are a public document available for inspection by members of the public in the Companies
Registration Office. This makes the articles of association an unsuitable means for dealing with matters
such as, for example, the remuneration of directors or other sensitive internal management matters.

Greater Binding Effect

As explained above articles of association can only bind a shareholder in his capacity as shareholder. By
contrast shareholders’ agreements may be used to give rights and impose obligations on shareholders
e.g. binding a person in his capacity as director or as a creditor or agent. However, one needs to be very
careful in imposing obligations on a party in his capacity as a director in the context of the duties owed
by a director to the company. This is considered in section 9 6

Variation
As explained above articles of association can be amended by way of a special resolution. By contrast,
unless a shareholders’ agreement expressly provides for a specific variation mechanism, it can only be
varied by unanimous agreement of the parties thereto.

DISADVANTAGES OF A SHAREHOLDERS' AGREEMENT

Binding Effect
Because of its nature as a contract a shareholders’ agreement only binds the parties thereto and
does not automatically bind all shareholders. Therefore, if a party transfers his shares the
transferee will not automatically be bound by the terms of the shareholders’ agreement. To
circumvent this, it is normal to provide in a shareholders’ agreement that an existing
shareholder who is party to a shareholders’ agreement can only transfer his shares if he procures
that the transferee enters into what is known as a deed of adherence which joins the transferee
as a party to the shareholders’ agreement.

6
Section 9, The Companies Act, 1956
9
Interpretation Again as shareholders’ agreements are contracts they are subject to the
ordinary rules of contract law, in the event a dispute arising as to the meaning of a provision in
the shareholders’ agreement, a court would, as a primary means of interpretation, seek to
establish what was the intent of the parties based on the wording of the contract. By contrast the
language in articles of association has become in many respects fairly standardised and many of
the provisions used in articles of association have been judicially considered over the years and
there may therefore be available judicial precedent to assist in the interpretation of those
provisions. Situations where inconsistencies arise between the articles of association and a
shareholders' agreement are considered in section 8.7

ARTICLE OF ASSOCIATION

The articles of a company often simply referred to as the articles are the regulations governing
the relationship between the shareholders and directors of the company, and are a requirement
for the establishment of a company under the Indian law and that of many other countries. AOA
must not be in conflict with the provisions of the Companies Act 2013. 8 Together with the
Memorandum of Association, they form the constitution of a company. Articles of Association
typically cover the issues of shares, the different voting and dividend rights attached to different
classes of share, restrictions on the transfer of shares, the rules of board meetings and
shareholders meetings and other similar issues. The AOA of a company are its byelaws or rules
and regulations that govern the management of its internal affairs and the conduct of its
business. According to sec-2(5) of the Act9 “articles” means the articles of association of a
company as originally framed or as altered from time to time or applied in pursuance of any
previous company law or of this act i.e. Act of [Link] also establish a contract between the
company and the members and between the members inter se. This contract governs the
ordinary rights and obligations incidental to membership in the company. 10 Articles are like
partnership deed in a partnership. They set out provisions for the manner in which the co It is
not obligatory to register Articles in the case of a public company limited by shares.
The case of Wood v Odessa Waterworks Co. 11provides an illustration of binding of articles
on the company to its members.

7
Section 8, The Companies Act, 1956
8
Madras stock Exchange Ltd v SSR RajKumar, (2003) 116 Comp Cas 214; (2003) 2 LW 190
9
Section-2(5) Companies Act, 2013.
10
Naresh Chandra Sanyal Vs Calcutta Stock Exchange Association Ltd., AIR 1971 SC 422.
11
(1889) 42 Ch D, 636.
10
Facts-In this case the articles of the Waterworks Co. provided that ‘the directors may, with the
sanction of the company at general meeting, declare a dividend to be paid to the members.
Instead of paying the dividend in cash to the shareholders a resolution was passed to give them
debenture bonds.
In an action by a member to restrain the directors from acting on the resolution, the Court held:
“The question is whether that which is proposed to be done in the present case is in accordance
with the articles of association of the company. Those articles provide that the directors may,
with the sanction of a general meeting, declare a dividend to be paid to shareholders. Prima
facie that means to be paid in cash. The debenture bonds proposed to be issued are not a
payment in cash.” Accordingly, the directors were restrained from acting on the resolution.
Similarly, in the case of Borland’s Trustees v. Steel Bros. & Co. Ltd. (1901) 12
The articles of association of the company provided that in the event of the bankruptcy of a
member his shares would be sold at a price to be fixed by the directors. Borland became
bankrupt. His trustee in bankruptcy wanted to sell these shares at their true value contended that
he was not bound by the articles. It was held that he was bound to abide by the provisions of the
company’s articles.

In the case of Rayfield v Hands13, Rayfield was a shareholder in a company. He was required
to inform the directors in the event of his intention to transfer the shares. The directors were
required to take the shares at a fair value. Rayfield informed the directors in accordance with
the articles. The directors contended that they were not bound to take and pay for Rayfield’s
shares and the articles could impose no such obligation on them. The court set aside this
argument by treating the directors as members and compelled them to take Rayfield’s shares at
a fair value. The court also held that it was not necessary for Rayfield to join the company for
bringing a suit against the directors.
Shareholder’s agreement and AOA:
Shareholders’ agreements closely relate to the company’s Articles of Association. All
companies have AOA but companies are not legally required to have a Shareholder’s
agreement. AOA are filed at Companies house when the company is first formed and they set
out the administrative and company law procedures affecting a company. Importantly they
should set out the classes of shares and the rights to vote, dividend entitlements and return of
capital on a winding up of the company. Some issues that can be dealt with in a Shareholders’
agreement could instead be included in the AOA and vice versa. The Shareholders’ agreement
12
[1901] 1 Ch 279
13
[1958] 2 WLR 851.
11
is a private document and not a public document.

ENFORCEABILIY OF SHAREHOLDER’S AGREEMENT IN INDIA

Enforceability of any contract is taken for granted if the same is not violative of any law for the
time being in force. However, the same may not hold in each and every circumstances and one
such circumstance is that of Shareholders Agreement (SHA). These agreements may sometimes
contain clauses that go against the company legislation like-
• Drag-along rights14
• Tag-along rights15
• Right of first refusal (ROFR) 16
• Composition of board of directors,
• maintaining a particular structure for the company
• conferring on shareholders such rights which would not otherwise be enforceable if not
contained in Articles of the company
• Specific provision as to quorum requirement for board and general meetings,
• Veto or supermajority rights available to certain shareholders at board or shareholder level.
Though these kinds of rights are available in a number of Investment or joint venture
agreements, this is the subject of much conversation as the Indian courts by and large have not
supported such complete liberty in these arrangements. Courts have either not
perceived/recognized clauses in SHA or, even when consistent with company legislation,
enforced such clauses only if they have been incorporated in the articles of association of the

14
Madhav Gawri , Drag along and Tag along rights: It is the majority of shareholders' right to drag along the
minority shareholders to sell their shares and ownership of the company to the buyer, in which the majority of
shareholders have agreed to sell their share,: Available at
[Link] .(Last Accessed at
29th August,2021, 19;07 pm).
15
Madhav Gawri , Drag along and Tag along rights Minority Shareholders hold these rights. The tag-along rights
secure the minority shareholders by giving them the choice of joining the transaction and selling their shareholding
in a similar transaction as the majority shareholders. This right obligates the majority shareholder to include the
holdings of the minority shareholder and then negotiate to sell it,: Available at
[Link] . (Last Accessed at
30th August,2021, 19;08 pm).
16
James Chen, Right of First Refusal.,-A right of first refusal is a contractual right giving its holder the option to
transact with the other contracting party before others can. ROFR assures the holder that they will not lose their
rights to an asset if others express interest,: Available at
:[Link]
ses%20are%20similar%20to,an%20agreement%20on%20an%20asset%20before%20others%20can (Last seen 29
August,2021, 19:10 pm).
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company. There is a series of decisions in the regard in the event of any contention between the
Articles and the SHA, the previous will consistently win.

In Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd 17, it was held that
such clauses are to hamper the free transferability of shares and in violation of section
111A(2)18 of the Companies Act, 1956 (Now Section-58(2) of Companies Act, 2013) 19 and
hence, are not enforceable. However, the Supreme Court in 2003 in its decision in M.S.
Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd.20 , not disagreeing with the decision in V.B
Rangaraj (Supra) but distinguishing itself from the facts in that judgment, held that a restriction
in relation to identified members on identified shares of a private company did not amount to
restriction of transferability of shares per se.
Moreover, the Division Bench of Bombay High Court in Messer Holdings Limited v Shyam
Madanmohan Ruia and Ors21, deferring from its own previous decision in Western
Maharashtra Development Corporation Ltd (Supra) held that any private arrangement in
relation to shares are not in violation of section 111A of the Act. The Bench, analysing interalia
the validity of ROFR, giving liberal meaning to the term ‘transferability’, held that Section
111A of the Act is not a law dealing with the right of the shareholders and does not expressly
restrict or take away the right of shareholders to enter into consensual arrangement/agreement
by way of pledge, pre-emption/sale or otherwise.
However, in the case of Bombay High Court in IL & FS Trust Co. Ltd v. Birla Perucchini
Ltd 22, it was held that the provisions in an agreement, cannot be given effect to insofar as the
management of the affairs of the company is concerned, unless those provisions have been
incorporated in the Articles of a company. The fact that a company is a party to the subscription
agreement (as in the case it was) makes no difference to this position because the same is well
settled in law.

17
(2010) 154 Company Cases 593 (Bom).
18
Sec-111A (2) of companies Act, 1956-Subject to the provisions of this section, the shares or debentures and any
interest therein of a company shall be freely transferable.
19
Section-58(2) of companies Act,2013- Without prejudice to sub-section (1), the securities or other interest of any
member in a public company shall be freely transferable: Provided that any contract or arrangement between two
or more persons in respect of transfer of securities shall be enforceable as a contract.
20
(2003) 117 Comp Cas 19 SC.
21
(2010) 98 CLA 325
22
(2003) 47 SCL 426.
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 CONCLUSION AND SUGGESSTION
There are no fixed laws in place to govern shareholder’s agreement but is judged on a case to
case basis. There is not fixes inclination in the direction of law either, unlike in most
economically dominant countries, where shareholder’s agreement 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’s agreement which affects their enforceability.
The Article of association establishes a statutory contract between the shareholders and the
company. The articles bind the member of the company even then when there is no contract
between each individual member. It is also evident from Section 9 to 31 of the Companies Act,
1956, any agreement which is inconsistent with the provision of the act or the memorandum or
the article of association of the company is ineffective and cannot be enforced. In India, there
has been a sea change with respect to the enforceability of shareholder’s agreement.
Courts in India tend to favour shareholder’s agreements if there is already a mention of the
same in the by laws of the company and the agreement does not conflict with the legislation.
The researcher has researched various aspects to analyse the current position of law. There have
been a plethora of cases dealing with this issue, but none of them has been able to provide an
established matter law on the matter.
It is a settled law that Article of Association prevails over shareholder’s agreement. However
in the absence of an expressed provision in the article, the issue remains unsolved as to whether
a clause in shareholder’s agreement in the absence of affirmance from the article is enforceable
or not. The supreme Court in Vodafone case has drawn a proposition thst restriction in a
shareholder’s agreement, though consistent with company law, are to be authorized only when
they are incorporated in article of the company.
In V.B Rangaraj v. V B Gopalkrishnan , the court held that unless incorporated in the Articles
of Association of the company will not be enforceable against the shareholders and the
company. However, in the recent judgements of the Delhi High Court and Bombay High court
have noted that incorporation of the shareholders agreement in the Article of association of the
company is not necessary for them to be enforceable. If the shareholder agreements do not
curtail the statutory power of the company and do not bind future shareholders, they can be
enforced even if they are not incorporated in the Article of association of the Company.

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The above judicial precedents make it very clear that the stand taken by courts have been
dynamic. The courts have not adopted a blanket approach in deciding that any provision in
SHA which have not incorporated in the AOA will be invalid. In certain instances, courts have
ruled that if SHA is consistent with AOA, then for any breach of terms and conditions of SHA,
independent legal recourse could be sought.

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 BIBLIOGRAPHY

Bare Acts-
1. The Companies Act, 1956
2. The Companies Act, 2013

Books
1. Singh Avtar, Company Law, Eastern Book Company, 17th Edition, 2019
2. Taxman’s Company Law Digest (1913-2009), 3rd Edition.

Websites
1. [Link]
2. [Link]
3. [Link]
4. [Link]
5. [Link]

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