Q1. Are shareholders’ agreements frequent in India?
Yes, shareholders agreements are quite common in India. They are used by small, medium and large Indian companies. Investors ask for such agreements as it protects their rights, inter-se as a shareholder.
Q2. What formalities must shareholders’ agreements comply with in India?
Shareholders’ agreements are not mandatory under Indian law. Shareholders’ agreements are binding only on the parties to the shareholders’ agreement and as it is a contractual arrangement between the parties.
Q3. Can shareholders’ agreements be brought to bear against third parties such as purchasers of shares or successors?
Under Indian law shareholders’ agreements are not enforceable on third parties. It only binds the parties to the shareholders’ agreement. However, if the shareholders’ agreements are to be enforced against third parties, company regulated issues which should be included in the shareholders’ agreement must be included in the bylaws of the company. Bylaws of the company are public documents and hence it is the duty of any third party to review the bylaws before entering into any transaction with the shareholders of the company.
Q4. Can a shareholders’ agreement regulate non-company contents?
Indian law does not prohibit regulating non-company contents in the shareholders’ agreements provided the same is explicitly mentioned in the said agreement. Non-company contents like management rights, licensing intellectual property etc are commonly included in the shareholders’ agreements.
Q5. Are there limits on the number of shareholders who can be party to shareholders’ agreements?
There are no limits specified under Indian law to restrict the number of shareholders who can be party to a shareholders agreement. The number of shareholders who can be party to the said agreement is left to the discretion of the shareholders entering in to the same.
Q6. Are shareholders’ agreements related to actions by directors valid in India?
Shareholders’ agreements related to actions by directors are not valid in India. Courts in India came down heavily on clauses under shareholders agreements which oblige a director of a company to undertake an obligation to benefit certain shareholders by compromising his fiduciary duties.
Q7. Does the law of India permit restrictions on transfer of shares?
In India, companies limited by shares are of three types, i.e., private companies, one person company and public limited companies. Private companies are closely-held companies and hence have the right to regulate transfer of shares by the shareholders as per their bylaws. However, in case of public companies, the shares are freely transferable.
Q8. What mechanism can a shareholders agreement permit for regulating share transfers?
The most commonly used mechanisms to regulate transfer for shares between shareholders, inter-se, or with third parties are:
Right of first refusal or ROFR:
ROFR clause in the shareholder agreement is usually between existing shareholders whereby the shareholder wishing to sell to a third party must first offer the shares to the existing shareholders, in proportion to their shareholding, in other words a ROFR right holder. If the holder of the right of first refusal does not buy the shares, the shareholder can normally sell freely to a third party.
Right of first offer:
This is a variation of the right of first refusal in which a fixed price is agreed to from the outset. The shareholder wishing to sell shall first offer the shares to the holder of the right of first offer holder at the fixed price. If the holder of the right does not purchase the shares, the shareholder wishing to sell is free to sell it to a third party.
Drag-along and Tag-along Rights:
Drag-along right is an agreement between the shareholder, where the shareholder wishing to sell his shares to a third party has the right to drag all the other shareholders and make complete exit from the company. Tag-along right is the opposite – the other shareholders have a right to tag along with the shareholder wishing to sell his shares to a third party.
Buy-back rights:
These give the company the right to redeem the shares of a certain shareholder in specific circumstances, such as withdrawal or death of the shareholder.
Call option:
Call option gives its holder the right to buy a specified number of shares of the underlying stock at a predetermined price (strike price) between the date of purchase and the options expiration date.
Put Option:
Put option gives its holder the right to sell a specified number of shares of the underlying common stock at a predetermined price (strike price) on or before the expiration date of the contract.
Q9. In India do bylaws tend to be tailor-drafted, or do they tend to use standard formats?
Bylaws of a company, whether private, public of one person, are dictated by what is known as the articles of association or AoA. An AoA is usually custom drafted keeping in mind the needs of the company, management and shareholding rights along with other ancillary aspects that govern internal rules and regulations of a company.
Q10. What contents tend to be included in shareholders’ agreements?
Shareholders’ agreements are more flexible and companies in India include various company and non-company regulated matters. However, companies should include only company regulated matters in the bylaws of the company to receive protection under the Companies Act, 1956 (“Act”) as the shareholders agreement is just a contractual arrangement between the parties and will not be regulated by the Act.
Hence, most companies amend their bylaws after signing the shareholders’ agreement to obtain benefits under the Act along with the contractual remedy available directly under the shareholders’ agreement.
Q11. What determines the content included in shareholders’ agreements in India?
A shareholders’ agreement typically grants rights to those shareholders who are party to the agreement that are above and beyond the rights that are inherent 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 their investments. For example, shareholders agreements may allocate among certain shareholders rights to designate the individuals who will serve on the company’s board of directors, grant certain shareholders special voting rights, ensure that certain shareholders have pre-emptive rights if the company issues additional equity securities, and/or provide rights to limit or participate in transfers of shares by other shareholders, among other things. Although “freedom of contract” is the legal principle that governs many provisions contained in typical shareholders’ agreements, there are numerous legal considerations that affect their enforceability and effectiveness.
Q12. What are the most common types of clauses in shareholders’ agreements in India?
The shareholder’s 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.
Q13. What mechanisms does the law of India permit to ensure participation of minorities on the board of directors and its control?
There are no specific provisions under Indian law to ensure participation of minorities on the board of directors of a company. Also, Indian law does not provide for provisions ensuring minority control over board of directors. However, the minority shareholders can be given the right to nominate directors on the board of directors by contractual arrangement between the shareholders usually known as a nominee director.
Q14. Is it possible in India to ensure minority shareholder control by means of a shareholders’ agreement?
Under a shareholders’ agreement minority shareholders can be given the power to appoint directors on the board of directors of a company. However, that does not in any way mean that the minority shareholder has control over the company. The recent judicial trend shows that Indian courts interpret ‘control’ to mean effective control of the management of the company and not merely having the right to appoint nominee directors. The test of ‘control’ is satisfied when a shareholder has the ability to control and decide the management decisions of the company.
Q.15. What are the motives in India for executing shareholders’ agreements?
Shareholders’ agreements lay down clearly defined rights and obligations between and of the parties, such as: 1) appointment of directors and quorum requirements, 2) determining the matters requiring special resolution or providing veto rights to certain shareholders (more in case of private equity and venture capital partners), 3) financing requirements of a company, 4) restrictions on right to transfer shares, 5) defining the obligation of each of the shareholder towards the company.
This is a contractual remedy available to an aggrieved shareholder in the event of any breach of any covenant or representation by the other shareholder. This contractual remedy is available to a shareholder in addition to the statutory rights provided under the Indian Companies Act, 1956, if the bylaws have been amended to incorporate the relevant provisions of the shareholders’ agreements.