Shareholders agreement vis--vis Articles of Association

SHAREHOLDERS AGREEMENT VIS--VIS ARTICLES OF ASSOCIATION

SHAREHOLDERS AGREEMENT
Shareholders agreement is the agreement between shareholders regarding the transfer of
shares. Initially the main issue was its confrontation of the principle of free transferability of
shares because this agreement lays down certain restrictions on the transferability of shares.
Basically such agreements create rights and obligations of one shareholder towards another
and it is a personal contract. Unlike the other documents of the company it is not subject to
public scrutiny as it is a personal contract between two parties without interference of the
company. Shareholders agreement work on the premise that shares are freely transferable
and thus it means that the shareholder can choose how to transfer it which includes laying
down certain conditions regarding it. The real nature of shareholders agreement is best
explained by Radhakrishnan, J., in Vodafone International Holdings B.V. v. Union of India.1
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 (shareholders).
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.2
So, the shareholders agreement governs relation among the shareholders and between
shareholders and corporation. These agreements include a catena of clauses including
special voting rights, and other powers.
JUDICIAL PRONOUNCEMENTS RELATING TO SHAREHOLDERS AGREEMENT
As far as shareholders agreement are concerned the case of V B Rangaraj v. V B
Gopalakrishnan3 is the most important case because of the fact that it has been pronounced
by the honourable Supreme Court and other cases are pronounced by the High courts of
different states. In this case there was an agreement between the shareholders of a private
1

(2012) 341 ITR 1 (SC).

Ibid, at para 154.
3
(1992) 1 SCC 160.
2

Electronic copy available at: http://ssrn.com/abstract=2329182

Shareholders agreement vis--vis Articles of Association

company which provided for a restriction on shareholder to not to transfer a share to anyone
who is not a member of the family. In this case the Supreme Court looked upon at the
companies act and came to conclusion that Articles of Association solely governs the relation
between the shareholders and the company and in absence of any explicit presence of any
agreement in the Article of Association it cannot be enforceable before the court of law. But
if such an interpretation of law is to be accepted then the whole purpose of shareholders
agreement is rendered useless as each restriction has to be necessarily included in the Articles
of Association.
Then another major case was of Mafatlal Industries Ltd. v. Gujarat Gas4, in which J. Shah
was the judge and he followed the precedent of Rangarajan case. In the present case Mafatlal
was a shareholder of a public company and he transferred some shares to another person
called Jardine Fleming and he entered into an agreement with him which provided for right of
first refusal to Mafatlal. It is noteworthy that this agreement was not incorporated in the
Articles of Association of the company. Later Fleming sold the shares to some third persons
and did not offer to sell the shares to Mafatlal. Then Mafatlal sued him and the case was
before the High court. Mafatlal contended that the Rangarajan case does not apply in the
present case as that is only applicable to the private companies and not public companies and
in the present case it was a public company. He also contended that free transferability of
shares relates to restriction imposed by third persons and thus restrictions can be laid by a
shareholder upon himself by way of agreements, etc. While Fleming contended that no
restriction can be imposed on free transferability of shares except by the act and Article of
Association and moreover the sections relating to free transferability of shares are not made
subject to a contract to contrary. The court accepted this argument and went on to hold that
only difference between private company and public company is that Article of Association
of a private company has a clause relating to restriction on transfer of shares while the other
does not and thus Rangarajan case is also applicable to Public companies also.
Then came the case of IL and FS Trust Co. Ltd. v. Birla Perucchini Ltd. before the Bombay
High Court. In this case the plaintiff wanted to restrict the respondent from accepting the
resignation of other people(also respondents) as directors of the company. In this case also
the decision of the Rangarajan was followed by the court and the held that only Article of
Association governs relation among shareholders and thus the agreement was not held to be

(1999) 97 Comp Cas 301 (Guj. HC).

Electronic copy available at: http://ssrn.com/abstract=2329182

Shareholders agreement vis--vis Articles of Association

enforceable before the court of law. The court also said that any agreement not explicitly
made a part of the Article of Association cannot be enforceable against the shareholder or the
company.
Next important case was the case of Madhusudan v. Kerala Kaumudi5 before the honourable
Supreme Court. In the present case there was an agreement between the shareholders of a
private company that on death of the chairman the shares held by her will be divided in the
ration of 50:25:25 and it was a shareholder named Madhu who was supposed to have 50% of
the shares. Later when the chairman died the 50% shares were not transferred to Madhu and
thus she sued for Specific Performance. In this case the defendants contended the holding in
Rangarajan case and that no Specific Relief lies in the present case. The court in the present
case analysed the case of Kalinga tubes and said that transfer of shares and issue of shares are
very different as in the latter case, the company just has to recognize someone else as a
shareholder and nothing else. The court also held that kalinga tubes case did not held that the
shareholders agreement are different from agreement as far as legal binding authority os
concerned. The court then went on to differentiate the case from Rangarajan case and in the
end held that any shareholder can sell his/her shares to anyone subject to conditions laid
down in the Articles of Association and such agreements can be specifically enforced. The
court also held that one of the conditions laid down in section 10 of the Specific Relief Act is
that when the object is not easily available in the market. So the court held that since the
shares of a private company are not easily available on the market and thus it can be
specifically enforced.
The next important case is that of Pushpa Katoch v. Manu Maharani6 before the Delhi High
Court. In the present case there was an agreement between 4 sisters that if any sister wants to
dispose of her shares then she will first offer it to all the remaining sisters. But in the present
case one sister sold her shares without offering it to the fourth sister and thus it was before the
CLB. CLB rejected it and thus the case was before the High Court. The court in the present
case solely relied on the section 111A of the act and said that there can be no restriction
whatsoever on the shareholder of a public company as far as transferability of shares is
concerned. The court also opined that had there been any such restriction then it would have
been ultra vires the act.

5
6

(2004) 9 SCC 204.

(2006) 131 Comp Cas 42 (Delhi HC).

Shareholders agreement vis--vis Articles of Association

Nest important case is that of Western Maharshtra v. Bajaj Auto7 before the Bombay High
Court. In this case there was a protocol between both the parties which provided that the
other party has the right of first refusal when one party sells its shares, and the price will be
predetermined or as awarded by an arbitrator. Later Western offered its shares to Bajaj and an
arbitrator was appointed to award the price. Then Western challenged the jurisdiction of the
arbitrator on ground of it being in violation of section 111A of the act. The high court
observed that by its very nature the private company has to restrict the transferability of its
shares while a public company cannot. The effect of a pre-emptive clause is always to put
some restrictions on the free transferability of the shares of a company and thus pre-emptive
clauses are impermissible. The court also said that if these agreements are allowed to stand in
the eyes of law then te effect of it would be to read section 111A of the act as subject to a
contract to the contrary, which cannot be done with a statute and thus even if it has been
included in Articles of Association, it would have been ultra vires.
After than another important case which arose before the Bombay High Court was Messer
Holding v. Shyam Ruia8. In the present case the Ruias and Hoechst group entered into a SPA
which provided that other party has a right to first refusal but subject to a condition that the
Hoechst can sell the shares to any of its subsidiaries in which it is holding 51% or more
shares. Later the Hoechst sold off its shares to one of its subsidiaries in which it had just 49%
stake holding. When the case came before the court Hoechst contended that pre-emptive
clauses are violative of section 111A of the act and thus impermissible while Ruias contended
that an agreement between the shareholders relating to transfer of a particular number of
shares does not amount to a restriction on the transferability of shares. They also contended
that entering into any contract which provides for Right to first refusal, etc comes within the
ambit of shareholders right to freely transfer shares held by them. The court observed that
deletion of section 22 A of SCRA and addition of section 111A to the companies act came at
the same time and both the legislative provisions had the same purpose. The court also said
that the purpose of the section 111A is to provide that Board of Directors cannot refuse
transfer unless there is sufficient cause and it is not intended to be curtailing the rights of a
shareholder to enter into an agreement regarding transfer of shares. The court further
observed that had it been the purpose, the legislative would have made a clear provision
regarding this. The court followed the reasoning that free transferability of shares implies the
7
8

(2010) 154 Comp Cas 593 (Bom.).

(2010) 159 CompCas 29.

Shareholders agreement vis--vis Articles of Association

right of a shareholder to decide the manner on which he/she wants to transfer the shares held
by him/her. The court then followed the decision on Madhusoodan case and said that it will
apply to public companies also and thus it implies that they can enter into such contracts until
and unless it is not in conflict with the provisions contained in the Articles of Association.

CONCLUSION
Unlike India, in UK the shareholders agreement are given a precedence over the clauses
contained in the Article of Association of the company while in India there is a judicial
paradox created by so many pronouncements on a single issue. As of now there is no correct
authoritative judicial pronouncement which sufficiently addresses the issue and that is the
most important reason for this paradox. The provisions relating to free transferability of
shares imply that there must be no blanket restriction on the transferability of shares and they
should not be interpreted in a manner which nullifies the effect of shareholders agreement. If
it is allowed to be so then it leads to a situation where the term free is not interpreted
properly as free means the shareholder is free to sell the shares in any manner whatsoever
which also includes putting certain restrictions on himself.