[Editor’s Note: We at trak.in, have been getting requests from our readers to cover legal aspects involved during company formation, mergers, Copyright / Trademark issues, equity investments etc. Therefore, we are starting a series where these issues will be covered]
A Shareholders’ Agreement between shareholders of a private limited company is a contract that details the various provisions that will govern each of the shareholders who are party to the agreement vis-à-vis the Company and the shares held by each such shareholder and also the provisions that will govern the management of the Company as agreed to by the parties to the agreement. It may be noted that in case of a public limited company, there may be enforceability issues with certain provisions of the shareholders’ agreement.
Under Indian law and based on the judicial pronouncements of Indian courts in respect of Shareholders’ Agreements, it may be noted that in order for the Shareholders’ Agreement to be binding on all Shareholders of a company and also on the company itself, many provisions o of the Shareholders’ Agreement would have to be also incorporated in the Articles of Association of the Company and the Articles must be amended to remove any inconsistencies with the provisions of the Shareholders’ Agreement.
Some of the critical clauses in a typical Shareholders’ Agreement between shareholders of a private limited company would be:
- 1 1. Representations and warranties from the Company and its Promoters
- 2 2. Composition of Board of directors of the company and other management related matters
- 3 3. Lock-in/first right of refusal/tag along/drag along
- 4 3. Restriction further issue of shares, any anti dilution rights, Pre-emptive rights
- 5 4. Management of the Company
- 6 5. Threshold Shareholding
- 7 6. Matters requiring consent of both parties
- 8 7. Indemnification
- 9 8. Non-compete
- 10 9. Information rights
1. Representations and warranties from the Company and its Promoters
Any investor who invests in a company would insist on certain representations and warranties being made by the Company and its promoters about the financial position of the company, compliance with laws by the company, litigations and claims against the company, assets of the company, liabilities of the company, status of the shares that are to be issued to/purchase by the investor and so on. The language of each representation and warranty should be carefully reviewed and if necessary, negotiated. Any exceptions to such representations and warranties must also be clearly captured. Promoters may make certain representations and warranties on a “best of their knowledge and belief” basis.
The shareholders may agree on the maximum number of directors on the Board, the number of nominee directors from each party, who will be the chairman of the Board meeting, quorum for board meeting, whether chairman will have casting vote and other such matters pertaining to the Board. Matters that require unanimous consent of the directors and matters on which a party’s nominee director shall have veto rights will also be addressed in this clause. By virtue of this provision, a shareholder may get control of the Board and the decisions of the Company that are taken at the Board level may also be steered through veto rights.
3. Lock-in/first right of refusal/tag along/drag along
A lock in clause impose restrictions on alienation/sale of shares held in the company by either party without prior approval of other party for a certain period of time. A First right of refusal clause makes it obligatory on a shareholders who wants to sell his shareholding, to first offer his shares to the other shareholder who is party to the Shareholders’ Agreement on the same terms and condition on which he proposes to sell it to a third party. If the Shareholders’ Agreement has a drag along clause then in the event that one shareholder wishes to sell his shares to a third party, then he can require the other shareholder who is party to the Shareholders’ Agreement to also sell his shares to the same third party on the same terms and conditions. A tag along clause gives a shareholder the right to insist that his shares also be sold to a third party to whom the other shareholder proposes to sell his shares, on the same terms and conditions.
By these clauses, the Company’s right to issue further shares or raise further capital can be curtailed. Further, pursuant to an anti dilution right, in case the company issues shares to any other person at a price lower than the price at which a shareholder who is party to the Shareholders’ Agreement was issued shares, then the shareholder who is party to the Shareholders’ Agreement has the right to receive such additional shares (at no cost to him) so as to reduce the price per share held by him to the same price as that at which shares were issued to the other person. A pre-emptive right obligates the Company to offer any future shares that may be issued, first to the Shareholder (on a pro rate basis) before offering it to any other party and may allow the shareholder to continue maintaining its shareholding percentage in the Company.
4. Management of the Company
The Shareholders’ Agreement can have clauses on who will manage the Company on a day to day basis, how the MD will be appointed and whether company can change or appoint an MD without concurrence of both parties.
The Shareholders’ agreement can also specify a minimum shareholding that a party must have in order to have all the special rights specified in the shareholders agreement.
6. Matters requiring consent of both parties
The Shareholders’ agreement can also specify matters that will require the consent of both parties in general meeting (eg. change in capital structure of the Company, fresh issue of capital, amendment of memorandum and articles of the Company, change in auditors etc.).
The Shareholders’ Agreement may require one of the parties (usually the founders or promoters) and/or the Company to indemnify the investing shareholder against any breach of representations and warranties.
Usually promoters/founders will be required to undertake that they will not directly or indirectly engage in or be employed by any party, to carry on similar business as the Company. The period of non-compete is usually a matter of negotiation.
9. Information rights
Usually any investing shareholder will insist on certain financial information being made available to such shareholder periodically by the Company, including balance sheets and profit and loss accounts.
The above are only indicative clauses that may be contained in a shareholders’ agreement. It would be advisable to seek the opinion of your legal counsel in respect of any shareholders’ agreement that you may be intending to execute.