DR. RAM MANOHAR LOHIYANATIONAL LAW UNIVERSITY, LUCKNOW

CORPORATE LAWFinal Draft

Conflict Between The Shareholder’s Agreement And Articles Of A Company

SUBMITTED TO :Dr. Manish SinghAssociate Professor (Law)

SUBMITTED BY :Apurv Singh

5th Sеmеstеr, 3rd YеarB.A. LL.B. (Hons.)

Dr. RMLNLU, LucknowRoll No. :28

ACKNOWLEDGEMENTS :

I would like to extend special thanks and gratitude to my subject teacher Dr. Manish

Singh who gave me the golden opportunity to work on this wonderful research topic "

Conflict Between The Shareholder’s Agreement And Articles Of A Company " which has

helped me gain a lot of standpoint regarding the legality of Shareholders Agreements and

any similar covenants over the provisions of the Articles of Association of a company in

case of any clash between the two. Throughout the research period I have been time and

again guided my by teachers whenever I faced any hurdles or was in a state of stupor

not being able to figure out the intricacies of the subject.

I would like to thank my university Dr. Ram Manohar Lohiya National Law University

for giving me the chance to be a part of a unique research oriented curriculum which

indeed boosts the understanding of the subject.

I would also like to thank my parents, mentors and well wishers who have been a

constant support and have time and again reviewed my work and have provided their

insights on the matter.

-Apurv Singh

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CONTENTS

1. ACKNOWLEDGEMENT …………………………………………….……………………..PAGE 2

2. RESEARCH METHODOLOGY……………………………………...…..…………………PAGE 4

3. INTRODUCTION………………………………………………...……………..…..………PAGE 5

4. ENFORCEABILITY OF SHA IN INDIA……………….…..……………...……………….PAGE 7

5. AN ANALYSIS OF THE CURRENT POSITION..…………………..………...…………..PAGE 9

6. CONTRIBUTION…..…………………………………………………..…………………..PAGE 13

7. CONCLUSION…………....…………………………………………..……….…………..PAGE 13

8. BIBLIOGRAPHY……………....…………………………………..……………....………PAGE 14

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RESEARCH METHODOLOGY

SCOPE & OBJECTIVE:

The objective of the project is to discuss the problem that is prevailing regarding the legality of

Shareholders Agreements and that whether the shareholders can agree on terms, outside the

articles of a company. The paper will also be deciding, with the help of the various case laws, the

issues as to whether a provision in a SHA that is contrary to the Articles of the company is valid

or not and what are the possible remedies for a shareholder against breach of a SHA by other

shareholders, when such an action is not construed to be a breach under the Articles of the

company.

HYPOTHESIS:

Based on the research that I conducted on this particular aspect of company law, my hypothesis

would be that the shareholders agreement is valid agreement and it has a binding value on all the

shareholders. But in case of conflict with the articles of the company, it is the articles which will

prevail. But nevertheless, all this doesn’t deny the shareholders their right to sue, and they can

claim a remedy in case of a breach caused by any other person.

RESEARCH QUESTION

1) What will prevail in case of contradiction between Articles of a company and the Shareholders

Agreement and whether a provision in a SHA that is contrary to the Articles of the company is

valid and enforceable?

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2) Whether shareholders have any remedy against such a breach caused by the other shareholders

when there is no breach under the Articles of the company?

Methodology:

The research for the project has been done through the doctrinal approach. There is no statistical

analysis of data. Analysis of the project topic in accordance with research questions will be done

through various articles and journals.

INTRODUCTION

Shareholders’ agreements are quite common in business, and more so today as variety of

strategic, institutional investors make investments in companies. There are numerous situations

where such agreements are entered into – family companies, JV companies, venture capital

investments, private equity investments, strategic alliances, and so on. In addition, there may be

put options, buy back agreements and so on. Questions commonly arise about their

enforceability, particularly as against the companies. There may not be a doubt as to their

enforceability as between shareholders inter se (except for violation of specific laws, for

example, Securities Contracts (Regulation) Act), but issues arise as to whether such an

agreement can govern the rights of shareholders of the company generally.

Essentially, Articles of Association constitute an agreement between the company and its

members as well as members inter se and is binding on all the members whether he was a

member originally or becomes later on. Section 36(1) of the Companies Act states that the

registered Memorandum and Articles of Association of a company binds the company and the

members to the same extent as if they respectively had been signed by the company and each

member and ‘member’ as defined in section 41 includes any person who has subscribed to the

Memorandum of a company and any person holding equity shares of the company whose name

has been entered in the register of members or in depository’s records. However, quite often,

sections of shareholders have private agreements among themselves generalizing, shareholders’

agreement (SHA). SHA is a contractual arrangement between the shareholders of a company

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describing how the company should be operated and the defining inter-se shareholders' rights

and obligations. SHAs are the result of mutual understanding among the shareholders of a

company to which, the company generally becomes a consenting party.

Such agreements are specifically drafted to provide specific rights, impose definite restrictions

over and above those provided by the Companies Act. They are seen as problematic as they can

be instruments for groups of shareholders to circumvent the normal scheme of the company’s

legislation or the company’s constitution in its Articles of Association.

A SHA creates personal obligation between the members signing such agreement however, such

agreements do not become a regulation of the company in the way the provisions of Articles are.

An agreement outside the Articles between shareholders as to how they are to exercise their

voting rights on a resolution to alter the Articles would not necessarily be invalid.

Shareholders agreement is an agreement among the shareholders of a company defining rights

and liabilities of shareholders and controls operations of the company. Articles1 of association,

also termed as constitution of company, is an internal document of a company which defines the

responsibilities of the directors, the kind of business to be undertaken, and the means by which

the shareholders exert control over the Board of Directors. The Shareholders agreement and

Articles of Associations have two major areas of conflict- first one is issues relating to transfer of

shares and second one is issues relating to management of company. The paper focuses on

judicial stand in respect of transfer of shares while drawing underlying principles in the event of

conflict arising between these two.

1 Section 2(2) of Indian Companies Act defines Articles as Articles means the articles of association of a company as originally framed or as altered from time to time in pursuance of any previous companies law or of this Act.

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ENFORCEABILITY OF SHA IN INDIA

It would be trite to state that the enforceability of any contract (which is not perceived as

violative of any law) is taken for granted. This may not however, always hold good.

Enforceability of SHA is one such instance. These kinds of agreements have, sometimes, clauses

that go against the company legislation like-

drag-along rights,

tag-along rights,

right of first refusal (ROFR),

composition of board of directors,

maintaining a particular structure for the company

conferring on shareholders 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

providing private arbitration of disputes

Though these rights are present in many investment and joint venture agreements, this is the

topic of much discussion as the Indian courts generally have not favoured such complete

freedom in these agreements. Courts have either refused to recognize clauses in shareholders

agreements or, even when consistent with company legislation, enforced such clauses only if

they have been incorporated in the articles of association of the company. There is a series of

rulings in the respect in case of any conflict between the Articles and the SHA, the former will

always prevail. Some of these are:

V.B. Rangaraj v. V.B. Gopalakrishnan (AIR 1992 SC 453)

Shanti Prasad Jain v. Kalinga Tubes Ltd., (35 Com. Cas. 351 SC)

Mafatlal Industries Ltd., v. Gujarat Gas Co. Ltd (97 Comp Cas 301 Guj),

Pushpa Katoch v. Manu Maharani Hotels Limited ([2006] 131 Comp Cas 42 (Delhi)]

In Western Maharashtra Development Corporation Ltd. Vs. Bajaj Auto Ltd2, it was held that

such clauses are to hamper the free transferability of shares and in violation of section 111A of

2 (2010) 154 Company Cases 593 (Bom).

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the Companies Act, 1956 and hence, are not enforceable. However, the Supreme Court in 2003

in its decision in M.S. Madhusoodhanan v. Kerala Kaumudi Pvt. Ltd.3, 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. Recently also, the Division Bench of

Bombay High Court in Messer Holdings Limited v Shyam Madanmohan Ruia and Ors 4,

overruling 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 inter-alia 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 Ltd5, 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. The provisions of a shareholders’ agreement curtailing the rights of directors

declared unenforceable if not included in Articles by Bombay High Court in Rolta India Ltd. &

Another vs Venire Industries Ltd. & Others.6 It was held that the shareholders cannot infringe

upon the Directors' fiduciary rights and duties. Even Directors cannot enter into an agreement,

thereby agreeing not to increase the number of Directors when there is no such restriction in the

Articles of Association. The shareholders cannot dictate the terms to the Directors, except by

amendment of Articles of Association or by removal of Directors.

AN ANALYSIS OF THE CURRENT POSITION

3 (2003) 117 CompCas 19 SC.4 (2010) 98 CLA 325.5 (2003) 47 SCL 426.6 2000 100 CompCas 19 Bom

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As a background, it would be apt to note that conflicts between SHA and the Articles of a

company can be of two types; first, where the conflict relates to the management of the company

(affirmative vote, board of directors, accounts, etc.) and second, where the conflict relates to the

transferability of shares. The latter has been the subject of extensive case law in the Supreme

Court and High Court. As regards the former, two main questions arise;

Whether a provision in a SHA that is contrary to the Articles of the company is valid and

enforceable?

What are the possible remedies for a shareholder against breach of a SHA by other

shareholders even though such action would not be construed as a breach under the

Articles of the company?

The most important case in this regard is that of VB Rangaraj v. VB Gopalakrishnan.7 The High

court had taken the view that sale by one defendant to other defendants was invalid according to

shareholders agreement which put restriction on transfer. The Supreme Court held that finding

recorded by the courts below that the sale by the first defendant of his shares to defendants 4 to 6

was invalid as it was in breach of the agreement, was erroneous in law. While asserting the

principle that shareholders agreement cannot go beyond Articles of Association, the Apex court

held that shareholders agreement clause, which was not expressly averred in Articles of

Association of the Company was unenforceable. In this case, while dealing with a conflict

between the SHA and the Articles of the company of the latter type, i.e. a conflict dealing with

the transferability of shares, the Supreme Court took the view that the provisions of a SHA

imposing restrictions even when consistent with the Companies Act, are to be authorised only

when they are incorporated in the Articles of the Company. The decision of the Supreme Court

was based on the seemingly settled position that where there is a contradiction between the SHA

and the Articles of a company, the latter will prevail.

In IL & FS Trust Co. Ltd. v. Birla Perucchini Ltd,8 the decision in Rangaraj was also held

applicable to conflicts in the Articles and SHA not involving transfer of shares.

Therefore, it is a settled law that the Articles of a company would prevail when there is a

contradiction between the SHA and the Articles. But assuming that there is a certain provision in

7 (1992) 1 SCC 1608 [2004] 121 Comp Cas 335

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the SHA that has not been incorporated in the articles of the Company, would it mean that

merely because the articles are silent (not contradictory), the articles will prevail?

The answer to this question might lie in recognition of the legal position that a company is

controlled only by its Memorandum and Articles. The Articles are a form of a statutory contract

binding all the members of the company as regards the affairs of the company. A company

cannot contract outside the Articles in so far as the management of the affairs of the Company is

concerned, and any other agreement attempting to bind the company as regards its affairs, not

provided for in the Articles and Memorandum of the company, may not be enforceable. For

instance, a provision in a SHA giving a casting vote to the Chairman of the Board in case of a tie,

not provided in the Articles, will not be enforceable. However, this may also depend on whether

the company is a party to the SHA.9

In the case of World Phone India Pvt. Ltd. v. Wpi Group Inc,10 the Board of Directors of the

company passed a resolution approving a rights issue in accordance with the Articles of the

company, even though such an action required the affirmative vote of the Appellant in

accordance with a SHA entered into between the shareholders of the company. The Company

Law Board held that since the provisions of the SHA granting an affirmative vote to the

appellant were not incorporated in the Articles of the company, the said provision is

unenforceable and the board resolution approving the rights issue was valid. On appeal, Justice

Muralidhar of the Delhi High court held:

“The legal position is that where the articles of association are silent on the existence of an

affirmative vote, it will not be possible to hold that a clause in an agreement between

shareholders would be binding without being incorporated in the articles of association. The

question to be asked is whether the provisions of an agreement, that are not inconsistent with the

Act, but are also not part of the articles of association, can be said to be applicable. All that

section 9 states is that the clauses in the agreement that that “repugnant” to the Act shall be

“void”. This does not mean that the clauses in the agreement which are not repugnant to the Act

would be enforceable, notwithstanding that they are not incorporated in the articles of

association.”

9 See Russell v. Northern Bank Development Corp Ltd, [1992] 1 WLR 58810 World Phone India Pvt. Ltd. & Ors vs Wpi Group Inc, CO.A (SB) No. 102 of 2012

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Thus, the court has held that the provisions of the SHA, though silent in the Articles of the

company, and not in contradiction with them, will not be enforceable. This ruling, as it stands,

brings in a lot of confusion to the issue of conflicts between SHAs and Articles of a company-

because the issues don’t stand resolved merely with the conflicting provisions being

unenforceable. Further issues arise in light of the judgment of the Supreme Court in Vodafone

International Holdings BV v. Union of India11, that have not been considered by the Delhi High

Court in World Phone.

In Vodafone, three main observations were made by the Supreme Court on the issue;

That the Supreme Court does not subscribe to the view in Rangaraj that restrictions in a

SHA, though consistent with company law, are to be authorised only when they are

incorporated in the articles of the Company.

Shareholders can enter into any arrangement in the best interests of the Company, but the

only thing is that the provisions of SHA shall not go contrary to the articles of the

Company.

Breach of SHA which does not breach the Articles of a company is a valid corporate

action, but the parties agreed can get remedies under the general law of the land for

breach of any agreement and not under Companies Act.

In light of the above, a logical extension of the judgment in World Phone12 would be that even

though the provisions of an affirmative vote are not incorporated in the Articles of the company,

and though the action of the company in providing for a rights issue would be valid under the

Companies Act, such an action will still be in breach of the SHA for which the aggrieved

shareholder can pursue an action for breach of contract.

This view is also consistent with the position in English law. In Southern Foundries Ltd v.

Shirlaw, [1940] AC 701 it was held, “a company cannot be precluded from altering its articles

thereby giving itself power to act under the provisions of the altered articles–but so to act may

nonetheless be a breach of contract if it is contrary to a stipulation in the contract validly made

before the alteration”, and the court awarded damages for wrongful dismissal of the managing

11 (2012) 6 SCC 61312 World Phone India Pvt. Ltd. & Ors vs Wpi Group Inc, CO.A (SB) No. 102 of 2012

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director of the Company even though the mode of dismissing was valid under the Articles of the

company. There is considerable opinion to show that the relief may also lie in terms of an

injunction to restrain it possible breach of the SHA contract.13

The same position also seems to have been incorporated in the new Companies Act of 2013,

Section 58(2) of which provides that any contract or arrangement between two or more persons

in respect of transfer of securities shall be enforceable as a contract and the same would not

amount to restraining the concept of free transferability of the shares.

However, the controversy still remains unsettled. In fact, the same seems to have been revived

once again in Bajaj Auto Ltd. v. Western Maharashtra Development Corporation Ltd.14, which

was recently decided by a division bench of the Bombay high court in appeal to its previous

decision15 of a single judge bench. The court in this case held that merely the fact that the shares

of a public company can be subscribed to by the public, unlike in the case of a private company,

does not in any way whittle down the right of a shareholder of a public company to arrive at a

consensual agreement/ arrangement with a third party or another shareholder provided the terms

are consistent with the AOA as well as the Companies Act and rules governing other laws. All of

this only leads to all the more confusion leaving scope for further speculation which means the

true resolution of the issue will have to await a pronouncement from the Supreme Court.

CONTRIBUTION

The researcher has researched the various aspects of the debate 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 law on the matter. The cases mostly say the same thing, some agree and

some don’t. What the courts have failed to do is to analyze both these aspects in a reasonable

13 Aditya Swarup, Conflicts Between Shareholders Agreement and Articles of a Company, India Corporate law (June 6, 2013)14 2015 SCC Online Bom 211115 supra note 2.

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manner and provide a final solution. In cases where some certainty is seemingly established, the

preceding cases don’t acknowledge it.

With the help of this project, the researcher has analyzed all these case laws, and pointed out

what the debate is all about. And it is with the help of the case laws only that the researcher has

tried to provide a conclusion to for this debate.

CONCLUSION

The issue of conflicting provisions in a shareholder’s agreement and the articles of association of

a company is a never ending debate. It is settled law that articles of association prevail over

shareholder’s agreement. However, in the absence of an expressed provision in articles, the issue

remains unsolved as to whether a clause in shareholder’s agreement in the absence of affirmance

from article is enforceable or not. Supreme Court in Vodafone case has drawn the proposition

that restrictions in a Shareholding Agreement, though consistent with company law, are to be

authorized only when they are incorporated in the articles of the Company. However, this view

was ignored in the cases following it, especially in the World Phone Case. On 9th May, 2013, the

Supreme Court refused to admit a SLP in the World Phone case stating the opinion expressed in

the order was only as regards interim relief and that the CLB was to decide the issue

uninfluenced by the observations of the High Court. This sets the stage for a new round of

litigation where it is hoped that issues concerning the conflicts between SHAs and Articles of a

company would be finally settled.

Nevertheless, it is hereby concluded that the breach of Share Holding Agreement which does not

breach the Articles of accompany is a valid corporate action, but the parties agreed can get

remedies for breach of any agreement as envisaged under the Contract Act.

BIBLIOGRAPHY

PRIMARY SOURCES-

1. The Companies Act, 1956

2. Taxmann’s Company Law Digest (1913-2009), 3rd Edition.

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3. Singh, Avtar, Company Law, Eastern Book Company, 16th Edition, 2015.

SECONDARY SOURCES-

1. Westlaw India

2. Manupatra

3. http://indiacorplaw.blogspot.in

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