Shareholders Agreement

What Would Happen In case a Shareholders Contract is Breached?

Here you can get details about what would happen in case the shareholder agreement is breached, read more to know!

A Shareholder Contract (SHC) is a contractual arrangement between the shareholders of a company. These agreements have gained enormous popularity because they are precisely drafted to provide certain rights and impose certain restrictions in addition to those offered by the Companies Act, 2013. (2013 Act). Breached of shareholders agreement

In contrast to the company’s articles of association, which are public charter documents, the Role of shareholders agreement (SHC) is a confidential agreement between the shareholders. The rights stipulated in an SHC are purely contractual, and the parties’ ability to exercise those rights is contingent on their ownership of shares in the company.

Generally speaking, an SHC is a by-product of transactions in which one entity acquires the shares of another entity. During these transactions, the parties involved, including the acquirer, execute an SHC inter-se to agree upon certain covenants. These covenants may include but are not limited to the following:

  1. Management and Ownership Rights, such as the appointment or removal of directors
  2. Describing how the business should function
  3. Regulating the sale of shares by shareholders.

As a result, the SHC details the rights and obligations of the company’s shareholders, as well as provisions related to the company’s management and its authorities. The interests of the shareholders, those who hold less than half of the company’s equity share capital, will be safeguarded thanks to this agreement’s provisions, which have been put in place for that very purpose.

Important Provisions Contained Within a Shareholder’s Agreement

  • Management of the company: The purpose of this clause is to make provisions for the issues directly related to the daily management of the company. The parties may reach an agreement here to settle the issues concerning the appointment, resignation, and removal of directors and the remuneration associated with those positions.
  • Non-compete clause: The purpose of this provision is to forbid the existing shareholders from participating in any other enterprise that is competitive with the company. 

The shareholder who receives the request must first make an offer to sell their shares to the other shareholders on terms comparable to the proposal before they can accept the offer. If the remaining shareholders do not decide to participate in the buyout, the company must sell itself to a third party under the same conditions presented to the existing shareholders.

  • Tag along Right: The non-selling shareholders are given the opportunity to force the purchaser or third party to acquire the majority shareholders’ shares and all of the claims through a title along clause. If an SHA contains such a clause, it will be mandatory for the third party to purchase minority shares, and they will have to do so at the same price and under the same conditions as the majority shareholders. It is important to note that the Tag along clause is only used when minority shareholders do not wish to remain shareholders with the third party. This is because the Tag along clause was created specifically for these scenarios.
  • Drag along Right:  If an offer is given by an acquirer or a third party for the purchase of all of the outstanding shares of the Target Company, and if a request is presented for the sale of all of the outstanding shares of Target When this occurs, it is typically because the majority of shareholders are in favor of a share sale deal. If this is the case, all shareholders, including minority shareholders, are required to sell their shares at a price and on the terms specified in the offer.

Relating to Both the SHC and Companies Act of 2013

Freedom to buy and sell shares in a public company, as well as confidential agreements between individual members. In particular, Section 58 of the Act  (titled “Refusal of registration and appeal against refusal”) declares unequivocally that any securities or other interests held by a member of a Public Company must be freely transferable.

Therefore, by the proviso above, SHC is legally recognized as a mechanism whereby parties in the case of public company contract terms concur on term and upon execution of the same, the agreed upon terms become binding on the investors. This is the case in the case of SHC. It is possible to give legal weight to a private agreement between two or more public company shareholders.

List of Significant Rulings Concerning the Enforceability of Shareholder Agreements

The provisions of the Act state that any condition that is either inconsistent with or not incorporated in the Articles of Association (AoA) is ultra vires and, as a result, void.

Changing the Articles of Association of the investee company to reflect the position held in SHC is a common and accepted business practice. This helps to ensure that none of the SHC’s provisions are rendered ineffective because they conflict with the constitutional documents of the investee company.

A violation of the SHC that does not violate the articles of association is considered a valid corporate action; however, the parties who have been wronged can seek redress for any breach of that agreement under the general law of the land.

In several cases in India, judges have ruled that an SHC is considered invalid if the same is not ingrained into the Articles of a company. This ruling has occurred in several different cases. Therefore, executing the SHC is not sufficient; it must be dutifully incorporated into the Articles to ensure that its enforceability is not called into question. Any provision in an SHC that is not included in the Articles will be regarded as inconsistent and, therefore, void if this requirement is not met.

Conclusion

Even though the implementation of SHC has become standard procedure for corporations, the question of whether or not it is enforceable cannot be dismissed entirely. The actual query of whether or not there is any genuine conflict between the Articles and SHC is still a mystery that needs to be solved after a thorough examination of the particular clauses of an SHC read in light of the previously cited judgments.

Are you looking for an expert who can help you out in case there is some breach of the shareholder’s agreement? If yes, then Vakilsearch experts are the best solution here to help you.

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