Shareholders Agreement

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Shareholders Agreement

A shareholders’ agreement (SHA) is an agreement among the different shareholders of the company with regards to their rights, duties and obligations as well as the operation of the company. It basically lays down the relationship between the shareholders. An SHA usually contains the following:

  • Shareholders’ rights and obligations
  • Regulating sale of shares
  • Describing the operation of the company on a day-to-day basis
  • Protection of minority shareholders*.

* A minority shareholder is one who owns less than half the share of the company and does not exert control over the operation of the company.

Enforceability of SHAs

Earlier, SHAs were not held to be enforceable unless they were incorporated as a part of the Articles of Association. However, recently, the legal position on this aspect has changed in India. Nowadays, as long as an SHA does not curtail the powers of a company under the Companies Act, and do not bind future shareholders, a standalone SHA is enforceable in India.

Why is an SHA important?

It is possible for the provisions in an SHA to overlap with those in other agreements such as article of association etc, but the SHA is still a very important document. Often, an SHA is referred to as a “business prenup”. The benefits and importance of an SHA are given below.

  • It allocates the rights and duties of shareholders- acting as a rulebook.
  • It also lays down the roles of shareholders, directors and other stakeholders of a company.
  • It lays down quorum requirements, voting rights etc. (which will be discussed in detail.
  • Rights and obligations regarding the transfer of shares are enumerated in the SHA.
  • It may allocate special rights and privileges to different classes of shareholders.

Thus from the above it can be seen that the SHA is a guideline on how the company is to function. It is the rulebook on whose basis the operation of the company takes place. While there are no laws in India that deem SHA to be mandatory or necessary, it is an essential part of companies’ documents that should be opted for.

Without an SHA it is difficult to streamline the operations of a company. While many provisions of an SHA is similar to that of the Article of Association, there are more details present in an SHA with regards to the day-to-day operation of the company. Hence it is a very crucial document that can be a part of the Articles of Association.

Drafting an Shareholders Agreement

Given below are the important clauses that should be present in this agreement.

1. Parties

The parties to an SHA are the company, the present shareholders and the investors.

2. Business Activity

The SHA should lay down the type of business to be conducted. Any change in business activity must be made with the consent of all shareholders.

3. Authorised and Paid Up Capital

the maximum amount of shares that the company is allowed to have is laid down in the SHA and is called the authorised capital. The amount that is funded by the shareholders is called the paid up capital.

4. Directors

The SHA defines the Board of Directors, the quorum required to have a board meeting. The shareholders also usually have a right to appoint one or more of their own directors to the board.

5. Voting

The process by which voting of the board/shareholders is to occur is laid down by the SHA.

6. Sale of Shares 

This is the most important clause in an SHA. It lays down certain rights of the shareholders. Some of the rights have been given below, though this is not an exhaustive list.

a.       Right of first refusal- When selling their shares, shareholders have to first offer these shares to the existing shareholders. Only when they refuse, can the shares be sold to an outside party.

b.     Right of first offer- Originating from the above right, all shareholders have the right to be offered for sale any shares, and only on their refusal can the shares be sold to outside parties.

c.       Tag along rights- When one shareholder sells their share, some other shareholders may have the right to “tag along” and sell their share to the same buyer.

d.     Drag along rights- Similarly, rights may exist where when one shareholder sells their shares, he may “drag along” others, thus forcing them to sell their shares to the same parties.

e.       Anti dilution rights: if a shareholder has bought shares at price X and the company issues new shares to another person at a price lower than X, then anti dilution rights allow the right holder to receive additional shares at no extra cost to offset the price difference.

7. Liquidation Preference

The SHA also lays down what happens in case of winding up/liquidation of the company. Liquidation preference lays down that certain shareholders will be given back their money first, before the rest of the shareholders are paid back. In most cases the investors get paid back first.

8. Dispute Resolution

As an SHA has many parties, it should always have a dispute resolution clause that makes it clear as to while court or tribunal to approach in case of a dispute.

9. Competition Restriction Clause

Competition restriction is one of the key issues when drafting an SHA. Having a non-compete clause in an SHA may prohibit/limit shareholders from engaging in competition with the company during their involvement with the company or for a certain period after their shareholding has terminated.

10. Intellectual Property

Every business has an aspect of intellectual property attached to it. An SHA should outline who the IP is owned by, who it may be assigned to and other relevant details.

11. Term & Termination

This clause outlines the term for which an SHA remains valid, after which renewal of the same may be required.

12. Confidentiality 

No details with regards to the SHA may be disclosed to any third parties. It is essential that a confidentiality clause details the extent to which shareholders are allowed to disclose/withhold information.

13. Indemnification

In case of any breach of the terms of the SHA, by a promoter/founder, the shareholder is entitled to indemnification. This means that losses incurred by the shareholder due to the actions of the promoters/founders of the company, are to be reimbursed.

14. General Clause 

A typical SHA includes boilerplate/standard clauses such as Governing Law, Severability, Notice, Waivers, Representations and Warranties etc.

Using PocketLawyer

PocketLawyer understands that no two SHAs can be identical. PocketLawyer does not believe in using templates, and instead drafts legal agreements from scratch so that the needs of the client can be tailor made into the agreement itself. The agreement will be drafted by an experienced lawyer who understands the importance of a well drafted SHA.

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