What is a Shareholders’ Agreement? Shareholders’ Agreement is a legal contract amongst the Company and its shareholders detailing their rights, duties and obligation in connection with the business operation of the company. It operates together with the Articles of Association but remains confidential and customizable to suit the shareholders’ precise agreements.

Enforceability of Shareholders’ Agreement in India: The enforceability of shareholders’ agreements in India majorly depends on its conformity with the Indian Contract Act, 1872, and the Companies Act, 2013. It shall include the rights, duties, and obligations within the provisions of the Companies Act, 2013, and the Indian Contract Act, 1872, ensuring enforceability and compliance with the corporate law in India.Besides, the clauses of the Shareholders Agreement shall not conflict with the Articles of Association of the company, as per the landmark judgement in V.B. Rangaraj v. V.B. Gopalakrishnan and others (AIR 1992 SC 453).

Importance of Shareholders’ Agreement for Success of Business: Shareholders’ Agreement plays a vital role in the success of businesses by ensuring:

• Conflict Resolution Mechanism: It provides clear conflict resolution mechanisms, minimizing disputes between shareholders’, and company management in its operations.

• Interest protection mechanism: To safeguard and protect the rights of minority shareholders particularly rights like pre-emption, tag-along, anti-dilution clauses etc., provisions should be included in it.

• Pre-Emptive Rights: Pre-emptive rights give existing shareholders priority access to new share issues before they are offered to new / external investors. So that the existing shareholders can maintain their proportional ownership and voting power in the Company. It prevents dilution of an individual shareholder’s stake when the Company decides to issue fresh shares.

• Anti-Dilution Clauses: Anti-dilution provisions protect investors from equity dilution in subsequent financing rounds, ensuring that their investment value does not get diluted when new shares are issued at a lower price than what the existing shareholders paid.

• Right of First Offer (ROFO): The Right of First Offer obligates the selling shareholder to offer their shares to existing shareholders before selling them to a third party. This clause gives current shareholders the chance to increase their stake in the Company under agreed-upon terms before offering it to a third party. The ROFO is instrumental in maintaining the internal balance of power and preventing unwelcome third-party interventions.

• Right of First Refusal (ROFR): The Right of First Refusal is a clause that gives existing shareholders the right to buy shares from a shareholder wishing to sell their stake, after the seller has received an offer from a third party. The crucial difference is that with ROFR, the sale to external parties is contingent upon the existing shareholders declining to purchase the shares under the terms offered by the external party. This clause is vital for shareholders to retain control over the management of the company.

• Tag-Along Rights: Tag-Along Rights protect minority shareholders in the event of a majority shareholder selling its stake by allowing minority shareholders to join the transaction and sell their shares at the same terms and conditions.

• Drag-Along Rights: Drag-Along Rights allow majority shareholders to force minority shareholders to join in the sale of the Company, ensuring that a potential buyer can acquire 100% of the company’s shares. These clauses are crucial for balancing the interests of majority and minority shareholders during exit events.

• Affirmative Rights: Affirmative rights require the Company to obtain approval from certain shareholders or a group of shareholders for making significant decisions. This may include decisions related to amending the company’s charter or bylaws, mergers, acquisitions, divestitures, issuance of new shares, or entering debts above a certain threshold, related party transactions, dissolution or winding up, entering into new line of business etc. These rights ensure that key shareholders have a say in critical company decisions, thereby protecting their interests.

• Sweat Equity and ESOP: Sweat equity clauses recognize and reward the contributions of shareholders particularly those who contribute their skills, expertise, and efforts towards the growth of the Company, beyond mere financial investment. Whereas ESOP clauses offer several advantages to employers and enhances employee retention by fostering a sense of ownership and loyalty, thus reducing turnover rates. Additionally, ESOPs allow employers to reward employees through equity rather than cash, minimizing the need for immediate cash outflows.
• Dividend Policy: Dividend policy in shareholder agreements specify the conditions under which dividends will be declared and distributed, ensuring that shareholders are adequately rewarded for their investment while balancing the need for reinvestment into the company.

• Precise Governance Mechanism: It outlines decision-making processes and governance structures, aligning with the company’s strategic goals.

• Exit Strategies and Mechanism: Detailed exit and sale of shares mechanisms provides a clear and easy way for shareholders wishing to liquidate their investments.

• Regulatory Compliance: It ensures that the company meets specific regulatory compliance requirements which are applicable to it.

• Arbitration Clause: Arbitration clause mandates that any disputes arising out of the Shareholders’ Agreement be resolved through arbitration rather than court litigation, providing a faster, more confidential resolution process. Any dispute, controversy, or claim arising out of or relating to this agreement, or the breach, termination, or invalidity thereof, shall be settled by arbitration in accordance with the provisions of the Indian Arbitration and Conciliation Act, 1996. The arbitration panel shall consist of three arbitrators; one appointed by each party and the third, who shall act as the presiding arbitrator, appointed by the two arbitrators appointed by the parties. The place of arbitration and language of the arbitration proceeding should also be included in this clause.

• Governing Law Clauses: The Governing Law clause specifies which jurisdiction’s law will govern the agreement, ensuring clarity and predictability in legal interpretations and enforcement.

A well drafted comprehensive shareholders’ agreement enhances investor confidence by showing a well-managed, low-risk investment opportunity.

If anyone needs any kind of help or legal advice on this issue or in general, please feel free to contact me at any time. My Number is 9818865693 and email is adv.jeetkumarsingh@gmail.com