The rights and obligations of investors against other shareholders and/or the company may range from rights with regard to the transfer of shares ("Share Transfer Rights") to the inter-se governance matters relating to the ownership of shares - such as affirmative votes, pre-emption rights, and call/put option rights ("Inter-se Governance Rights"). Our focus here is India's position, as of October 2020, on the enforceability of additional, non-conflicting rights in the shareholders agreements ("SHA") vis-à-vis the articles of association ("AoA"). What prompts our concern is that investors need to be aware that while the SHA provisions keep changing to keep abreast of change in shareholdings or shareholders, the said changes are not always reflected in the AoA, which may cloud their better judgment and be to their detriment. (The reason for this anomaly is that the efforts to amend the AoA/denial by the company to be involved in Inter-se Governance Rights would be too cumbersome.)

While Indian jurisprudence recognizes the right to transfer shares as being inherent in the ownership of shares (limited by reasonable restrictions)1, absolute restriction on Share Transfer Rights is not valid and binding. Judgments such as Mafatlal Industries2 and V.B. Rangaraj3, under the erstwhile regime of the Companies Act, 1956, have held that Share Transfer Rights should be included in the AoA to have the sanctity of enforceability of the provisions. In the V.B. Rangaraj judgment, dating back to 1992, the parties incorporated certain share transfer restrictions in the SHA that required them to offer shares to the other party before offering it to an outsider. However, as the pre-emption clause was not incorporated in the AoA, the parties eventually reached a juncture where the applicability of the share transfer restriction was questioned. The court, relying on Section 3(iii) and Section 82 of the Companies Act, 1956, held that "the AoA are the regulations of the company and binding on the company and its shareholders. Therefore, the only restriction on the transfer of the shares of a company is as laid down in its articles if any but a restriction which is not specified in the articles is not binding either on the company or on the shareholders."

This binding restriction in the erstwhile regime has been modified, to some extent, by the proviso to Section 58(2) of the Companies Act 2013 that recognizes that "any contract or arrangement between two or more persons in respect to transfer of securities shall be enforceable as a contract". However, this position, which upholds the provisions of the SHA in the event the AoA is silent in the matter, is applicable only to public companies, not private companies. Which begs the question as to why the same yardstick is not applicable to private companies. If a public company, instituted on the basis of free transferability of shares, has the right to incorporate (limited and not absolute) share transfer restrictions, by that logic, shares of a private company that feature the spirit of restrictive transfers should also be allowed to restrict transferability by entering into private contracts. If private companies are denied contractual transferability restrictions, then they should at least be allowed Inter-se Governance Rights that are not incorporated in the AoA.

This flexible position was recognized in 2012, under the Companies Act, 1956 purview, by the Supreme Court in the Vodafone4 judgment. The court therein held that the SHA is essentially a contract between some or all other shareholders in a company, the purpose of which is to confer rights, and impose obligations, over and above those provided by the Companies Act. In holding so, the court stated that the SHA is a private document that binds parties thereof, but not the other remaining shareholders or the company, giving greater flexibility to make provisions for the resolution of any dispute among the shareholders and also the modus operandi of future capital contributions. Hence, the court stated, in verbatim, that "this court (in V.B. Rangaraj) has taken the view that provisions of the Shareholders' Agreement imposing restrictions, even when consistent with Company legislation, are to be authorized only when they are incorporated in the Articles of Association, (is) a view we do not subscribe. (Therefore,) the shareholders can enter into any agreement in the best interest of the company, but the only thing is that the provisions in the SHA shall not go contrary to the AoA. The essential purpose of the SHA is to make provisions for proper and effective internal management of the company. It can visualize the best interest of the company on diverse issues and can also find different ways not only for the best interest of the shareholders, but also for the company."

In essence, the Vodafone judgment disagreed only with the V.B. Rangaraj holding without expressly overruling it. As evident from the above extract, the Supreme Court merely expanded the partisan view taken in V.B. Rangaraj by holding that if the provisions of the SHA conflict with the provisions of the AoA, in that event the provisions of the AoA would prevail and not the provisions made in the SHA.

As the holding was not overruled in express terms,  the Delhi High Court, in March 2013, while overruling the holding of the Company Law Board in the case of World Phone India5, held that as the existence of an affirmative vote cannot be found in the AoA, the right of the parties remained unenforceable. In August 2013, in HTA Ltd. And Ors6, wherein the shareholding was not maintained as per the pre-agreed ratios between the management and the non-management staff union, the Delhi High Court held that as the terms of the AoA were amended, the claims of such breach cannot be upheld. It is therefore evident that the cases adjudicated by the Delhi High Court have chosen to ignore the Vodafone ruling, creating ambiguity in the legal jurisprudence in respect of the enforceability of provisions.

Such confusion calls for a conjoint reading in the interests of maintaining harmony. A logical conclusion suggests either (i) overruling the stance adopted by the Delhi High Court (non-harmonious); or (ii) consideration of the non-enforceability of the SHA provisions valid under company law but as a breach under contract law, thereby allowing for relief under the Indian Contract Act, 1872 (for instance, damages or injunction). The latter, however, will dilute the essence of SHAs.

Future decision-making depends on whether a larger bench of the Delhi High Court, or the Supreme Court, overrules the position adopted by World Phone and the HTA Ltd. judgment. However, the lesson from previous experience dictates that - until further clarity on enforceability of Inter-se Governance Rights, provisions in the SHA in respect of transfer of securities should be incorporated in the AoA to avoid any impediment in enforcing the terms of the SHA.


1 Section 58, Companies Act 2013

2 Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd. And Ors. (1999) 97 Comp Cas 301

3 V.B. Rangaraj v. V.B. Gopalakrishnan And Others (1992) Comp LJ 11 (SC)

4 Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613

5 World Phone India Pvt. Ltd. & Ors. v. Wpi Group Inc. (2013) 178 Comp Cas 173 (Del)

6 HTA Employees Union (Regd.) vs Hindustan Thompson Associates CO. A (SB) No. 102 of 2012

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