Articles of association are one of the charter documents providing for, inter alia,management of a company, its shareholders and other matters governing the relationship amongst shareholders and the company. As per Section 10 of the Companies Act, 2013, articles of association, when registered, bind the company and its members to the same extent as if they had been respectively signed by the company and by each member, and contained covenants on their respective parts to observe all the provisions contained in the articles. As such, any action undertaken by a company and its shareholders cannot be inconsistent with a company's articles of association.
In this context, this article aims to analyze provisions relating to restrictions upon transferability of shares as agreed upon in shareholder agreements and the need for incorporation of such restrictions in the articles of association of the respective company.
Shareholder Agreements vis-à-vis Articles of Association
Shares are movable property, capable of being transferred, subject to reasonable restrictions under the Companies Act, 20131 and other contractually agreed restrictions such as put options, call options, buy-back clauses, affirmative votes and pre-emption rights, as usually incorporated in a shareholders' agreement. However, in order for any share transfer restrictions to be valid and binding on the shareholders and the company, such restrictions need to be validly incorporated within the articles of association of a company.
In Vodafone International Holdings BV v. Union of India2, the Supreme Court observed the difference between articles of association and a shareholders' agreement. It was held that the articles of association of a company are a public document which bind all shareholders and the company. Contrary to the articles, a shareholders' agreement is essentially a private contract between the shareholders in a company for the purposes of conferring rights and obligations in addition to those provided under statutory law and binds only the parties to the agreement. As held in V.B. Rangaraj v. V.B. Gopalakrishnan and Others3, the only restriction on transfer of shares of a company shall be as laid down in its articles of association of the said company. Any restriction that has not been specified in the articles of association of a company would not be binding either on the company or on the shareholders. Further, while shareholders may enter into shareholder agreements between themselves in the best interest of the company, it is essential that the provisions in the shareholders' agreements do not contravene the articles of association, failing which the articles of association would prevail in case of any conflict.4
As observed by Lord Macmillan in IRC v. Crossman, the principle behind the need for such restrictions to be incorporated in the articles of association arises from shares in a company being a congeries of rights and liabilities, which are a creature of both the statute and the memorandum and articles of association of the company.5 As such, any restriction thereof needs to be in accordance with the governing statute and the charter documents of a company.
Similarly, the Delhi High Court in World Phone India Pvt. Ltd. v. WPI Group Inc. USA6, observed that where the articles of association of a company are silent on the existence of an affirmative vote, it will not be possible to hold that a clause in an agreement between the shareholders would be binding without being incorporated in the articles. Further, the Delhi High Court, while relying upon judgments in, inter alia, V.B. Rangaraj v. V.B. Gopalakrishnan7 and HTA Employees Union v. Hindustan Thompson Associates Ltd8 held that an agreement arrived even between the shareholders and directors of a company with respect to management of the affairs of the company, without being incorporated in the articles of association of the company would not be enforceable against the company.
Indian Courts have also held that the law is well settled that it makes no difference that the company is also a party to the said shareholders' agreement and that in order for such shareholder' agreements to be valid, the provisions thereof need to be incorporated in the articles of association of a company. Further, the foregoing principle is not only confined to restrictions upon transferability of shares but applies to other situations as well involving management of the affairs of the company.9
Conclusion
The Companies Act, 2013 has attempted, to a certain extent, to provide validity to provisions incorporated in shareholder agreements, irrespective of the need for inclusion in articles of association. As per Section 58(2) of the Companies Act, 2013, any contract or arrangement between two or more persons in respect of transfer of securities and restrictions thereof shall be enforceable as a contract. However, the said provision has been made applicable only in case of public companies. With respect to private companies in India, as per the Indian jurisprudence, it is essential that articles of association of a company are appropriately amended to reflect the restrictions agreed upon in shareholder agreements, provided that such provisions are not violative of prevailing law.
The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal, Hyderabad.
Footnotes
1. Section 58, Companies Act 2013
2. (2012) 6 SCC 613
3. (1992) Comp LJ 11 (SC)
4. Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613
5. [1936] 1 All ER 762
6. MANU/DE/0686/2013
7. (1992) Comp LJ 11 (SC)
8. MANU/DE/3005/2013
9. IL&FS Trust Co. Ltd. v. Birla Perucchini Ltd., [2004] 121 CompCas 335 (Bom)
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