Navigating Share Transfer Restrictions In Shareholders' Agreements Part 2

In our previous Article, we explored the foundational aspects of share transfer restrictions in shareholder agreements ("SHAs"), with a focus on concepts such as tag-along rights, drag-along rights, permitted and automatic transfers, amongst others and the interplay with the Companies Act, 2013 (the "Act"). We highlighted how these provisions, when carefully drafted, balance the competing interests of majority and minority shareholders, while maintaining alignment with statutory provisions and judicial interpretations.

In this follow-up piece, we expand the scope by examining additional, conceptually significant restrictions and protective mechanisms that frequently find their place in SHAs. Shotgun Clauses, Anti-Dilution Protections, Lock-In Restrictions, and Call/Put Options are mechanisms that are critical in practice, though less frequently addressed in doctrinal writing. Each of these contractual devices reflects the constant tension in SHAs, balancing the investor's protection with promoter flexibility, certainty with liquidity, and contractual autonomy with the statutory framework.

Lock-in Restrictions

Lock-in restrictions are among the simplest but most consequential shareholder protections. Lock-in restrictions essentially bind a shareholder, not to transfer their shares for a specified duration. Investors typically demand lock-ins to ensure continuity of vision, stability of management, and alignment of incentives in the critical early years of the investee company.

Lock-ins have both, statutory and contractual foundations. Statutorily, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 mandate minimum promoter lock-in periods following an Initial Public Offer. In the context of a private company, contractual lock-ins are recognized if embedded in the AoA of a company, as emphasized in the case of VB Rangaraj v. VB Gopalakrishnan (1992)¹. Indian courts have upheld their validity in multiple instances. One such instance is the landmark case of Mafatlal Industries Ltd. v. Gujarat Gas Co. Ltd. (1999)², wherein, the Gujarat High Court observed that contractual restrictions, including lock-ins, are enforceable, provided that they do not impose an absolute restraint on transferability.

Doctrinally, lock-in provisions embody what scholars have described as the "commitment principle" in corporate law; long-term investment requires credible commitments from promoters to remain invested. Nonetheless, excessive restrictions may discourage promoters or founders by locking in individuals who may prefer to diversify. The balance, therefore, lies in calibrated lock-ins to achieve stability.

Shotgun Clauses: Resolving Deadlock through Buy-Sell Arrangements

Deadlocks are a recurring concern in closely held companies, particularly in joint ventures. When disagreements between shareholders prevent the company from functioning effectively, contractual mechanism to resolve the impasse become essential. The Shotgun Clause (also referred to as a "buy-sell" or "Russian Roulette" clause) provides a self-executing method of resolution.

Under this arrangement, one shareholder offers to purchase the other's shares at a specified price, and the offeree must either accept the offer and sell at that price or, conversely, purchase the offeror's shares on the same terms. Herein, the self-enforcing logic is that neither party will propose an unfair price, the offeror will hesitate to undervalue or overvalue the shares, lest the terms be turned against them.

The legitimacy of these clauses flows from the contractual autonomy under the Indian Contract Act, 1872, read with the allowance in the Act for private companies to restrict share transfer through their Article of Association ("AoA"). The Supreme Court's ruling in VB Rangaraj v. VB Gopalakrishnan (1992)³ established that any restriction on transfer of shares is enforceable only if incorporated in the AoA. Consequently, for a Shotgun Clause to withstand judicial scrutiny, like other buy-sell rights, it must also be reflected in the constitutional documents to achieve enforceability.

That said, scholars like Professor Umakanth Varottil⁴ have observed that while buy-sell arrangements may break deadlocks efficiently, they are often "financially coercive devices" that allow the shareholder with larger capital to push out weaker parties. This concern is particularly acute in India, where access to capital markets is unequal and minority shareholders may be unable to exercise the reciprocal limb of the shotgun. Nonetheless, the clause remains attractive in joint ventures and partnerships where prolonged stalemate can render the undertaking inoperable. Deadlock resolution mechanisms, including shotgun arrangements, have also been upheld in arbitral practices as well.

Call and Put Options: Structuring Exits

Call and put options are essential mechanisms in SHAs because they structure share transfers and help maintain control within a company, while also influencing corporate governance. Simply posed, a call option entitles a shareholder to require another to sell their shares to the holder at a predetermined price or according to a pricing formula, whereas a put option permits a shareholder to compel another to purchase their shares. Functionally, these clauses operate as internal transfer restrictions, regulating who may sell or buy shares, under what conditions, and at what price, thereby preventing uncontrolled transfers to third parties that could disrupt the company's ownership structure. In commercial arrangements, these rights give investors and stakeholders a clear way to exit their investment, protect against losses by guaranteeing a buyer.

These options can be triggered under specific events, such as failure to meet performance milestones, default events or change in control, or can be used more broadly as general exit tools that can be exercised at any time, thus providing flexibility to the option holder. By providing structured exit mechanisms, they reduce the likelihood of disputes and deadlocks between shareholders, as potential exits and valuations are predetermined. Call options enable strategic shareholders to consolidate control and influence in a fair and orderly manner, while put options provide minority investors with a reliable exit, ensuring that minority rights are protected.

Beyond their individual contours elaborated above, it is important here to focus on how call and put options differ from shotgun clauses, as each serves a distinct strategic purpose. Call and put options are primarily used for risk allocation and managing liquidity, whereas shotgun clauses are employed to resolve deadlocks and ensure a clear resolution of ownership of shares. A key distinction lies in how the counterparty is affected. Call and put options are unilateral rights, exercised solely at the discretion of the holder, and the counterparty must comply without any choice in the outcome once the option is validly triggered. As a result, the counterparty is a passive participant. In contrast, shotgun rights are bilateral mechanisms, which once triggered, the counterparty retains a limited degree of agency between selling their shares or purchasing the initiator's shares, thereby allowing the counterparty the choice of the favorable outcome.

Conclusion

Taken together, Lock-In Restrictions, Shotgun Clauses, and Call/Put Options, represent the second tier of transfer-related provisions in SHAs. Indian jurisprudence, though limited, has increasingly acknowledged the legitimacy of such contractual devices. The Courts have increasingly emphasised that shareholder autonomy will be respected so long as restrictions are properly embedded in the AoA of the company and remain consistent with statutory and regulatory frameworks. These demonstrate the competing policy values in corporate governance, efficiency versus fairness, stability versus liquidity, and investor protection versus promoter freedom.

In practice, their utility is not merely theoretical. Lock-ins secure continuity of vision; shotgun clauses bring closure to deadlocks; and call/put options offer negotiated certainty of exit.

Footnotes

1. AIR 1992 SC 453.

2. AIR 1997 SCC 506.

3. AIR 1992 SC 453.

4. The Advent of Shareholder Activism in India, Journal on Governance, Vol 1 No. 6 (2012).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.