Share Holders Agreement

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What is

Share Holders Agreement

The Persons holding shares in a company are called Shareholders of that company. A shareholder’s agreement is an agreement initiated between the members or the shareholders of the entity, and it has the power to monitor and regulate the relationship between these members or shareholders, the management prevalent in the company, and ownership of the shares. It even safeguards the shareholders from any injustice or deception. 

A shareholder’s agreement is also known as a stockholders’ agreement, and it is more or less an agreement between the shareholders of an organization. A stockholder’s agreement even describes how an organization needs to be operated along with outlining the rights and legal obligations of the equity holders. 

FAQs

1. When are shareholder agreements entered?

Shareholder’s agreements are commonly entered into in the following situations:

1. Existing shareholders wish to come to a common understanding towards the running of the company.

2. A new shareholder wishes to protect his interests in the company.

3. A few of the existing shareholders are selling their shares and the remaining shareholders wish to protect their interests in the company.

2. How does a Shareholders Agreement work?

Shareholder’s agreements are governed by state laws, but federal laws- specifically regulations by the Securities and Exchange Commission (SEC). SEC is involved because shares are securities, especially shares available to the public. Shareholder’s agreements are legally binding contracts. 

3. Is the execution of a shareholder’s agreement sufficient to make it enforceable against the company?

A shareholder agreement by itself might be enforceable against the other shareholders on execution, however, it might not be fully enforceable against a company, especially where the stipulations of the agreement are not in accordance with the charter documents of a company.

The courts in India have held that for the shareholder's agreement to be enforceable against a company the agreement needs to be ratified by the general body of the company and the charter documents of the company are to be amended to incorporate the stipulations under an agreement. Therefore, the execution of a shareholder agreement by the company cannot be enforced against a company unless its charter documents contain the rights and obligations granted under the agreement.

4. Can shareholding agreements override express provisions of the Companies Act 2013?

Section 6 of the Companies Act 2013, states that the Act shall override the charter documents of a company, any agreement executed by it, or any resolution passed by the company in a general meeting or by the Board of Directors, whether the same be registered, executed, or passed, as the case may be.

5. What is the right of first refusal in share sale? How is it different from the right of the first offer?

A right of first refusal in share is when a person has the right but not the obligation to purchase the shares being sold by another shareholder at the same (or better but not worse) terms and conditions as maybe offered by a third party, in the event the right holder is unable to purchase the shares at the same terms and conditions, the other shareholder may sell the shares to the third party. 

However, in a right of the first offer, the right holder has the right but not the obligation to make the first offer to the shareholder intending to sell his shares and can only sell his shares to a third party only if the third party is able to provide a better deal. 

6. What are tag-along and drag-along rights?  How are they different?

While tag-along rights and drag-along rights might sound somewhat similar but they are opposite to each other. Under a tagalong right, the right holders have the right but not an obligation to sell their shares (usually in proportion to their shareholding) in case any of the other shareholders wish to sell their shares to a third party. 

In contrast under the drag-along concept of rights, the right holders (usually a group of shareholders forming a majority) may force the other shareholders (minority shareholders) to sell their shares to a third party. Usually enforced where a majority of the investors feel that it would be better to sell the company to another company or an industrial group. Usually, these rights are one of the last resorts enforced by the investor when he wishes to exit the company. 

7. What are pre-emptive rights?

Pre-emptive rights give a shareholder the opportunity to buy additional shares in any future issues of a company’s common stock before the shares are made available to the general public. While these rights are already present under section 62(1) of the Companies Act 2013 for equity shareholders, investors wishing to subscribe to convertible preference shares or other convertible securities should ensure such rights are present under the shareholder's agreement.

8. Are shareholding agreements binding against shareholders not a party to the agreement?

Shareholding agreements may not be in totally binding on shareholders not a party to the agreement. Where the rights under the agreement are incorporated in the charter documents of the company the agreement might be binding on non-party shareholders, however where the stipulations are not incorporated in the charter documents of a company or are personal in nature, they cannot be enforced against non-party of the agreement pursuant to the doctrine of privity of contract. 

9. Can shareholders appoint directors to the board of a company pursuant to a shareholder’s agreement?

A shareholder may appoint a director to the board of the company pursuant to section 161(3) which states that the Board of a company may appoint any person as a director nominated by any institution in pursuance of the provisions of any law for the time being in force or of any agreement.

10. Is there a minimum shareholding requirement to enter into a shareholding agreement?

There is no provision under the Companies Act 2013, for a minimum shareholding for a person to enter into an agreement with the company. However, it is advisable that an investor should take up at least 10% of the shareholding of the company so as to be able to file suits for oppression or mismanagement of the company under the Companies Act 2013.