A Guide for Indian Startups and Businesses on Shareholders Agreements

Introduction

A shareholder’s agreement is a legally enforceable contract that delineates the rights, obligations, and responsibilities of a company's shareholders. It functions as a manual for managing the business and resolving conflicts.

A shareholder’s agreement is essential for new and developing companies because it guarantees the rights and interests of investors are protected. In addition, it helps avert conflicts among shareholders and offers a transparent structure for corporate decision-making.

A shareholder’s agreement: what is it?

A legally binding contract between a company's shareholders is called a stockholder’s agreement or shareholders agreement. It describes the shareholders' duties, rights, and responsibilities with regard to the business and its management. The management and control of the business, the rights and obligations of the shareholders, and the purchase and selling of shares are all commonly covered topics in a shareholder's agreement.

Objective

A shareholder’s agreement's primary goal is to guarantee the rights and interests of the shareholders are protected. It also offers a defined structure for internal decision-making within the organisation and aids in the prevention of conflicts amongst shareholders.

Important Sections of a Shareholder Agreement

Typically, a shareholder's agreement contains clauses like these:

·         limitations on the transfer of shares, such as first-refusal rights

·         Clauses about the appointment and removal of directors

·         Provisions for dividend distribution

·         clauses allowing for the purchase of shares in the case of a shareholder's retirement, infirmity, or death

·         Measures to settle disagreements between shareholders

·         Details on the funding and management of the business

·         limitations on rivalry with the business

·         Information on the manner and date of the company's dissolution

·         clauses that safeguard minority shareholders

A shareholder’s agreement is not the same as a company's articles of association or memorandum of association, which are required legal papers that must be registered with the Registrar of Companies in India. An agreement reached voluntarily by the shareholders is called a shareholder’s agreement.

Why Do Investors Need to Understand Shareholders' Agreement?

Shareholder Rights and Responsibilities

Determining the rights and obligations of shareholders is a crucial aspect of a shareholder’s agreement that safeguards investors' interests. It can outline, for instance, the total number of shares to which each shareholder is entitled as well as their respective ownership percentages. It can also delineate the rights of shareholders to engage in the decision-making process, including the ability to vote on significant issues like the appointment of directors or the endorsement of significant deals. This document serves to guarantee that the interests of all shareholders are taken into consideration and that they have a voice in the company's administration and direction.

Making Decisions

A shareholders agreement's providing of a framework for internal decision-making is another crucial feature. The process for requesting meetings, the minimum number of participants needed for meetings, and the shareholders' voting rights can all be outlined in the agreement. This makes sure that all shareholders have a chance to participate in the decision-making process and that decisions are made in a fair and transparent manner.

Dispute Settlement

Conflicts between shareholders can also be avoided with the aid of a shareholder's agreement. A structure for resolving conflicts, such as arbitration or mediation clauses, may be provided by the agreement. By doing this, the corporation and its stockholders may be spared the expensive and time-consuming legal fights. A dispute resolution provision, for instance, can outline the steps involved in choosing a mediator or arbitrator as well as how disagreements are settled via mediation or arbitration. By doing this, it may be possible to ensure that disagreements are settled amicably and without the need for pricey court cases.

Buying and Selling of Stock

A buy-sell agreement, which is a procedure for buying and selling shares in the event of a shareholder's death, disability, or retirement, can also be included in a shareholder's agreement. Guaranteeing that shares are not sold to uninvited outsiders; this serves to safeguard the interests of shareholders. This is especially critical for startups as it guarantees that the company's ownership structure stays intact and that unsolicited investors do not acquire control of the business.

A Look at the Shareholders Agreement's Legal Aspects

An agreement among shareholders is not required. A voluntary agreement between a company's shareholders is known as a shareholder’s agreement in India. The filing of this legal instrument with the Registrar of Companies is not required. It is imperative to verify that the shareholder's agreement complies with the regulations set forth by the Securities and Exchange Board of India (SEBI) and the Companies Act, 2013. There shouldn't be any clauses in the agreement that go against the law or regulations.

Enforceability

A shareholder’s agreement is enforceable in Indian courts and is regarded as a legally binding contract between a company's shareholders. All parties concerned should sign the agreement, which will be carried out as a deed. To make sure that the agreement is enforceable in Indian courts and conforms with all applicable laws and regulations, it is advisable to seek legal advice.

Tax Repercussions

A shareholder’s agreement has specific tax ramifications in India. Stamp duty, for instance, may be applied on the transfer of shares under a buy-sell arrangement. Furthermore, income tax may apply to the agreement if it contains a clause requiring compensation or remuneration to be paid. To make sure the agreement complies with Indian tax rules and regulations and to prevent any tax liabilities, it is crucial to speak with a tax specialist.

The shareholders' agreement signing, Crucial Sections of the Shareholders Agreement

According to the Companies Act of 2013, a shareholder’s agreement is usually enforceable only if all shareholders sign it. All parties concerned should sign the agreement, which will be carried out as a deed. This covers all current shareholders as well as any future additions of new shareholders.

It might not be possible for all of a company's shareholders to sign the agreement in some situations due to the sheer number of them. Under the Companies Act of 2013, a representative group of shareholders may sign the agreement on behalf of all shareholders in such circumstances. It is crucial to confirm that the agreement is binding on all shareholders and that the representative group has the right to sign on behalf of all owners.

It's also critical to remember that, in accordance with the Companies Act of 2013, any new shareholders must sign the shareholder’s agreement. This will guarantee that the company is operated honestly and openly in accordance with the Companies Act of 2013 and that the conditions of the agreement bind all shareholders.

How Should a Shareholders Agreement Be Drafted?

·         Agreement of Shareholders

A shareholder’s agreement is a complex document that needs legal advice. Nonetheless, the following is a list of sample terms that an Indian startup or business must have in their contract:

·         The Parties' Identification

The names and addresses of the company's stockholders should be included in this clause.

Example: "On the date of execution, [Name of the Company], a company incorporated under the Companies Act, 2013, with its registered office at [Address of the Company], herein referred to as the “Company,” and the shareholders of the Company, listed in Exhibit A attached hereto, herein referred to as the “Shareholders,” made and entered into this Shareholders Agreement (the “Agreement”).

·         Capital Organisation

The number of shares issued, their par value, and the percentage of ownership held by each shareholder should all be included in this section.

For instance, "The Company has [Number] shares of common stock outstanding, each of which has a par value of [Par Value]." [Shareholder 1] - [Percentage], [Shareholder 2] - [Percentage], and [Shareholder 3] - [Percentage] are the respective percentages of ownership that each shareholder has in the company.

·         Control and Administration

This section ought to delineate the entitlements and obligations of shareholders concerning the administration and command of the enterprise, encompassing the prerogative to cast a ballot on consequential issues like the selection of directors or the endorsement of significant dealings.

Example: "The Board of Directors shall have management and control over the Company. All matters needing shareholder approval, such as the election of directors and the approval of significant transactions, shall be subject to a vote by the shareholders. Additionally, upon written request to the Board of Directors, the Shareholders shall have the power to call a special meeting of shareholders.

·         Limitations on the Assignment of Stock

Pre-emptive rights and rights of first refusal, among other restrictions on the transfer of shares, should be included in this section.

Example: "Any shares that are offered for sale by another shareholder shall be purchased by the Shareholders first in the right of refusal. If a shareholder wants to sell, they have to first make an offer to other shareholders at the same price and terms that they would make to a third party. The selling shareholder may then offer the shares to a third party if the other shareholders decide not to buy them.

·         Purchase-Sale Contract

Provisions for the purchase and sale of shares in the case of a shareholder's retirement, disability, or death should be included in this section.

Example: "The surviving shareholders shall have the right to purchase the shares of the deceased, disabled, or retiring shareholder at a fair market value to be assessed by an impartial appraiser in the case of the shareholder's death, disability, or retirement. After the notification date, the remaining shareholders will have [number of days] to exercise this entitlement.

·         Dispute Settlement

This clause, which may contain provisions for arbitration or mediation, should offer a framework for resolving conflicts.

Example: "The Indian Council of Arbitration's rules shall govern the arbitration of any disputes arising under this Agreement. The arbitration will be held in [city], India, and will be carried out in English. The arbitrator's decision is final and enforceable against the parties.

Governing legislation, the agreement's governing legislation should be stated in this provision.

For instance, "The laws of India shall govern and be construed in accordance with this Agreement."

·         Whole Agreement

The agreement should state that it supersedes all previous understandings and agreements and expresses the parties' total understanding.

Example: "This Agreement supersedes all previous agreements and understandings, whether oral or written and constitutes the parties' entire understanding with respect to the subject matter hereof."

Concluding remarks

In summary, a shareholder’s agreement is a crucial contract that plays a crucial role in protecting the interests of investors in a specific business. It provides a structure for corporate decision-making and outlines the rights, duties, and responsibilities of shareholders with respect to the business and its management. It also describes the rights that shareholders have with regard to the company.

In compliance with the Companies Act of 2013 and the guidelines set forth by the Securities and Exchange Board of India (SEBI), the agreement serves to guarantee that the company is run in an honest and transparent manner, which lessens the possibility of conflicts amongst shareholders.

Every shareholder must sign the shareholder's agreement for it to be enforceable in Indian courts and have legal force. A representative group of shareholders may sign the agreement on behalf of all shareholders in cases where it would be impracticable for all shareholders to do so. It is crucial to make sure that new shareholders sign the agreement as well in order to guarantee that it remains valid at all times.

Startups and established firms need to draft a shareholder’s agreement as soon as they can in order to protect their financial assets. It is highly recommended that legal and tax professionals be consulted while drafting a shareholder's agreement. This will assist prevent any potential legal or tax liabilities and ensure that the agreement complies with all applicable rules and regulations. An intelligently crafted shareholders agreement can help draw in investors and show that the company is well-run with a transparent governance structure.