Are shareholders' agreements enforceable in India?

While shareholders' agreements are enforceable in England regardless of whether they have been incorporated in the articles of association of the company, in India they are not enforceable unless incorporated in the articles. This state of affairs in India has been reiterated in a recent judgment of Dr Chandchud of the Bombay High Court in IL & FS Trust Co Ltd v Birla Perucchini Ltd [2004] 121 Comp Cas 335 (Bom).

The learned judge held that since the provision contained in the subscription agreement to the effect that the second respondent would not resign from the board "till the validity of this agreement" was not translated into an amendment of the articles of association of the company. The fact that the company is a party to the subscription agreement makes no difference to this position because the position in law is well settled.

The provisions in an agreement such as the one in the present case, cannot be given effect to in so far as the management of the affairs of the company is concerned, unless those provisions have been incorporated into the articles of association. This point is no longer res integra but, is covered by the decision of the Supreme Court in VB Rangaraj v VB Gopalakrishnan [1992] 73 Comp Cas 201; AIR 1992 SC 453.

The Supreme Court has held that a restriction which is not specified in the articles of association is not binding either on the company or on the shareholders.

An attempt was made to distinguish the judgment of the Supreme Court by counsel for the petitioners on the ground that the law laid down by the Supreme Court in that judgment applies only in the context of a restriction on the transfer of shares of the company. But the judge rejected that by saying, "Rangaraj's case, undoubtedly, involved a situation relating to a restriction on the transfer of shares but the principle of law which has been enunciated by the Supreme Court cannot be confined to only that situation. The principle laid down by the Supreme Court in Rangaraj's case is, therefore, not confined to a situation involving only a transfer of shares.

As against this, in England the House of Lords has held in Russell v Northern Bank Development Corporation Ltd [1992] 3 All ER 161 that, a shareholders' agreement can be enforced in a court by the shareholder who is a party to the agreement against the other party, though not against the company where the enforcement of a term of the agreement is not consistent with the law, ie the Companies Act.

In Russel case, as part of the restructuring of a company, an agreement entered into between the company, its bankers and its senior executives, who held the entire issued share capital of the company, provided that no further share capital shall be created or issued without the written consent of all the parties to the agreement.

As against this, the company's articles provided that the company may from time to time, by ordinary resolution, increase the share capital. The law applicable to the company also provided similarly. When the company's board proposed to increase its share capital, the plaintiff, who was a party to the agreement, sought an injunction to prevent the company from doing so on the grounds that this was in breach of the agreement. The defendant counter-claimed for a declaration that the agreement was invalid in that it purported to restrict the statutory power of the company to create further share capital.

The House of Lords held that although a provision in a company's articles, which restricted its statutory power to alter those articles was invalid, an agreement outside the articles between shareholders as to how they would exercise their voting rights on a resolution to alter the articles was not necessarily invalid.

Curiously, in Rangaraj case the Supreme Court declined to enforce the agreement even though no order was sought by the plaintiff (shareholder) against the company and the company was not a party to the agreement and, in fact, held the agreement was "not binding either on the shareholders or on the company" because it was contrary to the provisions of the articles (emphasis supplied).

In India, we need a reform on this front in view of growing involvement of overseas companies in joint ventures formed by a partnership that is governed by an agreement usually called a shareholders' or subscription agreement or a joint venture agreement.

It regulates the relationship between the partners and lays down their mutual rights, duties and obligations. Both the parties sign the agreement with clear understanding and open eyes and decide to be bound by it. Having signed the agreement, it is absurd to allow any party to the agreement to go back on the promises given via the agreement and say "I will defy the agreement and go scot-free because the law is on my side." The law needs to take cognizance of the real life situation and protect such agreements and the parties against whom the breaching parties hatch the protection of law to hide behind.