IS IT ADVISABLE TO INCLUDE THE SHAREHOLDERS AGREEMENT ENTERED WITH A FOREIGN INVESTOR INTO THE ARTICLES OF ASSOCIATION OF AN INDIAN COMPANY?

IS IT ADVISABLE TO INCLUDE THE SHAREHOLDERS AGREEMENT ENTERED WITH A FOREIGN INVESTOR INTO THE ARTICLES OF ASSOCIATION OF AN INDIAN COMPANY?

Section 58 (4) of CA 2013 says that If a public company without sufficient cause refuses to register the transfer of securities within a period of thirty days from the date on which the instrument of transfer or the intimation of transmission, as the case may be, is delivered to the company, the transferee may, within a period of sixty days of such refusal or where no intimation has been received from the company, within ninety days of the delivery of the instrument of transfer or intimation of transmission, appeal to the Tribunal.

What is Sufficient Cause?

Section 111A of the Companies Act, 1956 states: that “…the shares or debentures and any interest therein of a (public) company shall be freely transferable: provided that if a company without sufficient cause refuses to register transfer of shares…the transferee may appeal to the Tribunal and it shall direct such company to register such transfer of shares.”

How to Protect the  Rights of Foreign Investors ?

There are occasions when foreign investor invests in an Indian company, to protect their rights, there will be shareholders agreement between the company and the foreign investors offering some restrictions on transfer of shares. There may be a pre-emptive clause in such shareholders agreement. If pre-emption rights exist, new or existing shares in a company cannot be offered to other potential investors without first being offered to the current shareholders.

Earlier, the Bombay, Gujarat and Delhi, High Courts had inferred contractually agreed share transfer restrictions as being violative of the ‘free transferability’ provisions under the Section 111A of CA 1956.

However, the recent Bombay High Court verdict has turned in favour of shareholders, by identifying their rights to enter into such arrangements.

In the Messer Holdings Ltd vs Shyam Madanmohan Ruia case, the Bombay High Court recognised the rights of shareholders to voluntarily enter into binding contracts by inserting pre-emptive clause. 

In the Western Maharashtra Development Corporation Ltd vs Bajaj Auto Ltd, the Bombay High Court therefore resolved that “free transferability” did not hinder on the shareholders’ privileges to enter into consensual contracts to deal with their shares, either in the future or at the time of contracting.

To remove the difficulty, the CA 2013 introduced through the Section 58 (2), which states: “Any contract... between two or more persons in respect of transfer of securities shall be enforceable as a contract” thereby recognising the pre-emptive rights of the existing shareholders. 

The Supreme Court in the VB Rangaraj vs VB Gopalakrishnan case held that the only restrictions on the transfer of shares of a company that are enforceable are those that are included in its by-laws namely Articles of Association. 

In Vodafone International Holdings BV vs Union of India & Anr case, the Supreme Court in the correctly deviated from the interpretation offered in the Rangaraj case, viewing that none of the sections of the 1956 Act precluded shareholders from signing into contracts providing share transfer arrangements or for voting rights attached to their shares .

It seems  that the Supreme Court in the Vodafone case as well as Bombay High Court in the Messer Holdings case have taken the view that irrespective of the terms of the share transfer agreements being incorporated into the by-laws or Articles of Association , such agreements would be valid under general applicable laws and binding on the contracting parties.

Insertion of Entrenchment Clause in AOA under Companies Act 2013
 

Under the Companies Act 2013, there is an entrenchment provision which is not available in the earlier CA 1956 Act. An Entrenchment clause is a provision which makes some alterations or amendments more difficult or impossible. Section 5 (3), (4), (5) of CA 2013 contains provision as regards to entrenchment clause to be inserted in the Articles of Association. 

At the time of Investment a foreign investor may ask the Indian company to Include Entrenchment provisions in its Articles. This provision provides that any affirmative rights such as issue of shares, creation of new subsidiaries, borrowing more than a limit in the articles only be done with consent of foreign investors. 

Conclusion  

However, it is suggested that to safeguard the interest of the foreign investors, It is always advisable to incorporate the shareholders agreement which contain the pre-emptive rights in the Articles of the Association of the Indian company to safeguard the interest the foreign investors. 

Such protection offered to foreign investors will no doubt enhance the flow of the FDI into India offering guarantee to the foreign investors about the safety of their investment. 

Courtesy - MUKESH BUTANI- BUSINESS LINE