What is shareholders agreement?

The shareholders agreement is that agreement which imposes certain rights and obligation
towards the company’s shareholders. This agreement is wilfully signed between the
shareholders of that particular company. There are two circumstances in which this
agreement is drafted. First, when 2 individual person are coming together to form a company
or when two individual companies are signing agreement to form a third company. The
agreement also focuses on how to manage the relationship between different shareholders of
that company.
Shareholders agreement in Indian Legal system:
The shareholders agreement is explicitly not mentioned anywhere in our statues or in any
bare section of any Indian act but it generally is presumed to be given protection under the
Indian contract act of 1872.
To avail the protection in the companies act the shareholders agreement must be in
conformity with the article of association of the company. The article of association of a
company is an agreement which governs the functioning of the company and prescribes
certain terms and conditions that must be followed by the company in order to have smooth
functioning of the company.
Difference between shareholders agreement and article of association:
There is no such big difference between article of association and shareholders agreement.
The shareholders agreement talks more about the rights and duties of the shareholders of that
company and the article of association talks more about the rules on how the company should
run. It lays down certain guidelines for the board of directors. In the case of VB Rangaraj V.
VB Gopalkrishnan and others the honourable Supreme Court made it clear that in case of
conflict between the article of association and shareholders agreement the former would have
more weightage. The S.C made it clear in this judgement and also in other judgement in the
future that if they want to make each and every clause of the shareholders agreement
concerning third party and non-company matters imposable then these clauses needs to be
mentioned in the article of association of the company as well.
Important clauses of shareholders agreement between:
Share vesting clause: This clause specifies certain conditions which should be fulfilled by
the shareholder in order to get the unvested shares. There is a separate clause containing
terms that need to be fulfilled in the vesting clause this clause is known as terms of vesting.
The terms should be explicitly mentioned in the agreement to avoid future disputes. There
can be many conditions that needs to be fulfilled. Some Terms of Vesting include remaining
with the business for a minimum period of time or hitting specific company targets. The
company has the automatic rights to purchase unvested share.
There is something call the cliff period in this clause. This means that the company will hold
the unvested shares for a particular time period before allotting it to the respective
shareholders. For example if the cliff period is of 6 months than 25% of the share will be sold
after the period of 6 months remaining 75% will be sold in the 18 months period.
Specific rights to appoint directors:
The shareholders play a very important role in the appointment of the directors of the
company. This clause can protect the interest of the4 minority shareholders because in a
company the minority shareholders are not permitted to remove the directors therefore this
clause can be used to give the rights to the minority shareholders to cast their votes along the
majority shareholders to cast their votes. Giving these rights to the investors would help
increase their confidence.
1) Affirmative Voting Clause: what this clause does is that it reserves certain matters for
the investors. This means that decision on certain matters can’t be taken without the
consent of the investors of that company.

Anti-dilution rights:
This is one of the most important clause as it protects the interests of the investors if the
company decides to issue new shares to a third party. In simple terms it means that if the third
party gets the newly issued share at greater valuation as compared to the valuation at which
the investor had bought then it that case the investor has the option to automatically update
the face value of his shares and make it as same as that of the third party. Thus, an anti-
dilution clause typically works by adjusting the conversion price of the preference shares or
convertible debentures that the investor holds, so that the investor can get correspondingly
higher number of shares. The objective is to treat the earlier investment as though it had been
made at the lower valuation.
Liquidation preference:
This clause is mentioned in the agreement to protect the rights of the investors. In this clause
if a company is getting bankrupt or it is in the stage of winding up then if the investors or
shareholders are under the protection of the liquidation preference then they will be on the 1st
position to whom the company will look to pay the invested amount of their investors under
this group. It is also valid when the company is making profit. This means that when the
company is making the profit the investor can retain his share of investment along with IRR
which is similar to interest rate of a percentage already agreed through the agreement.
Pre-emption rights:
These rights are those rights in which the existing shareholders can proportionately subscribe
to a fresh issue of shares so that they are not diluted. This clause is inserted to help the
shareholder maintain their shareholding pattern. Section 62 of the companies act 2013 talks
about the pre-emption rights of the shareholders in public company. Under the same section
the private companies are presumed to have this section of pre-emption rights for their
investors.
Drag-along and Tag-along clause:
Usually, a majority of shareholders (i.e. 51%) is needed to appoint and take away
administrators from the board that permits effective management of the corporate. However,
this suggests that a minority stockholder won't have the correct to illustration on the board,
despite the very fact they'll delay to forty ninth of the shares. Therein case, a stockholder
agreement could enable a minority stockholder the correct to appoint a director if they hold a
minimum share of shares (e.g. 25%). A “restricted activities” clause in a very stockholder
agreement can also need a “super-majority” of shareholders (e.g. seventy fifth or more)
before ensuring selections, like getting into a serious dealings, hiring key employees, paying
dividends, or provision a lot of shares. This could make sure that minority shareholders still
have some management over the governance of the corporate.
10. Fundamental Disputes
Sometimes, disputes between shareholders to such an extent that a dead-end happens that is
incapable of resolution and has the potential to cause serious injury to the business as a going
concern. This might embody a dispute over extra funding for the corporate, a rise or
reduction or shares, payment of dividends, or disagreement concerning the sale of the
business. During this case, a “fundamental dispute” clause is often accustomed to offer an
exit strategy as well as a mechanism for one or a lot of shareholders to shop for out the
others. There may well be a freelance valuation or pre-determined formula, as mentioned
higher than with relevancy restrictions on the transfer of shares. If AN agreement can't be
reached, a “shotgun” clause is additionally a remarkable (but somewhat dangerous) valuation
technique, whereby if one stockholder makes a suggestion to buy the shares at an explicit
value, the opposite stockholder will either sell their shares or purchase the shares at that
expressed value. This ensures that the offerer doesn't build a suggestion below the perceived
value of the shares unless they want to risk losing their own shares at below value. Though an
elementary dispute clause may be expedient, it's desirable to a dead end, which can end in the
corporate losing all the worth it's designed up over a few years.
CONCLUSION:
The shareholders agreement is an agreement that we will be hearing a lot in the coming years.
The emergence of Indian stock market and the spread of its awareness among the local public
has led to the increase in the significance of shareholders agreement. The careful drafting of
shareholders agreement has become more important than it ever was. However there are still
a lot of new-age investors who don’t go through the clauses carefully and end up trapping
themselves. This article will shed light on the important clauses which will help the new
investors get a brief idea about what shareholder agreement means and what are meanings of
the potential clauses, this will help them in becoming self-sufficient in understanding the
clauses and make wise decisions while investing in any companies. I feel the shareholders
agreement is the next big thing in the field of corporate contracts. It will act as a bridge
between the investors and the board members of the company in the coming days and this
agreement will also help in increasing the confidence of the upcoming investors.

Feedback: The topic assigned to you was “Explain the essential clauses of a shareholders
agreement in light of Kingfisher and Continental airlines”, I am assuming that a shareholders
agreement could not be discussed with reference to that deal and therefore you wrote about a
Shareholders agreement only, if not then please let me know. You need to incorporate the
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