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Shareholder’s Agreement – Explained!

What is Shareholders’ Agreement?

A shareholders’ agreement is a contract between shareholders which broadly defines the rights, powers and obligations of the shareholders. Ideally, the shareholders’ agreement is executed so that each of the shareholder is treated fairly and to ensure that no additional benefits are flowing to the other shareholder. 

Usually a shareholders’ agreement is constructed with the following parts:

  • A preamble which identifies the parties to the agreement
  • Preamble is followed by a list of recitals which captures the object and purpose of the agreement
  • Definitions section, which would define the critical terms of the agreement
  • Conditions agreed between the shareholders viz. management of the company, affirmative voting rights, pre-emption rights, anti-dilution, ROFO, ROFR, exit, etc.
  • Indemnification in case of breach of conditions
  • Term and termination

On a legal front, Shareholders’ agreement is usually governed by the law of the country in which such agreements are executed. 

In India, shareholders’ agreements are governed by the Indian Contract Act, 1872 and is enforceable in any court of law in India.  The parties to the agreement may also specifically define the court (for example, High Court of Bombay) as the jurisdictional court in which the disputes arising from the agreement.  Why is Shareholders’ Agreement Required?

We have briefly discussed what is the purpose of a shareholders’ agreement.  Before moving on to the detailed terms of the shareholders’ agreement, it is firstly, important to understand the basis and requirement of a shareholders’ agreement in the first place.

Under the Indian law, agreements are widely defined to include ‘every promise and every set of promises, forming the consideration for each other is an agreement’. From the definition, usually the following two types of Agreements have evolved:

  • Oral Agreement
  • Written Agreement

In the present day practice, all shareholders’ agreement are in the form of a written agreement.  The moot question is why shouldn’t a shareholders’ agreement be entered in the form of an oral agreement and why is it such that every investor seeks to execute a written shareholders’ agreement.  The answer to this question would probably address the need for a written shareholders’ agreement in the first place.

In principle, both oral and written agreement can convey the promise by one party to the other. An oral agreement is completely valid in law and is also admissible in court. However, as compared to a written agreement, an oral agreement may not prove to be much of evidentiary value. Also, in an oral agreement, in order to prove the consent between the parties various ancillary evidences needs to be collated such as various sequence of events and actions by each party, to prove existence of an oral agreement.  

Given that the shareholders’ agree for various rights and obligations, which otherwise can be agreed orally, but in case of a dispute, for the reasons cited above, a written shareholders’ agreement would always have better standing before a court of law and therefore, is preferred by the investors.

This post is part of our Founder’s handbook – “Negotiating Shareholder’s Agreement”, a comprehensive handbook for founders to negotiate shareholder’s agreement. Click here to download the complete handbook.

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