What is Shareholders’ Agreement?
A shareholders’ agreement is not very different from any typical agreement between two parties. It’s a written agreement between the shareholders of a company which broadly defines the rights, powers and
obligations of the shareholders.
Generally, shareholders’ agreement is executed so that each of the shareholder is treated fairly such that the rights and benefits of each shareholder are equitably vested.
Usually a shareholders’ agreement is constructed with the following parts:
- Title – usually titled as “Shareholder’s Agreement”. Title describes the broad purpose of the agreement
- Preamble – which lays out the important information about the agreement, such as description of 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 defines the critical terms of the agreement
- The consideration agreed between the shareholders viz. management of the company, affirmative voting rights, pre-emption rights, anti-dilution, ROFO, ROFR, exit, etc.
- Indemnification required to be provided by each of the parties in case of breach of the consideration mentioned in the agreement
- Term and termination – lays down the situations and conditions which will terminate the agreement
Legally speaking, shareholders’ agreement is governed by the law of the country in which such agreement is 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 can be settled.
Why is Shareholders’ Agreement needed?
Before moving on to the detailed terms of the shareholder’s agreement, it is important to understand the need of a shareholders’ agreement in the first place.
Under the Indian Contract Act, agreements are very widely defined to include ‘every promise and every set of promises, forming the consideration for each other is an agreement’. Evolving from the definition, there can be the following two types of Agreements:
- Oral Agreement
- Written Agreement
Therefore, a shareholder’s agreement can be entered in the form of an oral agreement as well as written agreement. Theoretically, both oral and written agreement can convey the promise by one party to the other. An oral agreement is 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.
Hence, to avoid any dispute between the parties due to ambiguities of an oral agreement a written shareholder’s agreement holds preference over an oral agreement.
When is a shareholder’s agreement executed?
Following step plan shows a suggested process in which a shareholder’s agreement is executed between the investor and the Founder at the time of raising funds.
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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