Shareholder’s Agreement is the agreement made between the shareholders of the company among themselves. This case is related to validity of provisions of shareholder’s agreement which is in contravention to the Article of Association.
The main question that falls for consideration in both the appeals is whether the shareholders can among themselves enter into an agreement which is contrary to or inconsistent with the Articles of Association of the company
There were appeals filed by defendant 1 and by defendants 4 to 6, against decision of Madras High Court. The defendant 3 was private limited company which had total shareholding of 50.
There was jointly family, which were the plaintiffs in the present case. They were group of minority shareholder holding 13 shares and the remaining 37 shares were held by people from outside. Later on, the joint family acquired the remaining 37 shares.
This family consisted of Baluswamy and Guruviah Naidu who were brothers, wherein both held 25 shares each in company. The plaintiffs said that in 1951 there was an oral agreement between Baluswamy and Guruviah Naidu.
The agreement said that each branch of family would always continue to hold equal number of shares, which are, 25. If any member in either of branches wished to sell his share, then he would give first option of purchase to members of that branch. Only if offer made was not accepted, then shares would be sold to others.
The plaintiffs, defendant no. 1 and 2 and Selvaraj are the sons of Baluswamy Naidu whereas defendants 4 to 6 are the sons of Guruviah Naidu. Baluswamy Naidu died on February 5, 1963 and Guruviah Naidu died on January 10, 1970.
The defendant 1 who was one of the son of Baluswamy Naidu made a contrary decision as to the agreement as he sold shares to son of defendant 4 to 6 who are sons of Guruviah Naidu.
So, the original application was filed by Baluswamy’s other sons in order to:
(i) Declaration that the sale made by defendant was void and therefore not biding upon plaintiffs and the defendant no. 2 who is also Baluswamy’s son but he joined as proforma defendant.
(ii) Order which directs defendant no. 1 and 4 to 6 so as to transfer the shares sold to them back to plaintiffs and defendant no. 2.
(iii) There must be a permanent injunction in order to restrain defendants 4 to 6 so that they will not be able to apply for registering the shares in their names. Also, they cannot act adversely to the interests of plaintiffs and defendant no. 2 on basis of transfer of shares.
Trial Court passed a decree in the present suit and held that sale of the shares were invalid. The sale was not binding on plaintiffs and defendant no. 2. The court also directed both defendant no. 1 and defendants 4 to 6 to transfer the said shares to the plaintiffs and also granted permanent injunction. The appeals which were filed by defendant no. 1 and defendants 4 to 6 were dismissed.
High Court held that
(i) Sale of the shares by the defendant no. 1 in favour of defendants 4 to 6 was invalid and therefore plaintiffs and defendant no. 2 became entitled to purchase the shares.
(ii) The agreement made was binding on the company.
(iii) The company was bound in law to register the shares in the name of plaintiffs.
The defendant contended that agreement imposed an additional restriction on right to transfer shares. The restriction was included in any of Articles of Association. Hence it was not binding on any shareholder of shares. It was unenforceable by law so, not binding on company. Therefore, the sale of shares by defendant no. 1 to defendants 4 to 6 was not invalid. The High Court was wrong in directing the transfer of shares in favour of plaintiffs.
They also contended that if we assuming that sale of shares by defendant no. 1 to defendants 4 to 6 was invalid as per agreement, High Court could only have declared that sale was invalid and it could not further direct transfer of shares in favour of plaintiffs. The defendant no. 1 could not be forced to sell shares to the plaintiffs.
They contended that shareholders were bound by agreement made in the year 1951. The agreement was entered in order to maintain ownership of company in the family and to ensure that two branches of family had an equal share in management and also in profits and losses of company.
Also, it contended that there was nothing in Articles of Association which prohibited such agreement and the two branches of family were a party to agreement so it was enforceable against them. So, the courts have done nothing more than to enforce agreement.
The sections involved in the case are section 3(iii), section 26, section 28, section 31, section 36, section 40 and section 82. These provisions of Act make it clear that AOA are regulations of company which are binding upon it and its shareholders. Also, shares are movable property and their transfer is regulated by the Articles of Association of the company.
The court in order to come at a conclusion relied on S.P. Jain v. Kalinga Tubes Ltd. This was a case between two groups of shareholders wherein these two groups held equal number of shares in the company which was then a private company. They entered into an agreement with the appellant who was a third party and certain terms were agreed to. Various resolutions were passed by company in order to implement agreement. But, neither AOA were changed to embody terms of agreement nor there was any resolutions were passed.
In 1956-57, the company was converted to public company but the agreement of 1954 was not incorporated into Articles. Disputes having arisen, the matter reached the Court. The appellant claimed the benefit of the agreement of July 1954.
It was held by Court that said agreement was not binding on private company and also not on public company when it came into existence in 1957. It was an agreement between non-member and two members of company and although for some time agreement was carried out, some of its terms could not be put in AOA of public company. The company was not bound by the agreement so it was not enforceable.
SUPREME COURT’S DECISION:
The court looked in to the article in the agreement which was related to restriction on shares of the company. The article read that: “No new member shall be admitted except with consent of majority of members on death of any member of his heir or heirs or nominee shall be admitted as member. If such heirs or nominee are unwilling to become member, such share capital shall be distributed at par among members equally or transferred to any new member with the consent of the majority of the members.”
So, the court after looking at the article said that the private agreement which is relied upon by plaintiffs, there is restriction on living member to transfer his shareholding only to branch of family to which he belongs in terms imposes two restrictions which are not stipulated in the Article. Firstly, it imposes a restriction on a living member to transfer the shares only to the existing members and secondly the transfer has to be only to a member belonging to the same branch of family. The agreement obviously, therefore, imposes additional restrictions on the member’s right to transfer his shares which are contrary to the provisions of the Article. They are, therefore, not binding either on the shareholders or on the company.
Therefore, the appeals of the defendants were allowed and the decree of the High Court was set aside.