Understanding SHAs for the Founders
Understanding SHAs for the Founders
by getfundedeasily
February 18, 2022
One of the cardinal and burning requirements on the Founders’ plate, right after laying out the AoA (Article of Association) and MoA (Memorandum of Association), is the Shareholder’s Agreement a.k.a. SHA. While MoA and AoA are public documents (under section 399 of Companies Act 2013 (CA 2013) required for incorporating a company, the SHA is a private legal contract between some or all the shareholders of the company.
MoA, AoA, SHA:
MoA acts as a charter defining the scope and limitations of the company,
AoA functions as a legal document that lays down the rules regarding the management of the company specifically with regards to Liability of the members, duty of the directors, meeting, record books appointment and removal of directors, means of communication, use of seal, Director’s indemnity and insurance, and outlines all the details regarding the following:
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Share capital, Variation of rights, number and Value of shares
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Share classes
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Issue of preference shares,
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Allotment of shares
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Calls on Shares
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Liens on Shares
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Transfer and Transmission of shares,
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Forfeiture of shares
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Alteration of capital
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Buy back
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Share certificates
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Conversion of shares to stocks,
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Dividends and other distributions to members
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Voting rights and proxies.
SHA outlines the internal management framework[1] of the company to effectively protect the overall interest of the shareholders by spelling out the rights, obligations, provisions related to the management and the authorities of the company, definition of business – its operations – decision making, detailed below:
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Rights, obligations of the shareholders, transfer of shares (Share transfer Rights)
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Right to vote
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Right to appoint directors and the company auditor
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Right to ask for a general meeting
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Right to inspect books and registers of the company
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Right to the financial statements of the company
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Clears Authority and standing of a Shareholder and License one commands as the issuer of the shares by taking into account the powers and risks associated. SHA governs the interaction between small and large shareholders.
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Shareholder Liabilities: Shareholders have only limited liability and are not liable directly for the activities of the company. The liabilities of the shareholders are defined clearly in the agreement.
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Protection of minority shareholders: The rights of the minority shareholders (CA, 2013), are detailed in the SHA, to protect the minority shareholders in the event of mismanagement, oppression, or Piggy Backing (sale of shares by majority shareholders). SHA details the roles and protects the rights of the Minority Shareholders, gives them rights to purchase shares like majority shareholders,
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Ease in making amendments: Suitable requirement for small and medium scale businesses when they need to make minor amends, rather than legally alter the whole Constitution of the company.
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Proportion in which the shareholders will hold the shares
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Pre-emption rights of shareholders
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Powers of the Board of Directors (BoD) with respect to issuance and transfer of shares
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Certain rules are required to be incorporated in the SHA in India to protect the shareholders’ interest with regards to the transfer and sale of company shares, to ensure that such a sale or transfer happens only after receiving the mutual consent of the parties associated.
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Methods for Valuation of shares of the company: Considering the fluctuations in the market, proper valuation of shares is a key aspect. In India, the valuation methods and approaches are laid down precisely in the SHA.
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How the company will be run[2]
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Financial requirements of the company: Shareholders can proceed to obtain the most feasible source of funding, whenever they think it to be beneficial for the company. The SHA draft includes the procedure to obtain such finances.
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Guidelines on directing the business: SHA contains the guidelines, policies, and procedures to ensure smooth operations of the company on a daily basis.
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How important verdicts and decisions will be finalized
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Requirements of Quorum: The SHA will mention the requirements related to a quorum (the minimum number of members required to constitute a valid meeting)
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SHA Sections[3]:
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Partners in Agreement: Names of Partners, Company
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Ownership of Shares: Shareholder names, # Shares, % of shares held
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Background, Rationale, Spirit of the Agreement
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General commitments: Main Tasks, roles, responsibilities, Incentive of each partner
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Proceedings: voting terms and exceptions, quorum and qualification, decision on share capital changes, new shares, issuing convertible loans or options, selling all or major part of business, BoD decision authorization, approved timelines, communication channels and IDs for the above
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Competition Restriction Clause: Non-Compete details for the partners
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Buy-Back option in normal partner exit (timeline, conditions) and share disposal restrictions.
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Exit: In case of liquidation, distribution details for the shareholders
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Abnormal Exit Situation
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Rules governing Share Disposal: clauses, restrictions
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Market value Determination: In case of disagreement between partners, 3rd party (non-arms-length deal) clauses
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Disclaimers and order of Interpretation: Consistency with other agreements and AoA, remedies, modification clauses
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Other SHAs:
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Insight and Confidentiality: disclosure, restrictions, communication from public information perspective
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Communication between partners: channels approved
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Costs: Who will bear the cost of the SHA
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Assign Ability for the SHA
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Disputes and Governing Law: Jurisdiction with respect to city, country.
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Term: duration timelines of the SHA
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Ancillary Provisions and Signature: Amendment, addition, modification conditions imposed on the SHA
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Exhibits: defining milestones, Roles Responsibilities, Incentives, Revenue allocation, Additional resources etc.
SHA enforceability1:
While SHA is legal contract determining the liaison between and binding the parties (shareholders, company etc. as mentioned in the contract) to it, AoA & MoA together form the constitution of the Company, and thus bind all the shareholders of the company (under Section 10, CA2013).
It can be deduced from information above that a lot of Shareholding related points are present in both the AoA and the SHA. Whereas the AoA is formulated at the time of incorporation, the SHA provisions keep changing to keep abreast with the change in shareholding. So, which one holds precedence in case of a legal battle? This is an area which is still murky, since various verdicts point to changing preference – AoA [4] [5] [6] [7] [8] [9] vs. SHA[10] [11] [12] .
Post 1992 V.B Rangaraj litigation, the Supreme Court accepted the proposition that an agreement between two shareholders of a company, by which restrictions are imposed on their ability to transfer the shares, is wholly ineffective unless it is incorporated in the AoA of the company.
For the time being, it can thus be deduced that:
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Generally, for Public companies SHA clauses are enforceable and valid as long as it is in compliance with the laws and not contrary to the Company’s AoA (Section 58(2) CA 2013), whereas, for Private Companies section 58(2) is not applicable.
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If the company is not a party to the SHA then the SHA shall not be enforceable against the company and the clauses of AoA shall prevail.
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If the company is party to the SHA, then the SHA shall be enforceable provided the SHA clauses are not conflicting with the AoA, otherwise AoA shall prevail.
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Additionally, SHAs shall not be contrary to the provisions in CA 2013, otherwise they will be rendered void as per Section 6 CA 2013.
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