What should a shareholders agreement actually contain?

A shareholders agreement is the document you never look at until the relationship goes wrong, at which point it decides everything. The clauses below are the ones that actually get litigated.

Control

• Board composition: how many directors each shareholder or class may nominate, quorum, and what happens if a nominee is absent.
• Reserved matters: the list of decisions that cannot be taken without the consent of specified shareholders. Issuing shares, borrowing above a threshold, related party transactions, changing the business, selling material assets.
• Information rights: what accounts and management information each shareholder gets, and how often.

Getting shares in and out

• Transfer restrictions and pre-emption: existing shareholders get first refusal before shares go to an outsider.
• Tag along: if the majority sells, a minority shareholder can require the buyer to take their shares on the same terms. This is the minority's main protection.
• Drag along: if a defined majority accepts an offer for the whole company, they can compel the rest to sell. This is what makes the company saleable.
• Valuation mechanism: who values the shares, on what basis, and whether the valuer's decision is final. Leaving this vague guarantees a dispute.

When it breaks down

• Deadlock resolution: escalation to founders, then a casting vote, then a buy-sell mechanism such as Russian roulette or a shoot-out.
• Default and exit: what counts as a material breach, and what the defaulting shareholder loses.
• Dispute resolution: a clean arbitration clause with seat, venue, number of arbitrators and governing law.

• Board composition, who nominates whom, and the quorum
• Reserved matters requiring investor or minority consent, listed exhaustively
• Transfer restrictions: right of first refusal, tag along, drag along, lock-in
• Pre-emption on new issues, so holdings are not diluted by a cheap round
• Founder vesting and what happens to unvested shares on exit
• Deadlock resolution, with a mechanism that actually terminates
• Exit: IPO, trade sale, buyback, and the valuation method for each
• Governing law, seat of arbitration, and the forum for interim relief
• Incorporation of the key terms into the Articles, or much of it is unenforceable against the company

How to make the agreement actually stick

Three provisions of the Companies Act, 2013 decide whether your document has teeth. Section 10 provides that the memorandum and articles, once registered, bind the company and the members to the same extent as if each of them had signed them. That statutory effect is distinct from contractual obligations the company may itself undertake in a shareholders agreement. Check both documents and who signed the agreement. Section 5 then lets you go further and entrench specified provisions of the articles, so that they may be altered only if conditions more restrictive than a special resolution are met. In a private company an entrenchment provision introduced after formation requires an amendment agreed to by all the members, and notice of it must be given to the Registrar. This is the mechanism for hard-wiring reserved matters and pre-emption so that a majority cannot quietly vote them away two years later.

There is a fourth provision that cuts the other way and is regularly overlooked. The proviso to Section 58(2) says that a contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract. So a transfer restriction that never reached the articles is not worthless: you can still sue the shareholder who broke it. Whether you can restrain registration depends on the articles, the parties to the contract and the particular relief available. In practice you may end up with a damages claim, or an order for specific performance, against a counterparty whose shares have already moved. That is a materially worse position than having the restriction in the articles, which is the whole point of amending them.

Section 58 also gives a shareholder a route when the company refuses a transfer. A private company that refuses must send notice of the refusal, with reasons, within thirty days, and the transferee may appeal to the Tribunal within thirty days of that notice, or within sixty days of delivery where no notice was sent.

For a private company

Restrictions on transfer are permissible and indeed expected, since a private company must by definition restrict the right to transfer its shares. That gives more freedom than a public company has.

When the agreement is breached

Choosing the right forum matters more than clients expect, because picking the wrong one costs a year. A dispute arising out of a shareholders agreement is expressly listed as a commercial dispute under the Commercial Courts Act, 2015, so where the claim meets the specified value it goes before a Commercial Court, with an appeal to the Commercial Appellate Division of the High Court of Karnataka. Where the complaint is not really breach of contract but a course of oppressive conduct, the forum is the National Company Law Tribunal, and for a company registered in Karnataka that is the Bengaluru bench. Our note on shareholder disputes in private limited companies works through how those routes interact and which one to start in.

Before there is a company at all

A shareholders agreement is usually the second document, not the first. Where the company is still being formed, these terms belong in a founders agreement and are then carried into the articles and, when investors arrive, folded into the shareholders agreement. Signing a new agreement without reading the old one is how two inconsistent contracts about the same shares end up in front of the same tribunal.

One last piece of housekeeping: have the stamp duty under the Karnataka Stamp Act, 1957 assessed before execution, because an inadequately stamped agreement can be impounded at the moment you most need to produce it.