Conflicts between Shareholders Agreements and Articles of a Company

The issue of conflicting provisions in a Shareholders Agreement (SHA) and the

articles of association (Articles) of a company is a never ending debate, and
perhaps a rather confounding one in company law. A recent order of the Delhi High
Court in World Phone India Pvt. Ltd v. WPI Group Inc USA, [2013] 178 Comp Cas 173 (Del),
holding that clauses in a SHA which are not repugnant to the Companies Act but not
incorporated in the articles of the Company, would be unenforceable, has only added to this
confusion. This post is an attempt to expound the law surrounding this decision.

As a background, it would be apt to note that conflicts between SHA and the Articles
of a company can be of two types; first, where the conflict relates to the management of the
company (affirmative vote, board of directors, accounts, etc.) and second, where the conflict
relates to the transferability of shares. The latter has been the subject of extensive case law in the
Supreme Court and High Court and has been dealt with in this blog at various instances. As
regards the
former, two main questions arise;

1) Whether a provision in a SHA that is contrary to the Articles of the company is valid
and enforceable?

2) What are the possible remedies for a shareholder against breach of a SHA by other
shareholders even though such action would not be construed as a breach under the Articles of
the company?

Probably the most important case in this regard is that of VB Rangaraj v. VB Gopalakrishnan,
(1992) 1 SCC 160 (available here). In that case, while dealing with a conflict between the SHA
and the Articles of the company of the latter type, i.e. a conflict dealing with the transferability of
shares, the Supreme Court took the view that the provisions of a SHA imposing restrictions even
when consistent with the Companies Act, are to be authorised only when they are incorporated in
the Articles of the Company.
The decision of the Supreme Court was based on the seemingly settled position that where there
is a contradiction between the SHA and the Articles of a company, the latter will prevail. In IL &
FS Trust Co. Ltd. v. Birla Perucchini Ltd., [2004] 121 Comp Cas 335 (available here), the
decision in Rangaraj was also held applicable to conflicts in the Articles and SHA not involving
transfer of shares.

It is settled law that the Articles of a company would prevail when there is
a contradiction between the SHA and the Articles. But assuming that there is a certain provision
in the SHA that has not been incorporated in the articles of the Company, would it mean that
merely because the articles are silent (not contradictory), the articles will prevail?
The answer to this question might lie in recognition of the legal position that a company is
controlled only by its Memorandum and Articles. The Articles are a form of a statutory contract
binding all the members of the company as regards the affairs of the company. A company
cannot contract outside the Articles in so far as the management of the affairs of the Company is
concerned, and any other agreement attempting to bind the company as regards its affairs, not
provided for in the Articles and Memorandum of the company, may not be enforceable. For
instance, a provision in a SHA giving a casting vote to the Chairman of the Board in case of a tie,
not provided in the Articles, will not be enforceable. However, this may also depend on whether
the company is a party to the SHA. (See Russell v. Northern Bank Development Corp Ltd, [1992]
1 WLR 588 )

In World Phone, the Board of Directors of the company passed a resolution approving a rights
issue in accordance with the Articles of the company, even though such an action required the
affirmative vote of the Appellant in accordance with a SHA entered into between the
shareholders of the company. The Company Law Board had held that since the provisions of the
SHA granting an affirmative vote to the appellant were not incorporated in the Articles of the
company, the said provision is unenforceable and the board resolution approving the rights issue
was valid. On appeal, Justice Muralidhar of the Delhi High court held “ the legal position is that
where the articles of association are silent on the existence of an affirmative vote, it will not be
possible to hold that a clause in an agreement between shareholders would be binding without
being incorporated in the articles of association. The question to be asked is whether the
provisions of an agreement, that are not inconsistent with the Act, but are also not part of the
articles of association, can be said to be applicable. All that section 9 states is that the clauses in
the agreement that that “repugnant” to the Act shall be “void”. This does not mean that the
clauses in the agreement which are not repugnant to the Act would be enforceable,
notwithstanding that they are not incorporated in the articles of association.”

Thus, the court has held that the provisions of the SHA, though silent in the Articles of the
company, and not in contradiction with them, will not be enforceable. This ruling, as it stands,
brings in a lot of confusion to the issue of conflicts between SHAs and Articles
of a company- because the issues don’t stand resolved merely with the conflicting provisions
being unenforceable. Further issues arise in light of the judgment of the Supreme Court
in Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613 (available here),
that have not been considered by the
Delhi High Court in World Phone.

In Vodafone, three main observations were made by the Supreme Court on the issue;

a) That the Supreme Court does not subscribe to the view in Rangaraj that restrictions in a
SHA, though consistent with company law, are to be authorised only when they are incorporated
in the articles of the Company. (it is still doubtful whether Rangaraj has been overruled as the
Court didn’t explicitly say so)
b) Shareholders can enter into any arrangement in the best interests of the Company, but the
only thing is that the provisions of SHA shall not go contrary to the articles of the Company.

c) Breach ofSHA which does not breach the Articles of a company is a valid corporate
action, but the parties agreed can get remedies under the general of the land for breach of any
agreement and not under Companies Act.

In light of the above, a logical extension of the judgment in World Phone would be that even
though the provisions of an affirmative vote are not incorporated in the Articles of the company,
and though the action of the company in providing for a rights issue would be valid under the
Companies Act, such an action will still be in breach of the SHA for which the aggrieved
shareholder can pursue an action for breach of contract.

This view is also consistent with the position in English law. In Southern Foundries Ltd v.
Shirlaw, [1940] AC 701 it was held, “a company cannot be precluded from altering its articles
thereby giving itself power to act under the provisions of the altered articles–but so to act may
nonetheless be a breach of contract if it is contrary to a stipulation in the contract validly made
before the alteration”, and the court awarded damages for wrongful dismissal of the managing
director of the Company even though the mode of dismissing was valid under the Articles of the
company. There is considerable opinion to show that the relief may also lie in terms of an
injunction to restrain it possible breach of the SHA contract.

On 9th May, 2013, the Supreme Court refused to admit a SLP in the World Phone case stating the
opinion expressed in the order was only as regards interim relief and that the CLB was to decide
the issue uninfluenced by the observations of the High Court. This
sets the stage for a new round of litigation where it is hoped that issues concerning the conflicts
between SHAs and Articles of a company would be finally settled.

Source: https://indiacorplaw.in/2013/06/conflicts-between-shareholders.html