Shareholders Agreement Drafting

Key Clauses in a Shareholders Agreement (SHA)

The Shareholders’ Agreement includes the following clauses:

1. Preamble and Recitals

This section gives an overview of the background and purpose of the agreement. It identifies:

• The parties involved are the shareholders and the company.
• The nature of the investment or partnership.
• The objective behind agreeing is to regulate shareholding, control, and exit.

2. Definitions and Interpretations

This section features a clear set of definitions that prevent ambiguity and ensure uniform interpretation of terms in the agreement. Common terms include:

• “Promoter”, “Investor”, “Affiliate”, “Material Breach”, “Exit Event”, “Tag-Along Right”, etc.
• Rules of interpretation, such as singular/plural meanings, inclusion of statutory amendments, and use of headings.

3. Shareholding Structure

This clause outlines the capital structure and equity pattern:

• Existing shareholding before execution of the agreement.
• Post-investment share distribution, including different classes of shares.
• Any contemplated changes in capital due to future investment rounds or share splits.

4. Governance and Board Rights

This clause governs the management and control framework of the company, which includes:

• Board composition: Right of shareholders to nominate directors.
• Quorum requirements: Presence of specified shareholders or directors for valid meetings.
• Affirmative vote matters: Issues requiring special consent (e.g., mergers, borrowing beyond limits, change in business).
• Formation of sub-committees such as audit, remuneration, and their powers.

Reserved matters sometimes include:

• Issuance of further shares.
• Transfer or disposal of substantial assets.
• Declaration of dividends.
• Amending constitutional documents.

5. Transfer of Shares

This clause is drafted to control the flow of ownership and protect shareholder interests. It includes:

• Right of First Refusal (ROFR): If a shareholder wishes to sell their shares, they must first offer them to existing shareholders on the same terms and conditions.
• Right of First Offer (ROFO): The selling shareholder must offer their shares to existing shareholders before approaching external buyers.
• Tag-Along Rights: If a majority shareholder sells their stake to a third party, minority shareholders have the right to join the transaction and sell their shares on the same terms.
• Drag-Along Rights: Majority shareholders can compel minority shareholders to sell their shares in the case of the acquisition of the company.
• Lock-In Period: A restriction on the sale of shares by specified shareholders (e.g., promoters or key investors) for a defined period to ensure commitment and stability.

6. Funding and Capitalization

• This clause specifies the mechanisms for raising additional capital, which include:
• Commitments from shareholders for future funding.
• Provisions for rights issues or preferential allotments.
• Anti-dilution protections: Adjustment of shareholding if new shares are issued at a lower price than earlier investments.

7. Dividend Policy

This clause outlines how profits will be distributed; it defines

• Whether and when dividends will be declared.
• Minimum dividend payout ratio, if any.
• Priority of dividends for different classes of shareholders.
• Reinvestment provisions, especially for growth-stage companies.

8. Exit Rights

This is the most crucial for investors; this clause outlines scenarios and procedures for exiting the company:

• Initial Public Offering (IPO): Provision for automatic conversion of preference shares and lock-in periods.
• Strategic sale: Rights of shareholders in case of merger, acquisition, or sale of substantial assets.
• Put/Call Options: Right to compel the company or other shareholders to buy/sell shares at a predetermined valuation.
• Valuation methods: Mechanisms such as DCF, EBITDA multiples, or third-party valuation.

9. Confidentiality and Non-Compete

This clause is drafted to protect the company’s proprietary information and market position. It clearly:

• Defines confidential information.
• Obligations of parties to maintain secrecy, even post-termination.
• Exceptions for disclosures required by law, regulators, or courts.
• Restrictions on shareholders from engaging in competing businesses or soliciting employees/customers, typically within a defined territory and time frame.

10. Covenants

These are ongoing commitments made by shareholders and the company to maintain compliance and discipline:

• Compliance with applicable laws, including the Companies Act, FEMA, SEBI regulations, and sector-specific guidelines.
• Not to encumber or pledge shares without consent.
• Maintenance of statutory registers and timely ROC filings.
• Adherence to agreed-upon business plans and operational budgets.

11. Representations and Warranties

These are the assurances made by each party to validate their legal and financial position, which include that the:

• The company is legally incorporated and validly existing.
• Shares are free from encumbrances.
• Financial statements reflect an accurate and fair view of the company’s affairs.
• No ongoing litigation or undisclosed liabilities exist.

12. Governing Law and Dispute Resolution

This clause determines the jurisdiction and forum for resolving disputes. It includes:

Governing Law: Usually Indian law (or another mutually agreed jurisdiction)

Dispute Resolution Mechanism:

- Arbitration under the Arbitration and Conciliation Act, 1996
- Number of arbitrators (one or three)
- Seat and venue of arbitration (e.g., Mumbai, New Delhi)
- Language of proceedings
- Allocation of arbitration costs

13. Termination

This clause specifies conditions/events that would terminate the agreement; it can be either:

• Mutual consent.
• Occurrence of specified events: insolvency, fraud, prolonged deadlock, or breach.
• Regulatory order requiring the dissolution or winding up of the company.

14. Miscellaneous Clauses

• Entire Agreement: Declares the SHA as the complete agreement superseding prior discussions or term sheets.
• Amendment: Requires consent of a defined majority (e.g., 75% of shareholding) for any changes.
• Severability: Invalidity of any provision shall not affect the enforceability of the rest.
• Force Majeure: Suspension of obligations due to unforeseen, uncontrollable events such as war, natural disaster, or pandemic.
• Assignment: Restrictions on transferring rights and obligations without prior written approval.
• Execution in Counterparts: Allows the SHA to be signed in multiple original copies, each considered a valid part of the agreement.