Shareholders' Agreement vs Articles of Association: Which Prevails and How to Enforce Them

Founders and investors usually negotiate a shareholders' agreement (SHA) in detail, covering board seats, veto rights, transfer restrictions, exit and valuation. What many do not realise is that the company's articles of association (AoA) have separate legal force, and the two documents do not automatically align. Disputes often turn on which document says what, who is bound by it, and how it can be enforced.

What Is the Legal Nature of Each Document?

The articles of association are the constitutional document of the company, filed with the Registrar. Under Section 10 of the Companies Act, 2013, they bind the company and its members as if signed by each of them. An act of the company or its board that violates the articles can be challenged as invalid. The articles can be changed only by a special resolution under Section 14, and the change must be filed with the Registrar.

The shareholders' agreement is a private contract among the shareholders, and often the company. It binds only its parties, and it is enforced like any other contract, by damages, specific performance or injunction, and often through arbitration. It can be changed by agreement of the parties and does not require a filing. Its provisions are not automatically binding on the company unless the company is a party to it.

Which Prevails If They Conflict?

The articles prevail as far as the company is concerned. An action by the company in line with the articles is valid even if it breaches the SHA, and the remedy of the aggrieved shareholder is then against the other party to the SHA, usually for breach of contract. Where an SHA requires, for example, the investor's consent to certain decisions, but the articles do not, the board may act without that consent, leaving the investor with a claim for damages and not the ability to invalidate the act.

That is why well-drafted SHAs include a clause requiring the parties to amend the articles to reflect the SHA and providing that, in case of conflict, the SHA prevails between the parties. Courts have been willing to enforce an SHA between its parties, even for provisions that are not in the articles, as in Messer Holdings v. Shyam Madanmohan Ruia, but the stronger course is to have the key rights in both.

Which Rights Should Be in the Articles as Well?

For a private company, rights that must bind the company, or that affect the transfer of shares, should be in the articles:

• Restrictions on transfer of shares, including rights of first refusal and lock-ins
• Tag-along and drag-along rights
• The right of an investor or founder to nominate directors
• Reserved matters that require the investor's consent
• Pre-emption rights and anti-dilution protections
• The procedure for board and shareholder decisions, including quorum

A private company's restrictions on share transfer must be in the articles to bind the company, because the definition of a private company in Section 2(68) rests on the articles. In V.B. Rangaraj v. V.B. Gopalakrishnan (1992), the Supreme Court held that restrictions on transfer not found in the articles are not binding on the company or on transferees. A different position applies to contracts between shareholders, and Section 58(2) provides, for public companies, that any contract or arrangement between two or more persons in respect of the transfer of securities is enforceable as a contract. Even so, aligning the articles removes doubt.

What Is Entrenchment?

Section 5(3) permits articles to contain entrenchment provisions, which make certain changes harder than a special resolution, for example by requiring unanimity or consent of a named shareholder. Entrenchment can be included in a private company only with the agreement of all members, and in a public company by special resolution, and the company must notify the Registrar. Entrenchment is a useful way to lock in the SHA's protections and prevent the majority from removing them by amending the articles.

How Is an SHA Enforced?

The usual remedies for breach are:

• A suit or arbitration for specific performance of an obligation, such as transferring shares at an agreed price
• An injunction to restrain a transfer, a vote or an act in breach of a negative covenant
• Damages for loss caused by the breach
• A petition for oppression and mismanagement where the breach is also oppressive to a member
• Termination or call options, if the agreement provides for them

Because the Specific Relief Act was amended in 2018, specific performance is now the general rule rather than an exception, which helps enforcement of SHA obligations. Most SHAs also contain an arbitration clause, and parties should check whether a particular relief, such as the Tribunal's statutory powers under Sections 241 and 242, is better pursued before the NCLT. Our guide to arbitration clauses and Sections 8 and 9 explains the interplay with courts.

What Mistakes Should Be Avoided?

Three recur. First, not making the company a party to the SHA, which limits what can be enforced against it. Second, leaving the articles unamended, so that the SHA's protections depend on contract alone. Third, using a template without adapting it, with inconsistent definitions or unrealistic provisions that a court may decline to enforce. Listed companies have additional disclosure requirements for agreements among shareholders, and conflicting provisions can have regulatory consequences.

For disputes between founders, see our note on co-founder disputes, and for director removal rights, see removal of a director under Section 169. Our Contract & Arbitration practice drafts and reviews shareholders' agreements and articles, and you can request a consultation.