Keywords: M&A, Veto Rights, Affirmative Voting Rights, Enforceability, SHA
INTRODUCTION
Veto rights or affirmative voting rights hold immense significance to the shareholders who wish to attain substantial control in the management and affairs of the company rather than just an interest in a term venture for profit. Its relevance is most pertinent to the minority shareholders of the company. However, it does not imply that Institutional or Private Equity Investors or Venture Capitalists are exclusively aloof to the affairs of internal management of the company, instead, such investors also have some bearing towards certain reserve matters of the company and claim a right of veto or affirmative voting rights, which are often heavily negotiated at the time of entering into a Shareholders/ Joint Venture Agreement.
However, there are certain concerns that have to be kept in mind by the investor while negotiating such rights in an M&A or a Joint Venture transaction, especially with respect to the enforceability of such rights, since the Companies Act, 2013 (Companies Act) is silent on certain aspects of these rights that have been discussed below.
ANALYSIS
Firstly, an investor can rightly insert a clause into the Shareholders’ Agreement (SHA) providing them veto rights with respect to the Shareholders’ General Meetings even though CompaniesAct does not address such a clause. However, the investor should ensure that the Company is also made party to the SHA and such Company undertakes to amend and incorporate those clauses in its Articles of Association (Articles). Since a company derives power and authority from its Articles, companies and their members are bound to comply with the provisions of their Articles as per Section 10 of the Companies Act. As already held in the case of V.B. Rangaraj v. V.B. Gopalakrishnan and Ors., that the terms of the Agreement shall not be enforced unless they have been incorporated in the Articles of the company.
However, the Company must ensure that the Articles are in consonance with the provisions of the Companies Act. If such Articles of the Company bypass or are ultra vires the provisions of the Companies Act, the provisions of the statute shall overrule the Articles of the Company.[1] The Companies Act ensures that the companies are democratically governed, therefore, providing special rights such as veto rights to the investor who is a minority shareholder, shall not be contrary to the provisions of the Companies Act nor its objectives.
The effect of such veto rights is to protect the minority shareholders’ interests i.e. the investors and hinder or restrict the possible arbitrary conduct or absolute control by the majority shareholders of the Company, especially over the matters relevant to the minority shareholders. However, to enforce such a clause it is necessary for the Company to amend its Articles bringing it in consonance with the SHA. As it has been observed by the Delhi High Court in the case of World Phone India Pvt. Ltd. and Others v. WPI Group Inc. (USA), special rights agreed under an SHA if not incorporated in the Articles, are not binding on the company and clauses in the memorandum, Articles, SHA or resolution if in contravention with the Companies Act, shall be void.
Secondly, while analysing the enforceability of an affirmative voting rights provision in favour of an investor, to further protect the interest of the investors with respect to their special rights, the Companies Act also allows for entrenchment provisions in the Articles, that means specified provisions of the Articles may be altered only if conditions or procedures previously agreed by the parties, which may be more restrictive than those required by law in the case of passing of a special resolution are met or complied with[2]. Thus, a clause requiring an affirmative vote of a particular shareholder for any amendment in the Articles will be enforceable.
Such an entrenchment provision further results in the protection of the interests of the investor where, the Company shall be restricted to exercise its majority opinion by making an arbitrary amendment in the Articles with respect to the concerned rights of the minority investor, thereby prejudicing the minority interests in the company. Thus, the insertion of an entrenchment provision lets the minority investors to exercise some amount of control and effectively put their view on board.
Thirdly, it has to be noted that the SHA is ultimately an ordinary contract. And since its subject matter revolves around the manner in which the Company’s affairs will be conducted, it defines the rights and liabilities of the shareholders and the Company. Hence, the SHA is governed by two legislations i.e. the Indian Contract Act, 1872 (Contract Act) and the Companies Act; its mere non-enforceability under corporate law does not ipso facto imply its non-enforceability under contract law as well. This is because under the Contract Act, an agreement becomes invalid if it falls under section 23, i.e. if it is forbidden by law or is of such nature that, if permitted, would defeat the provisions of law. Since the Companies Act is an enabling statute, a SHA is not forbidden under the it
Further, it is not always that enforcing a SHA under the Contract Act would defeat the provisions under the Companies Act, as sometimes the Companies Act itself allows for such contracting explicitly or impliedly or through its silence on certain aspects which a SHA deals with. Hence, where a SHA is not affected by section 23 of the Contract Act, it could be enforced as an agreement under contract law even when no remedy can be awarded for its breach under Companies Act .[3]
CONCLUSION
Since Veto, affirmative vote or consent rights are a bunch of contractually-agreed matters provided in a Joint Venture Agreement or a Shareholders’ Agreement that need consent of all the parties before being approved and implemented; for the investors their enforceability depends on the Company being made party to it, and the terms of such SHA be brought in consonance with the Articles of such Company by way of an amendment.
[1] Section 6, Companies Act, 2013
[2] Section 5(3), Companies Act, 2013
[3] Vodafone v. Union of India (2012) 6 SCC 613
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The term "joint venture" is used to describe a company where two or more companies are formed by the same person or persons and one of these companies is acquired by another company.