As a general rule, in the context of extraordinary transactions - mergers, acquisitions, establishment of new corporate vehicles - a joint venture or shareholder agreement is the precursor to and provides the framework for the incorporation of a newco / acquisition of a targetco / other hybrid structures. Once incorporated, the distinct legal entity is governed by its statutory documents like the Articles or Association (AoA) and Memorandum of Association. Prudent practice dictates that the covenants of the precursor agreements be included in the statutory documents, or at least reference be made to them, to ensure protection and enforcement of the initial intentions of the parties.
More specifically, in India, it is settled law that in case of repugnancy between the covenants of the precursor agreements and the articles of association, the latter prevails. It is in case of ‘silence’ in the articles of association in relation to a particular covenant of the precursor agreements that an interesting change in judicial approach can be observed. The shift has been one of enforcing precursor agreements to the extent that their provisions can be reasonably read within the framework of the articles of association.
The scope of this article is to examine the application of the provisions of the precursor agreements in cases where the AoA is silent on certain details of a particular statutory process.
V B Rangaraj approach: In case of AOA silence, JV provisions cannot be brought in
Matters which may find their place in the AoA as well as the JV agreement generally relate to the transfer and restriction on transfer of shares, right of preemption, tag along right, call and put options, powers of directors and the functioning of the board. It is in such matters that sometimes parties fail to include in the AoA what is agreed in the precursor agreements.
The approach taken by the Indian Supreme Court in VB Rangaraj v. VB Gopalkrishnan & Ors. AIR (1992) SC 453 was one where a provision of the precursor agreement relating to company affairs could not be enforced as the same was not provided also in the AoA. In this case, a private limited company had a total shareholding of 50, shared equally by brothers B and G of a joint family. The brothers entered into an oral agreement whereby it was agreed that each branch of the family (branch B and G) would always continue to hold equal number of shares (25 shares) and if any member of that branch wished to sell the shares, he/she would give members of its own branch the right to first refusal.
However, this oral agreement was not included in the AoA and its article relating to transfer of shares only provided that: No new member shall be admitted except with the consent of the majority of the members. On the death of any member, his heir or heirs or nominee, shall be admitted as member. If such heir, heirs or nominee is/are unwilling to become a member, such share capital shall be distributed at par among the members equally or transferred to any new member with the consent of the majority of the members.
After the death of brothers B and G, contrary to the oral agreement, son of B sold his shares to the sons of G which was contested by B’s son’s brother. Since the transfer only required the majority’s consent, the Court refused to apply the provision of the precursor agreement as it was not included in the AoA.
The reasoning of this approach is that the precursor agreement is a private document whereas the statutory process is governed by the AoA, requiring the parties to include in the AoA any provisions it sought to apply.
Deviation from V B Rangaraj Approach: AoA and JV provisions to be read harmoniously
The V B Rangaraj approach was unnecessarily restrictive as it refused to apply precursor provisions, agreed to by the parties, and in perfect compliance with the provisions of the Companies Act, on the sole ground that they were not written in the AoA.
The first deviation from this approach is observed in the Premier Hockey Development Pvt. Ltd. v. Indian Hockey Federation (2011) OMP 92/2011 & OMP 52/2011. The parties in this case had entered into a share and subscription agreement for the incorporation of a joint venture with the objective of organizing a domestic hockey tournament league. Amongst the various issues arisen between the parties, the respondents contested a board resolution authorizing a Mr. Rajput to act and initiate proceedings on behalf of the JV on the grounds that notice of the board meeting was not given in accordance with the provisions of the share and subscription agreement. The article is said agreement provided that at least 10 (ten) days’ notice was to be provided to all directors and the quorum of the board meeting would not be satisfied unless a director nominated from each party was present.
The petitioner argued that this requirement was not present as said provisions were not incorporated in the AoA. Striking down the board resolution as not fulfilling the notice and quorum requirements provided in the agreement, the Court opined that the agreement formed part of the legal framework for operating the JV and that the AoA could not be viewed independently or in isolation.
The subsequent opinion of the Supreme Court in Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613 clearly explains the reason for this change in approach. It stated that the provisions of AoA would take undisputed precedence over the provisions of the precursor agreements only in case of repugnancy or conflict. It acknowledged that a precursor agreement provides more flexibility to parties to agree on procedures in more detail and held that provisions of such an agreement, entered into in the best interest of the company, are valid and enforceable.
Strangely, this approach was not followed in World Phone India Pvt. Ltd. & Ors. v. WPI Group Inc. USA (2013) 178 Comp Cas 173 where the Delhi High Court refused to strike down a board resolution passed with simple majority to transfer of the shares of the minority shareholder to another shareholder where the JV agreement required the affirmative vote of all the shareholder as well.
Conclusion
It is evident that the ambiguity arises from the courts considering the precursor agreements as private documents between shareholders and the AoA being a public document providing the framework for company processes. However, where the shareholding presents the entirety of the parties to the precursor agreement, it is difficult to understand why contractual intentions of the parties not be given force. Section 58(2) of the Companies Act, albeit only for public companies for unexplained reasons, provides legislative intent in favor of enforcing contractual arrangements in respect of transfer of securities. It is unfortunate that ambiguity persists as the V B Rangaraj approach has not been overruled.
To avoid controversies, it is still advised to incorporated provisions of the precursor agreement or at least make reference to them wherever necessary to avoid future controversies. As joint ventures and shareholder agreements are now sine qua non to today’s complex transactions, an overruling would allow interpreting the relationship between the shareholders in a more holistic manner.
