Important Clauses of a Shareholder’s Agreement

• 1. Pre-emptive Right/Anti-Dilution Protection-

  Pre-emptive right means a subscription privilege. This Clause helps a Shareholder by protecting its shareholding from getting diluted in subsequent rounds of funding. Under this Clause, the Shareholders at all times, have the right, but not the obligation, to participate in Fresh Issues, to the extent required to maintain their respective percentage shareholding in the Company.

• 2. First Refusal-

  Right of first refusal offers protection to the Company from hostile takeovers. Under this Clause, before any Shares held by a Shareholder or any transferee of a Shareholder may be sold or otherwise transferred (including transfer by gift or operation of law), the Company gets a right of first refusal to purchase the Shares on terms and conditions set forth in the Agreement. The Company may accordingly either- (i) exercise its Right of First Refusal and purchase the Shares or (ii) reject to exercise its Right of First Refusal and permit the transfer of the Shares to the Transferee.

• 3. Drag along and Tag along-

  A ‘Drag along’ clause is mainly inserted for protecting a potential purchaser of a Company from the erring Minority Shareholders during a takeover. A ‘Drag along’ right allows majority shareholders (i.e., the ones holding more than 50% of shares in a Company that have voting rights attached) of a Company to force the remaining Minority Shareholders to accept an offer from a third party to purchase the whole company. Therefore, a drag along clause enables the majority shareholders to 'drag' the remaining minority shareholders with them.
  A ‘Tag along’ right is the opposite of drag along right. It is inserted for the benefit of the minority shareholders. When majority shareholders sell their shares, a ‘Tag along’ right entitles the minority shareholder(s) to participate in the sale at the same time for the same price per share. The minority shareholder(s) therefore 'tag along' with the majority shareholder's sale.

• 4. Liquidation Preference-

  This clause determines the payout order in the event of liquidation of the Company. Under this Clause, the Preference Shareholders can secure preference in payment over the other holders of all classes of Equity Securities on occurrence of a “Liquidity Event” (after all amounts as required by Applicable Law are paid or set aside for the payment to creditors of the Company, if applicable).

• 5. Dispute Resolution-

  The Dispute Resolution Clause lays down the manner in which the disputes between the Shareholders and the Company regarding the terms and conditions of the Shareholders’ Agreement are to be settled. This clause may provide for the use of Alternative Dispute Resolution (ADR) methods like Arbitration, Mediation or Conciliation. The main benefit of having a Dispute Resolution Clause is that it offers more flexibility and freedom to the Parties to choose what rules shall be applied to the dispute. For example, an Indian Company and UAE based Shareholder may choose to refer dispute, if any, which may arise between them to London Court of International Arbitration (“LCIA”), thereby avoiding any home court advantage that one of the parties may enjoy in court-based litigation.