Rethinking the Need for Incorporation of the Arbitration Clauses into the Articles of Association under the Indian Company Law

In 2024, Mumbai Centre of International Arbitration has reported a 48% increase in arbitral fillings, emphasising the growing arbitration in streamlining corporate disputes in a fast-tracked manner.[1] In Company Law, incorporation of arbitration clauses in Articles of Association has become a focal point of discussion amid rising disputes between shareholders.[2] 

The Companies Act, 2013 marked a paradigm shift in the corporate governance by codifying the framework within which the companies are to operate, including the constitution of companies through the Memorandum of Association (MoA) and Articles of Association (AoA).[3] The AoA functions as the “bible” and outlines the rules which binds its company and shareholders. Shareholder’s Agreement (SHA), on the other hand, is a private contract, which is designed with an aim to protect investors’ interests and provide flexibility in governance.[4] 

With the rise of India’s economic growth and complex transactions, parties engaging in a commercial connection frequently form an intricate agreement which defines parameters of their relationship. These intricate interactions become the cause for disagreements among the shareholders requiring the need for incorporating arbitration clauses for resolving disputes. However, the enforceability of such clauses has frequently been mired in judicial ambiguity especially when they are not incorporated into the Articles of Association.

Further, the Arbitration and Conciliation Act, 1996 empowers contracting parties to include arbitration agreements independent of corporate constitutions, raising a question on the legal necessity and effect of non-incorporation of clauses into AoA.[5] This paper aims to critically assess the incorporation of arbitral clauses and to situate discussion within broader shift towards contractual flexibility and efficient resolution mechanisms.

Through numerous judicial decisions and amendments, the Indian regime has emphasised on a more modern and pro-arbitration stance, yet persistent gaps exist concerning party autonomy and enforceability when clauses are not embedded within the AoA.[6] The emergence of divergencies due to contrasting opinions on incorporation doctrine with the contractual view creates risks for both investors and the companies as it undermines the predictability of dispute resolution mechanisms and corporate governance frameworks.[7]

Analysis

This research article articulated about the contradictory views recognized by Indian courts, through judicial interpretations. As per the first view i.e. the “incorporation view” holds the position that the internal management and affairs of a Company are exhaustively regulated by its articles, and the terms of an SHA (including arbitration clauses) cannot by themselves bind a company and would render those terms ineffective unless expressly incorporated into its articles. [8] However, another conflicting approach is known as the “contractual view” regards the SHA as a binding and valid contract among shareholders, enforceable on its own terms/provisions regardless of its incorporation into the Articles.

[Image Sources: Shutterstock]

The SHA play a constructive role in defining duties, dispute resolution mechanisms and rights among company members, often containing the arbitration clauses that are intended to facilitate a streamlined mode for resolution of internal conflicts. The issue pertaining to incorporation of arbitration clause into the constitution of company law and its implications and legal validity is of utmost importance as it touches upon the principles of corporate governance, effective administration of justice and party autonomy in the corporate sphere. The evolving judicial stance on the present subject could be understood through a thorough examination of cases that shaped the doctrine surrounding the incorporation of arbitration clause. [9]

Landmark Case and its Facts- The landmark case of concerning around the interpretation on incorporation of provisions of SHAs (including the arbitration clauses) into the AoA is V.B. Rangaraj v. V.B. Gopalakrishnan & Ors., 1992[10], which formed the foundational case leading to emergence of numerous ancillary and conflicting judicial interpretations. The case revolved around a private company wherein all the shareholders were the members from the same family, who entered into a shareholders agreement restricting the transfer of shares. However, this restriction on transfer of shares was not incorporated into the AoA of the company. Later on, a dispute arose wherein one shareholder attempted to transfer the share in violation to the signed agreement but in adherence to the AoA of the company.

Issue- The main issue surrounding the case are;

1.     Whether SHAs and its provisions including restriction on transfer of shares and arbitration agreements could override the statutorily mandate under Companies Act, 2013?

2.     Whether the restriction in shareholder’s agreement, not incorporated into AoA of the company should be made binding on the parties?

Rule and Application in the Case- The case referred to the Section 44 of Companies Act, 2013 which defines shares as movable property made transferable in the manner prescribed by the articles.[11] Furthermore, Section 10, Companies Act, 2013 described AoA as contract between company and its members, indicating the importance of AoA both as guiding and binding force.[12] The court ruled that private agreements could not override  Articles, and in present case since the restriction was allowed under AoA and provisions of SHA was not incorporated into AoA, it was held that the company is not to be made bound by private agreement including any arbitration clause, unless it was part of  AoA.

Evolution through Landmark Case-Even though the case established a principle which affirmed shareholders freedom to transfer shares within private company and underscored the pivotal role of the articles in ensuring governance over private agreements as reiterated in IL and FS Trust Co. Ltd. vs Birla Perucchini Ltd.,[13] wherein the Bombay High Court cited ruling of V.B. Rangaraj and stated if a provision/restriction is not incorporated in AoA, it is not binding on either stakeholders or company. The same was reiterated by noteworthy cases pronounced in 2013 by High Court of Delhi, World Phone India Pvt. Ltd. vs Wpi Group Inc. [14]and Hta Employees Union vs Hindustan Thompson Associates Ltd.[15] But still the stance has been heavily criticized for undermining the principle of party autonomy and resulting in protracted litigation, wherein the parties themselves expressly agreed for arbitration in numerous contemporary rulings by Supreme Court. In 2010, Messer Holdings Ltd. v. Shyam Madanmohan Ruia[16], revolved around enforcement of provisions including refusal and arbitration clauses within SHA, wherein the court held that private agreements may hold validity as long as they do not impede the rights of the shareholders.

Contemporary Stance on Incorporation- The principle emphasising party autonomy was upheld in 2011, Premier Hockey Development Pvt. v. Indian Hockey Federation.[17] In this, the court upheld the validity of SHA and directed that the clause would be binding on parties unless they are in contravention to the AoA or the Companies Act, 2013 even though not expressly incorporated into the AoA.

Furthermore, in 2012, Vodafone International Holdings BV v. Union of India,[18]it was held that the shareholders have the right to enter into a contract in best interest of company and as long as the provisions in SHAs does not conflict with AoA, such clauses should be held enforceable and valid. This judgement caused widespread deliberations in the industry as the Hon’ble Court clearly stated that it did not subscribe to the position of V.B Rangaraj case. However, still the judicial plethora lacks certainty on enforceability of clauses as this judgement was overlooked in numerous judgements the next year.  

Independent nature of Arbitration Clause- In Cheran Properties Ltd. v. Kasturi & Sons Ltd. & Ors[19]., the court departed from the conventional stance held in the Rangaraj case and took a pro-arbitration stance wherein it held that the Cheran Properties were bound by the arbitral award as the parties themselves consented to arbitration. It was emphasised though incorporation into AoA prevent uncertainties, but the court might still bind the company if it is closely connected to or derive benefits from the agreement.

Findings 

Undermining of validity of arbitration clauses; Indian courts has maintained a conservative approach, insisting on explicit incorporation of SHA provisions (including arbitration clauses) into AOA to make the terms enforceable, resulting in disputes being relegated to courts or statutory bodies like NCLT/NCLAT undermining the party autonomy, confidentiality and increasing costs for corporates.

Pro-arbitration stance in International Jurisdictions; Countries like Hongkong and Singapore are considered arbitration-friendly countries. This can be effectively proved by analysing their case laws such as Dickson Holdings v. Moravia CV & Ors.[20] Courts have repeatedly affirmed the arbitrability of shareholder disputes under SHA, even for complex matters such as oppression, by broadly interpreting clauses to encompass both contractual and non-contractual obligations related to company affairs.[21] 

Relevance of Party Autonomy and Intent- In BTY V. BUA, a joint venture agreement was verbatim adopted into Articles except of the arbitration clause which solely existed in the SHA. The plaint stated a breach of Articles, without making reference to JVA. The main issue before court was whether the arbitration clause in JVA could also apply to disputes arising under Articles as well or not. The court rejected the arbitration but only after carefully examining the language and scope of arbitration clause to assess whether it reflected an “objectively ascertainable intent” which can extend to disputes under Articles as well.

The court’s approach to release the decision after conducting thorough inquiry is significant as it highlights a strong commitment to honouring arbitration agreements wherever possible.[22] The High Court acknowledged that if the arbitration clause had been worded broadly enough to cover both agreements, it would have referred the matter to arbitration even though the dispute was technically framed under Articles. This decision reflects Singapore’s pro-arbitration stance unlike the rigid; conservative stance followed in Indian Jurisprudence.

Suggestions 

Need for Legislative and Policy-Making Reforms; India could clarify the law by amending the Companies Act. For instance, Section 58(2) states that “any contract or arrangement between two or more persons in respect to the transfer of securities shall be enforceable as a contract”.[23] This means that Section 58(2) has aimed to somewhat clear the ambiguity by provide validity to provisions specific to transfer of securities mentioned in SHA without the need for inclusion of the same in AoA.

However, this provision is currently applicable only to public companies and not to private companies. One of the suggestions is to extend this provision to private companies. However, Statutory recognition that arbitration clauses in a SHA are valid even if not in the AOA would align with arbitration-friendly policy and indicates. that changes are being made to bring both of these legal documents on an equal footing. 

Inclusion of Academicians and Juridical Opinions- Commentators also highlight drafting strategies. For example, a Hong Kong analysis points out that simply including an arbitration clause in a SHA may not suffice unless that clause’s scope is very broad or echoed in the articles. The commentaries on Singapore and Hong Kong emphasize that SHA and AOA create distinct legal planes, so an arbitration clause “only binds the parties to the agreement” and cannot by itself bind disputes under the articles. Thus, literature suggests that without explicit incorporation or very broad arbitration wording, conflicts may leave arbitration clauses ineffective. [24]

Need for Judicial Certainty and Clarity on the Subject- Matter; Indian case laws is split between these two “irreconcilable view” regarding this particular subject matter. The Supreme Court or legislature could explicitly reconcile the views in Rangaraj and Vodafone[25]. A larger bench judgment could affirm the contractual view while delineating boundaries. This would give NCLTs and tribunals confidence to honor arbitration commitments. This will not only help remove the ambiguity between the conflicting position but can be immensely beneficial to the economy by improving the Ease of Doing Business and boosting the Foreign Direct Investment in our country. Until the Supreme Court renders a conclusive judgment on this matter to clear the ambiguity, it would be prudent for the provisions of SHA to be incorporated in the AoA in order to avoid obstacles to the SHA's provisions being enforced.

Conclusion 

The authors, in this research paper, have delved into the debate regarding the relationship between the AOA and the SHAs of a company which has raised several questions about the enforceability of arbitration agreements incorporated solely in SHAs despite its absence from the AOA of a company which has been the subject matter of various judicial pronouncements. The Economic Survey of 2018–19 has explicitly recognized that the single largest constraint to the ease of doing business in India lies in the enforcement of contracts and timely resolution of disputes.^[26] The need for speedy and efficient redressal of disputes is witnessed universally and even more acutely in shareholders’ disputes, which are often characterized by huge money claims, wherein Alternative Dispute Resolution has the capability to improve the ease doing business. However, such technical impediments i.e. the failure to incorporate the arbitration clause into the AOA should not prevent a court from referring such a dispute to arbitration as it and force the parties to litigate under corporate law or seek remedies available under NCLT instead. This directly defeats the purpose of ADR mechanisms and frustrate the legitimate expectations of commercial parties who invest significant resources based on negotiated SHAs.

Author: BHAVYA GUPTA and RITIKA JAIN , in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney. 

[1] Mumbai Centre for International Arbitration (MCIA), Annual Report 2024 (2024).

[2] Navigating Shareholder Disputes in India: Unveiling Causes, Arbitrability, and Effective Resolution Strategies,” IJIRL (June 2023).

[3] The Companies Act, 2013, § 2 (India).

[4] Miliauskas, P., Shareholders’ agreement as a tool to mitigate corporate conflicts of interests. International Journal of Private Law, 6(2), 109-131, 2013.

[5] The Arbitration and Conciliation Act, 1996 (India).

[6] Dave, D., Hunter, M., Nariman, F., & Paulsson, M. (Eds.), Arbitration in India. Kluwer Law International BV, 2021.

[7] Chilumuri, R., & Gambhir, A., Invocation of Arbitration Clauses in Shareholder Agreements for Disputes under Articles of Association. NUJS L. Rev., 13, 807, 2020.

[8] Avantika, Navigating Shareholder Disputes in India: Unveiling Causes, Arbitrability, and Effective Resolution Strategies. Indian J. Integrated Rsch. L., 3, 1, 2023.

[9] Nayar, D., & Sharma, L, Mandatory Shareholder Arbitration: Future Prospects for Litigation Management in India. AIADR J. Int'l ADR F., 1, 32, 2020.

[10] (1992) 1 SCC 160.

[11] The Companies Act, 2013, § 44 (India).

[12] The Companies Act, 2013, § 10 (India).

[13] IL&FS Trust Co. Ltd. v. Birla Perucchini Ltd., 2002 SCC OnLine Bom 1004.

[14] World Phone India Pvt. Ltd. v. WPI Group Inc. USA, 2013 SCC OnLine Del 1098.

[15] Arjya B. Majumdar, The (Un?) Enforceability of Investor Rights in Indian Private Equity, SSRN, June 3, 2019, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3387887 (Last visited on November 23, 2020).

[16] Messer Holdings Ltd. v. Shyam Madanmohan Ruia, SLP (Civil) Nos. 33429-33434 of 2010.  

[17] Premier Hockey Development Pvt. Ltd. v. Indian Hockey Federation, 2011 SCC OnLine Del 2621.

[18] Vodafone International Holdings B.V. v. Union of India, (2012) 6 SCC 613.

[19] Cheran Properties Ltd. v. Kasturi & Sons Ltd. & Ors. (2018) 16 SCC 413.

[20] Dickson Holdings v. Moravia CV, [2019] HKCFI 1424 (Hon’ble High Court of Hong Kong).

[21] Ravitej Chilumuri & Aaditya Gambhir, Invocation of Arbitration Clauses in Shareholder Agreements for Disputes under Articles of Association, 13 NUJS L. REV. 807 (October-December 2020).

[22] BTY v. BUA, [2018] SGHC 213 (Hon’ble High Court of Singapore).

[23] The Companies Act, 2013, § 58(2) (India).

[24] Ahmed, M, Arbitration Clauses: Fairness, Justice and Commercial Certainty. Arbitration International, 26(3), 409-420, 2010.

[25] Vodafone International Holdings B.V. v. Union of India, (2012) 6 SCC 613.

[26] Jeet Bijlani, Ease of Doing Business: Legal Developments and Its Implications, 3 INDIAN J. INTEGRATED RSCH. L. 405 (November-December 2023).