Dispute resolution: A brief guide to settling differences between promoters and other shareholders of the Company

We are all familiar with the infamous shareholders dispute of Bakshi and Mcdonalds, Tata and Mistry. While such incidents of disputes are not uncommon, it is essential for us to understand as to what could possibly lead to such disputes. To begin with, let us first try to understand what is a Company and who are shareholders of the Company and how to be inducted as a member and/or shareholder of the Company.

Section 2(20) of the Companies Act, 2013 defines Company as a company incorporated under Companies Act 2013 or under any previous company law. Simply put, a company is an association that can be formed by natural persons, legal entities, or a mixture between the two, and the main purpose of the company is to develop commercial activities whereas the shareholders are the real owners of a company. They collectively constitute the company as a corporate body and the Companies Act, 2013 permits, any person to become a member and a person could mean an individual, body corporate or an association.

In the startup ecosystem, the most common and sought-after mode of becoming a shareholder is investing in such Company at certain pre-determined valuation which is arrived at based on mutually accepted commercial parameters. The Investor, however, invests in the Company based on principal representations and warranties provided by the promoters/founders of the Company who are the driving force for the success of the Company.

For any business, whether it is an early stage startup or an established company, certain elements are crucial to knit the business together; promoters and shareholders. With a passage of time, there has been a significant increase in shareholders’ active engagement in the company and its business modalities. The fast-paced world has brought about a change in the mindset of investors who are now vocalizing their opinions and casting votes and are engaging in active discussions to arrive at the best decision.

Understanding shareholders and promoters


As an initiation point, let us understand what essentially the difference between a shareholder and a promoter is. In simple terms, promoter/s is one or more people who take responsibility to establish a business, either directly or indirectly, i.e., the founders of a company. The promoters plan the business, carry out all the legal formalities that are required to be fulfilled, and ensure that the business is running at the desired pace. Shareholders, on the other hand, are only considered to be owners of the company. A shareholder invests capital in the business, thereby becoming part owner.

The relationship between the founders and the shareholders in the startup ecosystem


There lies a symbiotic relationship between the founders and the shareholders and both these elements are vital to a company. Over time, both startups, and established companies tend to raise funds by way of equity and/or through investors as opposed to a typical debt scenario. For the founders, their emphasis is in line with their passion and short-term/long-term vision for the company. However, when we consider the investors’ perspectives, it is more often a financial deal/decision. Their assessment of the company’s growth is determined by the nature of the market scenario, revenue, and profitability of the business for any period. For this reason, more often than not, the operational flexibility lies in the hands of the founders, although their responsibilities also include addressing areas of concern such as the economic and financial security of the investors.

How do these differences create tensions?


Since 2010 India has witnessed more than 25,000 startups and Indian ecosystem in this regard has witnessed a remarkable growth trajectory. Over the past few years, however, there has been a notable increase in the difference(s) between investors and founders of such start-ups and it would be incorrect to presume that such disputes arise out of mistrust only. Often, these differences are out the manner in which the business is running, future aspirations and expectations of the shareholder and long term and short goals, and quite often there lies certain inherent psychological and goal-based difference between the founders and the investors of a start-up. Further, when both shareholders and promoters jostle for control, there are bound to be some differences of opinion. To gain a better understanding of what the differences are and how we can resolve them, let us delve deeper.

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The key underlying issues which leads to the differences and disputes can be summarised below:

• Breach of definitive agreements: Definitive agreements are such agreements which outline the inter se rights and obligations of the shareholders of the Company. These definitive agreements often encapsulate the material covenants that are material to the investors. Any breach of such covenants would lead to mistrust and thus differences


• Breach of fiduciary duties: Promoters have fiduciary duties to the shareholders of the Company and at a bare minimum, promoters are required to deal with the shareholders in an open and honest manner with loyalty and candour and failure to perform these fiduciary duties often leads to disputes.


• Direction of the business. There is bound to be some difference of opinion on how things are running and where they are going which denotes the diversity its shareholder brings about in the Company. Some shareholders may even wish to close up shop when others want to plough ahead. In most cases, the deployment of the funds is decided by the promoters and the board. More often than not, there are significant differences in the visions of promoters and the shareholders regarding the utilization of the funds. There have also been cases where the company misuses the funds for the benefit of their related parties or entities where their interests lie. Recent times have seen the investor funds being exhausted merely within a few months of fundraising and this comes to light only much later since account books can be managed.


• Oppressive conduct on the minority shareholders: Much like sovereign democracy, corporate democracy plays to the will of the majority and it is essential to prevent a tyranny of the majority that steamrolls minority shareholders.

Possible ways to resolve the differences and dispute:


The disputes between the shareholders are not uncommon and board members experience the difficulties that arise when matters between members become litigious.

1. There are practical things that can be done to try and mitigate the potential for shareholder disputes and, even when those prove impossible or unsuccessful, directors may still be able to avoid litigation or disruptive shareholder action.


2. For an investor, it is always advisable to have the right to conduct financial audits on the company and its present state of affairs. Investors acquiring substantial percentage shareholding in the Company should emphasise for consent rights for key decisions in relation to the Company.


3. Mediations have also been known to be more efficient and effective. To take some statistics into account, the Bangalore mediation center reported a success rate of 65% with 146 minutes spent on each case. A recent amendment in the Commercial Courts Act 2015, made it mandatory for both parties to seek mediation and settlement before filing a suit, unless urgent interim relief is sought, in the case of commercial disputes.

However, although most documents specify arbitration as the suggested method of dispute resolution, this may not be viable in all circumstances. For example, in case the Company does not obtain consent for a specific matter whereas such understanding is well documented in the agreement. In this situation it may not be financially and commercially viable for such investors to invoke arbitration. Whereas sometimes the parties involved also take matters to the National Company Law Tribunal (NCLT), or courts. The drawback is that dispute resolution, particularly in company matters can take years, thereby reducing the value. In such situations, mediation is preferred as it involves a third party who is neutral and can facilitate the settlement. Appointing mediation bodies also proves to be more cost-effective in the long run.

It is essential to understand that more often than not the investment agreements to be executed between the shareholders of the Company may seem to grant enough protection on the face of it but unfortunately are not practically tenable so as to keep a check when the relationships sour and minority shareholders have little or no bargaining power. It is often witnessed that ‘standard market practice’ guides the ethos of investment agreements but it is the awareness of the appropriate Law that plays a vital role for the investors when things so south. The Registrar of Companies (“ROC”) has sufficient powers to protect the interest of minority shareholders and the Registrar or the inspector may also report to SFIO under section 208 of the Companies Act, 2013 and hence may utilise of ROC as a medium to complain for oppressive and mismanagement in case where majority (usually the promoters) act as per their discretion since they control the board.

Adopting a pragmatic and realistic approach to the dispute resolution


From a lawyer’s standpoint and a documentation perspective, the scope of both corporate and litigation lawyers has evolved. There exists a glaring gap between lawyers who are filing the documentation vis-à-vis a person who takes care of the end-to-end litigation at the courts but may not necessarily have an in-depth understanding of contractual agreements. Given this gap, lawyers need to put out a notice and brief their investors regarding the pros and cons of various possible legal scenarios and how they can pan out in case of litigation and offer legal advice accordingly. Opting for litigation and availing a settlement for the dispute is both a legal and a psychological exercise to align both parties’ claims with a SWOT analysis and find a middle ground to solve the differences.

While all parties involved wish for quick and efficient resolution of disputes, it requires a carefully designed strategy that covers all aspects including circumstances, risks, facts, and the consequences that can impact the potential outcome. Dispute resolution methods need to be analysed thoroughly before opting for any one mode of resolution.

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The writer is Partner – Burgeon Law, a leading boutique law firm that provides a one-stop legal shop to emerging companies, incubators, accelerators, angel investors, family offices and venture capital/ private equity funds)