Entrenchment Provisions in Articles of Association (Section 5): Meaning and Use

The Articles of Association of a company can ordinarily be altered by a special resolution of its members. For founders, investors and joint venture partners, this creates a risk: a protection they negotiated can be removed by a majority they do not control. Entrenchment under section 5 of the Companies Act, 2013 addresses this by allowing specified provisions of the Articles to be altered only if conditions or procedures more restrictive than a special resolution are met.

This article explains what entrenchment is, how it is adopted, its limits, and how it is used in practice to protect rights agreed in shareholders’ and investment agreements.

What section 5 provides

• The Articles may contain provisions for entrenchment, to the effect that specified provisions may be altered only if conditions or procedures that are more restrictive than those applicable to a special resolution are met or complied with.
• Entrenchment provisions can be made either in the Articles adopted on formation of the company, or by an amendment to the Articles.
• In a private company, an amendment introducing entrenchment must be agreed to by all the members.
• In a public company, it must be passed by a special resolution.
• The company must give notice of the entrenchment provisions to the Registrar in the prescribed form and manner.

What can be entrenched

Any provision of the Articles can be made subject to entrenchment. Common examples are:

• The right of a founder or investor to nominate one or more directors
• Affirmative voting rights or reserved matters that need the consent of a particular shareholder
• Restrictions on transfer of shares, including rights of first refusal, tag-along and drag-along rights
• Pre-emption rights on new issues of shares
• Quorum requirements that need the presence of a particular shareholder or director
• Provisions on the business the company will or will not carry on, in a joint venture

How entrenchment works

Ordinary provision	Entrenched provision
Can be altered by a special resolution (75% of votes cast)	Can be altered only if the more restrictive condition stated in the Articles is met, for example the written consent of a named shareholder, a resolution passed by 90% of members, or unanimous consent
A majority shareholder holding 75% can change it alone	A minority shareholder whose consent is required can block the change

The restrictive condition must be stated precisely in the Articles. Vague wording, such as “with the concurrence of the promoters”, creates uncertainty about who must agree and in what form.

Procedure

1. At incorporation: include the entrenchment clause in the Articles filed with SPICe+.
2. By amendment, private company: obtain the agreement of all members, usually by a resolution passed with the consent of every member recorded in writing, and amend the Articles accordingly.
3. By amendment, public company: pass a special resolution at a general meeting.
4. Filing: file the resolution in Form MGT-14 and give notice of the entrenchment to the Registrar, with the altered Articles, within the time prescribed.

See amending the MOA and AOA.

Why entrenchment matters: the shareholders’ agreement problem

Rights agreed in a shareholders’ or investment agreement bind the parties to that agreement, but the Supreme Court held in V.B. Rangaraj v. V.B. Gopalakrishnan (1992) that a restriction on share transfer not contained in the Articles is not binding on the company or its shareholders generally. Later decisions have taken different approaches in specific situations, but the safe practice remains to incorporate the key terms of a shareholders’ agreement into the Articles, and to entrench those that should not be changed without the consent of the protected party. See drafting a shareholders’ agreement.

Limits of entrenchment

• Entrenchment cannot override the Companies Act. A provision that is contrary to the Act is void, whether entrenched or not.
• It does not prevent alteration altogether. An entrenched provision can still be changed if the specified condition, such as unanimous consent, is met.
• It cannot take away statutory rights of members, such as the right to seek relief against oppression and mismanagement before the NCLT.
• Excessive entrenchment can make the company difficult to manage and can deter new investors, who will usually want their own protections.

Frequently asked questions

Is entrenchment the same as a special resolution?

No. Entrenchment requires a condition more restrictive than a special resolution, such as unanimity or the consent of a specified shareholder.

Can existing Articles be amended to add entrenchment?

Yes. In a private company, all members must agree. In a public company, a special resolution is required.

Does entrenchment bind future shareholders?

Yes. The Articles bind the company and all its members for the time being, including those who become members later.

ചുരുക്കം (Summary in Malayalam)

കമ്പനിയുടെ ആർട്ടിക്കിൾസ് ഓഫ് അസോസിയേഷനിലെ ചില വ്യവസ്ഥകൾ സ്പെഷ്യൽ റെസല്യൂഷനിലൂടെ മാത്രം മാറ്റാൻ കഴിയാത്ത വിധം, അതിനേക്കാൾ കർശനമായ വ്യവസ്ഥകൾ പാലിച്ചാൽ മാത്രം മാറ്റാവുന്ന തരത്തിൽ സംരക്ഷിക്കുന്നതാണ് എൻട്രെഞ്ച്മെന്റ് (സെക്ഷൻ 5). പ്രൈവറ്റ് കമ്പനിയിൽ എല്ലാ അംഗങ്ങളുടെയും സമ്മതവും പബ്ലിക് കമ്പനിയിൽ സ്പെഷ്യൽ റെസല്യൂഷനും വേണം. ഡയറക്ടർ നാമനിർദേശ അവകാശം, ഓഹരി കൈമാറ്റ നിയന്ത്രണം, നിക്ഷേപകരുടെ അംഗീകാര അവകാശങ്ങൾ തുടങ്ങിയവ സംരക്ഷിക്കാൻ ഇത് ഉപയോഗിക്കുന്നു. ROC-യെ നിശ്ചിത ഫോമിൽ അറിയിക്കണം.

This article gives a general overview of entrenchment under the Companies Act, 2013. Provisions and rules are revised from time to time; for accurate and current requirements, refer to the Act and rules as amended. The article is not advice on any particular case.