Articles of Association guide PDF

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Articles of Association(handout) (slides)1- Content (107)With the reduced importance of the memorandum, the articles of association form a company’s principle document.The contractual nature s (art 25 NIO 1986) CA 85s(1) – ‘Subject to the provisions of this Act, the memorandum and articles, when reg...

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Articles of Association (handout) (slides)

1.1- Content (107) With the reduced importance of the memorandum, the articles of association form a company’s principle document. The contractual nature s.14 (art 25 NIO 1986) CA 85 s.14(1) – ‘Subject to the provisions of this Act, the memorandum and articles, when registered, bind the company and its members to the same extent as if they were respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all provisions of the memorandum and articles.’ Wording of s.14 can be traced back to the Company Act 1856 – controversy surrounding the contractual nature and effect of s.14 Clear from judicial pronouncement that s 14 cannot be interpreted as conferring rights and obligations which one would normally expect to flow from the law of contract. S.33 (1)– The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions. Every company must have a set of articles (s. 18(1), and promoters are free to draft their own articles that suit the needs of their particular business requirements, and submit them upon registration, or they can simply rely on model articles. Companies are generally free to draft their own articles and can include whatever provisions they wish, subject to some requirements, exceptions and limitations including: -

The articles must be contained in a single document and must be divided into paragraphs number consecutively (s. 18(3)). Article provisions cannot exclude or modify rights provided for under statute, unless the statute so provides Articles cannot deprive a company of powers conferred to it under statute, unless the statute so provides.

Certain provisions that formed part of the memorandum will now form part of the articles. (s. 28) Model articles- The CA states that different model articles may be prescribed for different descriptions of companies. (s. 19(2)). The CA is accompanied by the Companies (Model Articles) Regulations 2008, which Sch.1 provides articles for private companies limited by shares and Sh. 2 for public companies.

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1.2- Interpretation of articles (109) The courts may be required to interpret the provisions of the articles to resolve a dispute, as in Rayfield v Hands [1960] Ch 1 (Ch). As articles constitute a contract, they will be interpreted in line with general contractual principles, however, specific rules have been created. In Re Hartley Baird Ltd [1955] Ch 143 it was stated that when interpreting articles, the maxim ut res magis valeat quan pereat applies, meaning that the courts will attempt to interpret the articles in such a way to produce a workable result and avoid unreasonable results. Thompson v Goblin Hill Hotels Ltd [2011] UKPC 8 held that the plain and obvious meaning of words used in the articles may be rejected if it produces a ‘commercial absurdity.’ Limits on the courts ability to interpret include: -

When interpreting an amendment to the articles, the courts cannot consider the effect that the amendment was meant to have. (Rose v Lynx Express Ltd [2004] EWCA Civ 447) The court is not empowered the rectify the articles, even if it can be established that they do not give effect to the wishes of the parties. (Scott v Frank F Scott (London) Ltd [1940] Ch 795) The courts cannot add terms to make the articles fairer or more reasonable. (Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10)

Whilst the courts cannot add terms to the articles, they can imply terms as the implication of terms is not an addition to the instrument. It only spells out what the instrument means.

Implication of terms -

Equitable Life Assurance Society v Hyman [2002] 1 AC 408 demonstrates that the courts are able to imply terms into the articles. The courts cannot imply terms into the articles based on extrinsic circumstances. (Bratton Seymour Service Co Ltd v Oxborough [1992] BCC 471)

1.3- Amending the articles (113) As a company or market evolves, it may become desirable or necessary for a company to amend its articles. There are 3 principal ways in which this can be done: 1- The court or some other relevant authority may alter the company’s articles if empowered to do so. 2- A company may amend its articles by passing a special resolution (s. 21(1)), subject to entrenchment conditions. 3- If all of the members agree to an amendment (irrespective of whether a resolution is passed), then the amendment will be valid. (Cane v Jones [1980] 1 WLR 1451) 2

Statutory restrictions Statute may restrict a company’s ability to alter its articles or may restrict the effect that an alternation has. For example, the ability to alter its articles is limited by the CA when provisions have been entrenched.

Common law restrictions The common law imposes a number of restrictions upon a company’s ability to alter its articles, including: -

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An amendment may not be valid if it deprives a member of a right that he has already accrued, unless the member agrees to the amendment. (James v Buena Ventura Nitrate Grounds Syndicate Ltd [1896] 1 Ch 456) A company cannot contract out of the statutory ability to alter its articles (e.g., by placing a provision in its articles that seeks to render any part of the articles unalterable). (Walker v London Tramways Co (1879) 12 ChD 705). However, it is possible to make a company’s articles unalterable if all of the members (or enough to defeat a special resolution) enter into a shareholder’s agreement under which they agree not to exercise their ability to alter the articles. In some cases, amending the articles may end up breaching a separate contract that exists between the company and some other person (often a director). (Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701)

Tests Lindley MR in Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656 stated that the power to alter articles must: ‘like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole...” ‘the company’ refers to the body corporate as per Allen. In the rare instance where an amendment exists to benefit the shareholders but not the company, this will be deemed invalid as per Dafen Tinplate Co Ltd v Llanelly Steel Co (1907) 2 Ch 124. ‘bona fide for the benefit of the company’ was meant as subjective, meaning that if the majority shareholders honestly believed that the alteration was for the companies benefit as a whole, the alteration would be valid even if the court disagrees. In Shuttleworth v Cox Brothers and Co (Maidenhead) Ltd [1927] 2 KB 9 it was held that the reasonableness of the amendment was also relevant:

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“the alteration may be so oppressive as to cast suspicion on the honesty of the persons responsible for it, or so extravagant that no reasonable men could really consider it for the benefit of the company. In such cases the Court is... entitled to treat the conduct of the shareholders as it does the verdict of a jury, and to say that the alteration of a company’s articles shall not stand if it is such that no reasonable men could consider it for the benefit of the company.” Lindley MR’s test was formulated to deal with situations where interests conflicted, providing that the company’s interests prevailed. Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 moved the focus to the effect the amendment had on shareholders by establishing an alternative test: ‘It is now plain that...the phrase, “the company as a whole,” does not (at any rate in such a case as the present) mean the company as a commercial entity as distinct from the corporators. It means the corporators as a general body. That is to say, you may take the case of an individual hypothetical member and ask whether what is proposed is, in the honest opinion of those who voted in its favour, for that person's benefit. I think the thing can, in practice, be more accurately and precisely stated by looking at the converse and by saying that a special resolution of this kind would be liable to be impeached if the effect of it were to discriminate between the majority shareholders and the minority shareholders so as to give to the former an advantage of which the latter were deprived.’ Evershed MR

Entrenched provisions A company cannot formally make its articles unalterable. However, s. 22(3) provides that provision for entrenchment does not prevent alteration for the company’s articles by agreement of all the members of a company or by court order.

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Prior to 2006 companies would try to entrench certain constitutional provisions by placing them in the object’s clause instead of the articles as alteration of objects was far more difficult.

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It was argued that entrenchment unduly restricts the future freedom of members and should be prohibited. However, the contrary view was stated saying that entrenchment has a role to play in enabling those that established the company to protect certain interests.

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The CA consequentially introduced the ability for companies to entrench article provisions at any given time. (s. 22(2)) Entrenched provisions are not unalterable but can only be of certain conditions or procedures are complied with that are more restrictive that those applicable in the case of a special resolution. (s. 22(1))

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In order to prevent abuse, the act imposes that entrenchment will not prevent alternation where all of the members agree to an alteration or where court orders

can be made. (s. 22(3)). A company must also inform CH (i) if the articles contain provision for entrenchment upon formulation, or if the articles are amended to include an entrenched provision, (s. 26(1)) or (ii) if the articles are amended to remove entrenched provisions (s. 23(2)). The company must also provide a statement of compliance certifying that the amendment was made in accordance with the company’s articles. (s. 24)

Notification to Companies House -

If a company amends its articles, it must send a copy of the amended articles to CH not later than 15 days after the amendment takes effect. (s. 26(1)).

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Failure to do so is a criminal offence (s. 26(3)) and CH is empowered to send notice to the company requiring it to send a copy of the amended articles within 28 days of the notice being issued. (s. 27(1 &2))

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If the company complies, no criminal proceedings will be brought. (s. 27(3))

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If the company does not comply, criminal proceedings may be brought with an additional civil penalty of £200. (s. 27(4)).

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Upon receipt, CH must publish in The Gazette an notice stating (i) the name and registered number of the company, (ii) a description of the document, and (iii) the date the document was received. (s. 1077(1 &2)). The amendment to the articles and the text of the amended articles must also be provided. (s. 1078(2))

If a company fails to comply with these rules, then it cannot rely on the article amendment against any other person until the amendment has been officially notified, or it can be demonstrated that the other person knew of the amendment. (s. 1079(1) and (2)(a)).

1.4- Enforcing the constitution (121) The courts have long held that a company’s articles form a contract between the company and its members, and also between the members themselves. (Re Tavarone Mining Co (1873) LR 8 Ch App 956). S. 33(1) expands upon this to cover the constitution in general, by providing. ‘the provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions.’ A s. 33 contract can impose obligations upon: 5

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The company when dealing with its members;

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The members when dealing with the company; and

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The members when dealing with each other.

Breach of certain provisions may therefore constitute breach of contract, thereby allowing the non-breaching party to commence a personal action and obtain a remedy. The s. 33 statutory contract

Standard contract

s.33 contract

Source of binding force

From agreement between parties

From s. 33 CA

Alternation of terms against a parties wishes

Not usually

As they can be altered by passing a special resolution, the majority can alter the terms against the wishes of the minority.

Regulation of unfair terms

Subject to provisions of Unfair Contract Terms Act 1977

Not subject to ss. 2 and 3 of Act

Enforcement by a third party

Generally, third parties cannot enforce a standard contract but can do so where s. 1(1) Contracts (Rights of Third Parties Act) 1999 applies

Third parties cannot enforce the statutory contract, and the statutory contract is not subject to s.1

Action for breach of contract

Any breached term gives rise to BoC

Only the terms that relate to membership rights can form a basis for an action of BoC

Rectification of contract

Courts may rectify a standard contract of it fails to give effect to the party’s

The courts will not rectify the statutory contract if it fails to give effect to wishes

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Defeasible on certain grounds

intentions, or if it contains a mistake

or contains a mistake.

Can be defeated on the grounds of mistake misrepresentation, duress or undue influence

Cannot be defeated on these grounds

As the constitution forms a contract between the company and its members, it follows that both parties can enforce compliance with the terms of the constitution against the other. Company enforced the terms against a member- Hickman v Kent or Romney Marsh Sheepbreeders’ Association [1915] 1 Ch 881 Member enforcing term against the company- Wood v Odessa Waterworks Co (1889) 42 ChD 636 Member enforcing against another member- Rayfield v Hands [1960] Ch1

Outsider rights One rule that applies to both standard and statutory contracts is privity of contract. The statutory contract is formed between a company and its members- persons not party to the statutory contract (outsiders) are therefore not permitted to enforce the constitution. Eley v Positive Government Security Life Assurance Co (1876) LR 1 Ex D 88 The constitution cannot be used to enforce outsider rights. ‘the purpose of the constitution is to define the position of the shareholder as shareholder, and not to bind him in his capacity as an individual.’ Therefore, members can only enforce those terms of the constitution that relate to membership rights and members must being their claim in their capacity as members. E.g., if a person is a member and a director, he will not be able to enforce the constitution if he is bringing his claim in his capacity as a director. (Beattie v E and F Beattie Ltd [1938] Ch 708) Common membership rights contained in a constitution include: -

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The right to attend, speak, and vote at general meetings

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The method of counting votes at general meetings

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Rights relating to the transfer and transmission of shares

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The right to dividend, once it has been validly declared.

Internal Irregularities

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Even if a constitutional right is breached, a member may still be prevented from enforcing the constitution if the breach is regarded as an ‘internal irregularity.’

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This occurs where the alleged wrong is a transaction which might be binding on the corporation and all its members by a simple majority of the members. (MacDougall v Gardiner (1875) 1 ChD 13)

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This is clearly the result on the principle of majority rule which requires that the rights of the individual are... subordinated to the wishes of the majority....