Week 3 Handout: Articles of Association (Company Law) PDF

WEEK 3 LAW559 Company Law CORPORATE CONSTITUTION - ARTICLES OF ASSOCIATION The articles of association are the main element of a company’s constitution. They regulate the rights of members of the company inter se(among themselves), and determine the manner in which the business of the company shal...

WEEK 3 LAW559 Company Law CORPORATE CONSTITUTION - ARTICLES OF ASSOCIATION The articles of association are the main element of a company’s constitution. They regulate the rights of members of the company inter se(among themselves), and determine the manner in which the business of the company shall be conducted. The articles deal with such matters as the appointment and powers of directors, general meetings of the company, the voting rights of members, the transfer of shares, and dividends. A company may have its own articles or may adopt Table A as set out in regulations. Under the CA 2006 there will be separate model articles for private and public companies. The prescribed articles are the default articles if articles are not registered. However, even where a company (public or private) has its own articles, table A or the new model articles will still apply, except where excluded or modified expressly or by implication in the company’s special articles. The registrar is empowered by the Electronic Communications Order 2000 to accept the articles when filed electronically with electronic signatures replacing paper arrangements. Construction of the Articles 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) CA 2006 – 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. NB: Company now included as covenantor (initiated by Lord Wedderburn) Special Features: Unlike orthodox contract; - e.g. not liable to be set aside on grounds of misrepresentation, mistake, undue influence, or duress. Court has no jurisdiction to rectify articles – In Bratton Seymour Service Co Ltd v Oxborough BCC 471. Company involved in management of a developed piece of land which comprised a number of properties sought rectification of an agreement by which a shareholder, an occupier of property within the developed site, had agreed to contribute a pre-determined sum of money for the maintenance of specified parts of the common land attached to the developed property. Company claimed that agreement should have been rectified so as to accord with the true intentions of the parties, namely that the shareholder concerned should have been liable to contribute to all parts of the common areas of the developed property and not just those areas of common land specified in the agreement. Court of Appeal; unanimously held that rectification would be inconsistent with the statutory nature of a company’s articles i.e. if the agreement forming part of the articles was to be rectified this could only be done by altering the articles (s9). Prior to 1989 members could not sue for breach of his membership contract – remedy limited to injunction or declaration. S.131 CA 1989(art 66 NIO 1990) – member can claim damages. Effect of Membership Contract: Only membership rights are enforceable – Members are contractually bound to the company insofar as the articles give them in their capacity as members. See Hickman v Kent Company similarly bound to the members. See Salmon v Quin & Axtens Ltd ; Borlands Trustee v Steel Bros; Beattie v Beatties Ltd Articles constitute a contract between members in their capacity as members. See Rayfield v Hands Company only bound to members in their capacity as members. See Eley v Positive Government Security Life Insurance(1876) Obligations Enforceable by the membership of the company; Judicial interpretation has had the effect of limiting the enforcement of membership rights – exact scope of limitation is unclear. No dispute surrounding member’s right of enforcement regarding pure membership or ‘insider rights’ e.g. Right of member to insist that once a company has declared dividend, the dividend should be paid in accordance with the articles. Right to a share certificate. Right to return of capital on winding up of company once creditors paid.  On valid transfer of shares, the right to have name on register of members. Another commonly perceived example of an insider right is the entitlement of a member, holding voting shares in a company, to exercise his vote at a company meeting in any way he wishes, - leading case of the enforcement of the right to vote at a company meeting is Pender v Lushington (1870) 6 Ch D 70 – in this case the articles gave the shareholders the right to vote. The articles also fixed a maximum amount of votes which each member could cast – for every ten shares held a member was entitled to one vote – no more than 100 irrespective of the number of shares held. To evade this rule Pender transferred some of his shares into the names of nominees who were bound to vote as directed by him. The shares were also registered in their names. Votes used to support a resolution which would have had the effect of indirectly benefiting interests of a rival company in which Pender had a substantial interest. At the meeting the chairman refused to count the nominees’ votes and the resolution was lost. Pender sued for an injunction to restrain the chairman from declaring the nominees, votes invalid. Court of Appeal held that the vote attached to the shares of the nominees had been improperly rejected. Shareholders had the right to vote as set out in the articles of association. View confirmed by House of Lords in Carruth v ICI AC 707 Exceptional example of the court’s ability to refuse a member’s entitlement to vote: Standard Chartered Bank v Walker BCLC 603. In this case, it is difficult, if not impossible to reconcile the decision with the principles enunciated in Pender v Lushington. (read case notes) Unenforceable Rights: Obligations classed as insider rights or pure membership rights are enforceable by the membership of the company, other obligations contained within the company constitution which may be termed as outsider rights are generally regarded as unenforceable. Outsider rights = obligations which do not relate to the collective constitutional rights of any given class of shareholder. This view owes much to the comments of Astbury J who in Hickman v Kent laid down 3 principles of law which he considered governed what is now s14. Quoted with approval in subsequent cases. E.g. Beattie v Beattie. No articles can constitute a contract between a company and a 3rd person. No right purporting to be given by an article to a person, whether member or not, in a capacity other than that of a member can be enforced against the company. Articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the company respectively. Indirect Enforcement of ‘outsider rights’: No privity of contract exists between a company and a non-member of the company. Obligation which confers some form of right on a non-member of the company will be unenforceable by the non-member. However, where the outsider right is held by a member of a company, the right, whilst unenforceable in respect of the generally accepted judicial interpretation of s.14 may be in certain circumstances be held to be indirectly enforceable. In those decided cases where outsider rights have been prima facie enforced, the right in question has usually been one associated with the management of a company, i.e. the right may belong to a corporate office such as a directorship. See Salmon v Quin & Axtens See also Rayfield v Hands – Vaisey J held that the directors, whilst in the strict sense outsiders, were, as members of the company, bound by the provisions of the articles. Academic theories which have attempted to explain cases in which the enforcement of an apparent outsider right has been allowed have resulted in two different lines of thought: Theory A: A member of a company has the right to enforce any obligation contained within the company’s memorandum or acticles, irrespective of whether the right is an ‘insider’ or ‘outsider’ right. However, the member must sue qua (in the character of) member and the enforcement of the obligation must constitute something more than the enforcement of an internal irregularity. Supported by Lord Wedderburn who takes the view that a member always has the right to have the articles and memorandum enforced – one basic membership right. Theory B: A member of a company has the right to enforce any obligation contained within the company’s memorandum or articles. Nevertheless, where the member seeks to enforce an ‘outsider right’ he can only do so where he sues qua member and the right is essential to the proper functioning of the company i.e. the right in question relates to the ability of a company to function within the constitutional framework of its own regulations and those imposed on it by statute. Supported by academics suck as Goldberg and Prentice – Prentice contends that it is necessary to ask whether the particular provision affects the power of the company to function. These contentions may help to rationalise the decision in Salmon v Quin & Axtens – however there is no evidence that the judges were thinking in this way. Different view put forward by Roger Gregory who argues cogently that there are two lines of cases supporting different views and that the cases are irreconcilable. Any attempted reconciliation of the case law in respect of judicial interpretation of outsider rights is difficult if not impossible since s 14 was drafted in such an obscure way. Submitted that a common factor, in seeking to explain those cases in which outsider rights have been apparently enforced, is one which is based on the premise that the underlying nature of the so-called outsider right is an essential constituent of a pure membership right. e.g. Eley case – outsider right belonging to company solicitor was unenforceable because it could not be related to a right commonly held by the membership; the right belonged to the solicitor and no other member of the company. Salmon v Quin – the failure to enforce the MD’s power of veto would have affected a membership right (insider right) to have the business decisions of the company dealt with according to the terms of the company articles i.e. if the right had not been enforced the terms of the company articles would have been flouted without the authorisation of the general meeting. ALERATION OF THE ARTICLES: It is said that a company’s articles are freely alterable. Section 9 CA 1985 (CA 2006 s 21(1)) provides that a company may by special resolution alter its articles. An alteration is as valid as if it had been in the original articles and can only itself be changed by the special resolution or written resolution procedure, though the court is given power by the legislation to change the articles, for example as part of assisting minority shareholders to overcome the unfairly prejudicial conduct of the majority. Resolution or agreement effecting the alteration must be sent to Companies House within 15 days. Copy of amended articles to be sent no later than 15 days after amendment takes effect. Criminal sanctions for failure to comply. New power under CA 2006 for Companies House to send out notice requiring compliance with this obligation within 28 days and to impose civil penalty of £200 for failure to comply. Entrenchment: Under CA 2006 it is possible to entrench a provision in the articles. Any attempt to make particular articles unalterable is not possible. S 22(3) provides that provision for entrenchment does not prevent alteration of the company’s articles by agreement of all the members of a company or by court order. Before Oct 2009 articles cannot be entrenched. Alteration by special resolution. An alteration on the articles may operate retrospectively and so affect the existing rights of members. In Allen v Gold Reefs of West Africa Ltd 1 Ch 656 the articles originally gave the company a lien (A right to detain the goods of another until some claim has been satisfied) on partly-paid shares. The claimant was the only member with fully-paid shares but he also owed calls on certain other partly-paid shares which he owned. The company altered its articles to give itself a lien on fully paid shares, thus putting itself in a position where it could refuse to transfer the claimant’s fully-paid shares unless and until he had paid calls owing on his partly-paid shares. It was held that the alteration was valid and for the benefit of the company, even though it operated retrospectively so far as the claimant was concerned. Is the alteration bona fide for the benefit of the company as a whole? Master of the Roles Lindley said in Allen v Gold Reefs of West Africa Ltd 1Ch 656, (see above) the court has a jurisdiction to regard an alteration of the articles as invalid unless it is made for the benefit of the company as a whole. The court does not solely look at the company as it is at the time of the act (which would be a subjective test) but tries to see the company in equilibrium. That is the court envisages the company in a hypothetical situation in which shares and voting power are evenly distributed among the members, and assumes that members will vote independently of each other and not, as it were, combine to coerce other members. Having viewed the company in this situation, the court then decides on the validity of the alteration. This is an objective test and is really the only one the court can adopt. If it were to test the validity of the alteration against the present state of the shareholding, then the day after the resolution was approved the shareholding may alter and there may be a shift in the centre of power in the company. Rather than cope with so many imponderables, the court decides the question by putting the company into a state of equilibrium (hypothetically at least) and then looking at the alteration. However, the objective test is not altogether satisfactory and can sometimes operate unfavourably towards particular shareholders. See Greenhalgh v Arderne Cinemas Ltd Ch. The result of the objective test which the courts uses is that most alterations are allowed, though alterations which give the company power to expel members without cause are not acceptable to the court. However, expulsion is allowed where it would benefit the members as a whole, as where the member expelled is competing with the company or defrauding it. Sidebottom v Kershaw Leese & Co Ltd 1 Ch 154 – minority shareholder in company carried on business in competition with the company. Proposed to alter articles to insert clause whereby a shareholder who competed with the company would be required to transfer his shares at a fair value to the directors. Alteration held to be valid even thought it was specifically carried out against one member. The clause in question could apply to in relation to any member. Contrast Brown v British Abrasive Wheel 1 Ch 290 – 98% majority sought to alter articles to compel minority who were not prepared to invest further capital in the business to sell their as a condition of the majority’s providing further capital. Alteration held invalid. Noted that such a provision could be used to require a minority to sell its shares at the will of the majority. Alteration may have been unfair to the interests of the minority it is questionable whether or not the potential survival of the company was in this instance more important than the interests of the very small minority holding. Inconsistency – if the question is not what is for the benefit of the company as a separate corporate entity, it is difficult to conjure up a hypothetical shareholder in whose interest the alteration must be. Malevolence did not prevent Mr Mallard succeeding in Greenhalgh, why should the majority’s view be overridden in Brown? Possible interpretation offered by Lord Evershed MR in the Greenhalgh case where he agues that if the effect of the alteration is to discriminate between the majority shareholders and the minority shareholders to give the majority an advantage, then the alteration should be permitted. Did Evershed intend his test to be applied in all future cases? Mayson, French & Ryan suggest that the true position is that the discrimination test in only necessary in cases where it is inappropriate to apply the test of benefit to the company as a whole. In Gambotto v WCP Ltd (1995) 182 CLR 432 – High Court of Australia – the valid test should be whether the alteration is ‘beyond any purpose contemplated by the articles or oppressive as that expression is understood in the law relating to corporations’. The law must try to achieve a balance between protecting minorities without giving them disproportionate power. See also Citco Banking Corporation NV v Pusser’s Ltd Bus LR 960 Due to the general reluctance of the courts to interfere in business decisions of a company the majority of the decided cases emphasise the importance and predominance of the subjective element of the test over the objective part. See Shuttleworth v Cox 2 KB 9 – company had a board of directors appointed for life. Alteration provided that any one of the board of directors should lose office if his fellow directors requested in writing that he should resign. The alteration was directed at a particular director whose conduct had not been satisfactory. Director claimed his dismissal was wrongful. Court of Appeal upheld the validity of the company action. Scrutton LJ: ‘shareholders must act honestly having regard to and endeavouring to act for the benefit of the company.’ Court will only intervene in extreme cases. Effect of alteration might cause disadvantage to minority but disadvantage alone is not sufficient to warrant a declaration that the alteration was invalid.