Every limited company must have two documents which together constitute its constitution. These are the Memorandum of Association and Articles of Association. The Memorandum sets out the basis on which a company exists and the Articles provide for the way in which the company is run.
Memorandum of Association
In companies incorporated before October 2008 the Memorandum is an important document as it sets out the company’s basic powers and objects (in other words, what the company can and cannot do). However, as most companies had very general Memoranda which usually permitted them to do almost anything, and in any case the shareholders could change the Memorandum at any time to allow for extra powers, in October 2008 the law changed. For companies incorporated since then, the Memorandum simply states that the company exists (and it cannot be subsequently changed). Even for pre-October 2008 companies, the Memorandum may now be amended to the form used for newer companies.
Default Articles of Association
The Articles of Association regulate the way a company is administered. While the Articles do not usually address matters of day-to-day management, they will govern such fundamental matters as the issue of new shares, the procedures surrounding shareholder decisions and board meetings, and appointment of directors. They may also provide for restrictions on sales of shares, or set out circumstances in which a shareholder might be forced to sell his shares (for example, a minority shareholder might be required to sell his shares to someone who wants to buy the whole company, when the majority shareholders have already agreed the terms of a deal).
There are default Articles, set down by law, which will apply to most companies, but these default Articles can be changed, and it is often good practice to amend the default Articles to fit the specific requirements of a company.
The sorts of issues that might commonly be addressed in a company’s Articles are:
• restrictions on shareholders selling their shares. Without such restrictions, a shareholder can freely sell his shares, which might result in the remaining shareholders being in business with someone they do not know or approve of;
• the ability to force minority shareholders to sell their shares to someone to whom the majority have agreed to sell the company (called “drag-along” rights);
• the ability for a minority shareholder to block the sale of the majority’s unless the buyer also buys the minority’s shares (called “tag-along” rights);
• restrictions on the issue of new shares, which could change the proportions in which shareholders own the company, or bring in new shareholders, thus diluting the existing shareholders’ interest in the company;
• the minimum or maximum number of directors of the company;
• provisions for how directors meetings are to take place;
• provisions setting out shareholders can make decisions.
It is common for shareholders to enter into a contract between themselves (called a “shareholders agreement”), which might deal with many of these issues. However, they are often better dealt with in the company’s Articles of Association. This is because a shareholders agreement is a contract between the shareholders and as such any action taken in breach of it may lead to a right to claim damages, but will usually not affect the legal validity of the act complained of. For example, a transfer of shares in breach of a shareholders agreement will usually be a perfectly valid and legal transfer, even if the other shareholders have a claim for breach of contract. The claim is only worth anything to the other shareholders if they have suffered any loss, as the normal remedy for a breach of contract is to be awarded compensation for losses caused by that breach.
However, if the relevant matters are in the company’s Articles of Association, then the rights of the aggrieved shareholders are stronger, because a company cannot act outside the provisions of its Articles. Therefore, for example, a transfer of shares which is not permitted by the company’s Articles will often be legally invalid.
For more on shareholders agreements, click here.
How can we help?
We are very experienced in advising on and preparing Articles of Association. We can also advise on the initial setting up of the business and on the other legal issues that arise in running a business, such as property and employment matters and all kinds of commercial agreements. If you have any questions or are looking for information on shareholders agreements or any other business law matter, please contact Catherine Drew.