Topic 4: The Constitution of the Company - The Articles of Association

CA 2006 does not seek to exhaustively regulate the internal affairs of

companies. Much is left to the companies themselves who will usually create
their own internal rules via the companys constitution
A company's constitution largely fulfills the same function as the constitution
of a country namely to set out the powers, rights and obligations of those who
are subject to the constitution.
A company's constitution aims to set out the powers, rights and obligations of
the company's members and directors, and also lay down certain processes
regarding how the company is to be run
The Evolution of the Corporate Constitution
Prior to the passing of the CA 2006, a companys constitution consisted
primarily of two documents, namely (i) the memorandum of association, and
(ii) the articles of association
Section 17 now provides that a companys constitution will include:
1. the company's articles, and
2. resolutions and agreements affecting the companys constitution
A memorandum no longer forms a principal component of the constitution
and its importance and content are greatly diminished
As s. 17 uses the word 'include', it is clear that it does not provide an
exhaustive definition of the constitution and other documents will also form
part of a company's constitution
For example s. 32 provides the members with a right to request
'constitutional documents' which will include the documents referred to in s.
17, but will also include a copy of the company's certificate of incorporation
and in the case of a limited company, a statement of capital or guarantee
Memorandum of Association
Prior to the CA 2006's enactment, the memorandum was of fundamental
importance and formed one of two principal documents that formed a
company's constitution
To simplify company formation and to make it easier to discover the
constitutional workings of a company the Company Law review Steering
Group originally proposed that the memorandum and the articles should be
merged to create one single constitutional document
The government disagreed and recommended retaining both the
memorandum and articles, and s. 7(1)(1) provides that all companies must
have a memorandum. However, under the CA 2006, the content and the
importance of the memorandum have been reduced significantly, and it no
longer forms a principal component of the company's constitution
it can therefore be seen that, under the CA 2006, all the memorandum does
is to provide an 'historical snapshot' that indicates the company's state of
affairs at the time it was created
Companies Act 1985
-Section 1(3)(1) and 2 of the CA 1985 (now repealed) provided that the
memorandum must state:
-if the company is public, the memorandum must state that the company is public
-the name of the company
-whether the company is to be situated in England and Wales or in Scotland
-the objects of the company

whether or not the liability of the members is limited, and the method of limitation,
and
-details concerning the companys share capital and the subscriber's of the
company's first shares.
Modern Role of Memorandum - S. 8, CA 2006
-provides that the memorandum must state that the subscribers:
(1)A memorandum of association is a memorandum stating that the subscribers
(a)wish to form a company under this Act, and
(b)agree to become members of the company and, in the case of a company that is
to have a share capital, to take at least one share each.
(2)The memorandum must be in the prescribed form and must be authenticated by
each subscriber.
The Articles of Association
with the emasculation of the memorandum, the articles now form a
company's principal constitutional document.
article regulates the internal workings of the company and covers issues such
as the balance of powers between the member and the directors, the conduct
of the general meeting and certain issues pertaining to shares and the
distribution of assets
if a company chooses to limit its objects, the objects clause will also form part
of the articles
every company must have a set of articles (CA 2006, s. 18(1)) and
promoters are free to draft their own articles that suit their needs of their
particular business requirements and submit them upon registration
The Companies (Model Articles) Regulations 2008 provide model articles
Resolutions and Agreements affecting the Company's Constitution - Section 29 CA
2006
certain resolutions and agreements will also form part of the company's
constitution
The Constitution as a Contract
the courts have long held that a company's articles form a contract between
a company and its members and between the members themselves
section 33(1) CA 2006 expands upon this by stating that:
o the provisions of the company's constitution bind the company and its
members to have the same extent as if there were covenants on the
part of the company and of each member to observe those provisions
Accordingly, the company's constitution forms what is known as the 'statutory
contract' and imposes obligations upon:
o the company when dealing with its members
o the members when dealing with the company, and
o the members when dealing with each other
breach of certain provisions of the company's constitution may therefore
constitute breach of contract, thereby allowing the non-breaching party to
commence a personal action and obtain a remedy
however, not all of the constitution's provisions will amount to terms of the
statutory contract
The Statutory Contract - s. 33

statutory contract differs from a standard contract and is not subject to

certain standard contractual rules
statutory contract is formed between a company and its members-- persons
not party to the statutory contract (known as 'outsiders') are therefore not
permitted to enforce the provision of the constitution
The Contract Between the Company and its Members
both parties can enforce compliance with the terms of the constitution
against the other
in the following case the company enforced the constitution against one of its
members
Hickman v Kent or Romney Marsh Sheepbreeders' Association
o Facts: The articles of the defendant company provided that any dispute
between it and a member should be referred to arbitration before any
legal proceedings were initiated. The defendant purported to expel one
of its members (the claimant) from its organisation but, instead of
referring the dispute to arbitration, the claimant petitioned the High
Court for an injunction restraining his expulsion
o Held: The articles formed a contract between the company and its
members. The company was therefore permitted to enforce the term of
the articles and require disputes to be referred to arbitration. The High
Court therefore stayed the legal proceedings initiated by the claimant,
and the claimant was subsequently expelled.
A member can enforce compliance of a term of the constitution against the
company
however, it is vital to note that not all the terms of the constitution can be
enforced in this way
Pender v Lushington
o Facts: the companys articles provided that its members would have
one vote for every ten shares, up to a maximum of 100 votes.
Consequently, members with over 1000 shares would not have voting
power commensurate to their shares. To avoid this, members with over
1000 shares transferred some of their excess shares to several
nominees (including the claimant), thereby unlocking the votes within
them. The companys chairman ( the defendant) refused to accept the
nominees' votes and the claimant alleged that his votes were
improperly rejected.
o Held: The claimant's action succeeded. The shares were properly
transferred and registered to the nominees, so refusing to accept their
votes constituted a breach of the articles. The court therefore issued an
injunction restraining the rejection of the nominees' votes.
Wood v Odessa Waterworks
o Here the Plaintiff who was a member of the company petitioned the
court to stay the implementation of a resolution not to pay dividends
but issue debentures instead. Holding that a member was entitled to
the stay of the implementation of the resolution, Sterling J. had the
following to say: the articles of association constitutes a contract
not merely between shareholders and the company but also
between the individual shareholders and every other.

It is vital that you can determine whether or not a provision of the

constitution concerns a membership right. Common membership rights
contained in the constitution include:
o the right to attend, speak and vote at general meetings
o the method of counting votes at general meetings
o rights relating to the transfer and transmission of shares
o the right to dividend, once it has been validly declared
o in the case of a quasi-partnership company, the right to manage a
company
The Contract Between the Members and Themselves - unusual for a member to
enforce contract on another member, usually company will enforce contract
just as the constitution forms a contract between the company and its
members, it also forms a contract amongst the members themselves
Accordingly, a breach of the statutory contract by a member can be enforces
by another member, providing that the provision breached concerns a
membership right
Member Enforce contract against Company
Courts reluctant
The Capacity of a Company
as the company is a legal person, it can enter into contracts in much the
same way as natural persons can
however, historically, the company's ability to enter into contracts was
subject to a significant limitation
prior to the CA 2006, all companies were subject to state their memoranda
the objects or purposes for which the company was set up (known as the
'objects clause')
the objects clause serves to limit the contractual capacity of the company
and if a company entered into a contract that was outside the scope of its
object clause, the company would be acting ultra vires ('beyond ones
powers) and the contract would be void ab initio.
Ashbury Railway Carriage and Iron Co Ltd v Riche
o Incorporated under the Companies Act 1862, the Ashbury Railway
Carriage and Iron Company Ltds memorandum, clause 3, said its
objects were to make and sell, or lend on hire, railway-carriages and
clause 4 said activities beyond needed a special resolution. But the
company agreed to give Riche and his brother a loan to build a railway
in Belgium. Later, the company refused the agreement. Riche sued,
and the company pleaded the action was ultra vires.
o Held: The House of Lords, agreeing with the three dissentient judges in
the Exchequer Chamber, pronounced the effect of the Companies Act
to be the opposite of that indicated by Mr Justice Blackburn. It held that
if a company pursues objects beyond the scope of the memorandum of
association, the company's actions are ultra vires. Lord Cairns LC said,
"It was the intention of the legislature, not implied, but actually
expressed, that the corporations, should not enter, having regard to
this memorandum of association, into a contract of this description.
The contract in my judgment could not have been ratified by the
unanimous assent of the whole corporation.
the restriction on a company's capacity was introduced to protect persons
who provided a company with capital, namely members and creditors

such persons provided capital on the expectation that the company would
pursue the lines of business for which it was set up and would not expend
capital on frolics outside the company's stated purposes.
the problem was that the rules relating to ultra vires were overly complex,
technical and vague and served to harm third parties who had innocently
contracted with the company
the ultra vires doctrine also served to inhibit a companys ability to diversify
into other areas of business that could prove profitable
accordingly, successive Companies Acts have weakened the ultra vires
doctrine with the CA 2006 significantly curtailing its scope, especially in
relation to companies incorporated under the CA 2006 and third parties, for
whom the doctrine is now largely irrelevant
there is no doubt that the CA 1985 and CA 2006 have substantially weakened
the doctrine of ultra vires, but it has not been abolished (despite what other
sources say)
The Abolition of the Requirement to Include an Object Clause
the requirement of an objects clause has been abolished by the CA 2006
(although companies can still include an objects clause if they so wish) and
such companies will accordingly have unrestricted objects (CA 2006, s 31(1)).
- unless a companys articles specifically restrict the objects of the company,
its objects are unrestricted.
For such companies, the ultra vires doctrine will be of little relevance as the
companys contractual capacity will not be limited
This is the default position for companies incorporated under the CA 2006
of course, companies incorporated under previous Companies Acts will still
have an objects clause but, as a result of the CA 2006's reforms relating to
the memorandum, such an objects clause will now be regarded as forming
part of the company's articles and not its memorandum
As the articles can be altered by passing a separate resolution (CA 2006, s
21(1)), such companies can accordingly delete the objects clause by passing
a special resolution to that effect and, in doing so, will acquire unrestricted
capacity
Inclusion/Retention of the Objects Clause
the objects clause and the doctrine of ultra vires are still relevant in 2
instances:
1. Although companies incorporated in the CA 2006 do not need to
include an objects clause in their articles, they may do so if they wish.
It is anticipated that very few companies incorporated under the CA
2006 will include an objects clause
2. Companies incorporated under prior Companies Acts may decide not
to, or may neglect to, remove their objects clause. As regards such
companies, the objects clause will serve t olimit the directors' authority
and the ultra vires doctrine will still be of relevance, although, it has
lost much of its force.
External issue: s. 39, CA 2006: (1) The validity of an act done by a company
shall not be called into question on the ground of lack of capacity by reason
of anything in the companys constitution - nobody can raise an issue that it
is ultra vires-ensures issues of capacity cannot be raised -cures capacity
problem

the result of s. 29(1) and 40(1) is that if a company or director enters into an
ultra vires contract with a third party, then the contract cannot be attacked in
the ground that it is ultra vires. Therefore, from the point of view of a third
party, the ultra vires doctrine is or little relevance, which is why it is often
stated that the CA 2006 abolishes ultra vires externally, because it is of little
concern to third parties
Internal issue: s. 40 -Also see s. 171(a),Directors are required to act in
accordance with the constitution so while the shareholders have limited
powers to enforce the constitution, the directors are bound by their duties to
adhere to it.

Alteration of the Articles - amendment of articles

Section 21(1), CA 2006 provides that a company may amend its articles by
passing a special resolution and, in certain cases, the courts also have the
power to amend the articles
however, the ability to alter the articles on not limitless and both statute and
the common law impose restrictions on a company's ability to alter its
articles.
o Statutory Restrictions: statute may limit a companys ability to alter its
articles - Examples:
the ability to alter the articles is limited by the provisions of the
Companies Act
a member is not bound by any change in the articles made after
he became a member in effect of the change is to require him to
take or subscribe for more shares than the amount he had at the
date of the alteration, unless he expressly agrees in writing to
the change (s. 25)
in certain situations, statute empowers the court to prohibit a
company from altering its articles without the court's permission
(eg. where the members of a public company object to it reregistering as private (CA 2006, ss 97 and 98(6))
o Common Law Restrictions
the power to alter the 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." - Lindley MR in Allen v Gold Reefs of
West Africa Ltd
the test imposed by Lindley, whilst flexible enough to grant the
court a wide discretion, is rather vague, to the extent that the
High Court of Australia described it as 'almost meaningless'
CA 2006, s. 21
o By special resolution, unless the provision has been entrenched in
which case it can only be altered in accordance with the mechanism
provided for alteration or with unanimous agreement of the
shareholders, s 22; or the provision is a class right, alteration of which
is governed by s 630.
o majority of at least 75%

members join the company on the basis that contract may be changed
at any time
o Allen Test: the alteration must be bona fide for the benefit of the
company as a whole
o subjective test: would those voting in favour of alteration consider
the change to benefit the members or company as a whole and would
the reasonable man come to the same decision?
o members are able to vote in their own favour
o weighed voting rights & class rights (to protect the minority)
Drag and Tag Provisions: if offer was made to A, B, and C, and D does not
agree, D must drag ie. Re Charterhouse (below)
Allen v Gold Reefs of West Africa Ltd - Allen Test : the alteration must be bona
fide for the benefit of the company
o It held that alterations could not be interfered with by the court
unless a change was made that was not bona fide for the
benefit of the company as a whole. This rule served as a marginal
form of minority shareholder protection at common law, before the
existence of any unfair prejudice remedy.
o Facts: Gold Reefs articles gave it a "first and paramount lien" (the right
to retain possession) on all partly paid shares held by any member for
any debt owed to the company. Mr Zuccani held some partly paid up
shares. He also owned the only fully paid up shares issued by the
company. He died insolvent. The company altered its articles by special
resolution to create a lien on all fully paid shares (deleting the words in
brackets of upon all shares (not fully paid) held by such members). Mr
Allen, one of the executors of Mr Zuccani (trying to get money back)
sued to get the fully paid shares value.
o Kekewich J held the company could not enforce the lien. The company
appealed.
o Lien Definition: a right to keep possession of property belonging to
another person until a debt owed by that person is discharged
o Judgement: Lord Lindley MR held the alteration of the company's
articles was valid to introduce a lien on fully paid up shares. So long
as the resolution was done bona fide for the benefit of the
company as a whole, restrictions on freedom of a company to
alter its articles are invalid. According to Lord Lindley MR the power
to change the articles is, "like all other powers [to] be exercised 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, and it must not be
exceeded. These conditions are always implied, and are seldom, if
ever, expressed...
o How shares shall be transferred, and whether the company shall have
any lien on them, are clearly matters of regulation properly prescribed
by a companys articles of association...
o It is easy to imagine cases in which even a member of a company may
acquire by contract or otherwise special rights against the company,
which exclude him from the operation of a subsequently altered
article...
o

The altered articles applied to all holders of fully paid shares, and
made no distinction between them. The directors cannot be charged
with bad faith.
Shuttleworth v Cox Brothers & Co
o Facts: The company's articles provided that its directors (one of whom
was the claimant) would hold office for as long as they wished, unless
they became disqualified by virtue of one of six specified events. The
claimant engaged in a financial irregularity, but it did not fall within
one of the six specified events. The other directors therefore used their
shares to pass a special resolution altering the articles by adding a
seventh event, namely that a director must resign if all the other
directors required him to. Following the alteration, the claimant's codirectors demanded his resignation. The claimant challenged the
alteration
o Held: The test imposed by Lindley is predominately subjective,
meaning that if the majority shareholders honestly believed
that the alteration was for the company's benefit as a whole,
then the alteration would be valid, even if the court disagrees
with the majority's assessment. On this basis the court held that
the alteration was valid, as the other directors did believe that it was
for the companys benefit. The Court did however, impose an
objective requirement, namely that an alteration would not be
valid if 'no reasonable man could consider it for the benefit of
the company'
o It is therefore apparent that a minority shareholder who wishes to
challenge an alteration on this ground will face a difficult task. As our
system of company law is based heavily on the principle of majority
rule, the courts are reluctant to invalidate alteration of the articles
Entrenched Article Provisions
CA 2006, s 22 - Entrenched Provisions of the Articles - there is a lack of
clarity
o (1) A company's articles may provide that specified provisions of the
articles may be amended or repealed only if conditions are met, or
procedures are complied with, that are more restrictive than those
applicable in the case of a special resolution. This is referred to as
"provision for entrenchment".
a company cannot make its article unalterable, however, the CA 2006
introduced the ability to entrench article provisions, thereby making them
more difficult to alter (s. 22 CA 2006)
this could be done by requiring additional conditions to be met (eg. by
requiring unanimity instead of the normal special resolution) or by imposing
restrictive procedures to be adhered to (eg. by requiring the alterations to be
approved by certain specified members).
In order to prevent abuse, the Act imposes several safeguards:
o Entrenchment will not prevent alteration where all of the members
agree to an alteration, or where the court orders an alteration to be
made
o if a company wishes to entrench an article provision after the company
has been formed, it can only do so with the agreement of all members
of the company

Citco Banking Corp v Pusser's Ltd

Resolutions amending the company's articles of association were valid. The
Court of Appeal of the Eastern Caribbean Supreme Court had applied the
correct test, namely whether reasonable shareholders could have
considered the amendment was for the benefit of the company.
The proper test was whether, in the opinion of the shareholders, the
alteration of the articles was for the benefit of the company and
whether there were grounds on which reasonable men could come to
the same decision. Since reasonable shareholders could have accepted in
good faith the reasons put forward by the chairman as to why the
amendment had the effect of vesting voting control in him, and since there
was no dispute as to whether the chairman had acted bona fide, Citco's
challenge to the special resolutions failed
The Privy Council added that it was not necessary to show that the
resolutions would have been passed even without the votes controlled by the
chairman. This was on the basis that it is 'not necessary to require that a
person voting for a special resolution should, so to speak, dissociate
themselves altogether from their own prospects' However, the evidence
should the resolution would in fact been passed by the requisite majority.
Re Charterhouse Capital Ltd, Arbuthnott v Bonnyman - Drag and Tag Provision
A recent decision by the High Court in Re Charterhouse Capital Ltd Arbuthnott
v Bonnyman and others [2014] EWHC 1410 (Ch) is a useful reminder of the
test for unfair prejudice and the inherent difficulties in the valuation of
companies. The well-publicised case involved a retired partner from a private
equity business (Charterhouse) claiming unfair prejudice in relation to the
acquisition of his shares in Charterhouse Capital Ltd (CCL) by the remaining
partners. The judge rejected Mr Arbuthnotts claim for unfair prejudice under
section 994 of the Companies Act 2006 and/or under the rule in Allen v Gold
Reefs of West Africa [1900] 1 Ch 656.
The judgment (paragraph 214 onwards) is a useful overview of the relevant
law and the distinct requirements for establishing unfair prejudice. It also sets
out the well-known principle that the exercise of the power of the majority
by special resolution to alter the articles of association may be subject to
restraint in equity if it is abused, referring to Allen v Gold Reefs. The judge
noted: Any resolution that offends the Allen principle will inevitably
be unfair and prejudicial for the purposes of section 994, but an
alteration of the articles does not have to offend the Allen principle
in order to amount to unfair prejudice. Unfair prejudice is a wider
concept, judged in accordance with an objective standard, and gives rise to
greater and more flexible remedies.
The case makes interesting reading, not least in relation to the method to be
applied when valuing a business. While the case was decided on its facts,
applying the principles under section 994 and Allen v Gold Reefs, a point to
highlight in relation to the application of Allen v Gold Reefs is that the case
was distinguished from the application of Allen v Gold Reefs to other
situations where articles were amended to insert a drag provision. In this
case, drag rights already existed in the shareholders agreement
and articles and were simply being altered.

Drag and Tag along Provision: A drag along right allows a shareholder of a
company (usually a majority shareholder or institutional investor) to force the
remaining shareholders to accept an offer from a third party to purchase the
whole company, where the majority shareholder has accepted that offer, on
the same terms. The other (usually minority) shareholders are then "dragged
along" and forced to sell their shares at the same time and at the same price
for each share.
The aim is to provide liquidity and an exit route to the majority shareholder or
institutional investor for its investment as most buyers will want to acquire
100% of the company and not be left with a (potentially uncooperative, or
even hostile) minority shareholder group. It is sometimes known as a
"squeeze out" provision.