ARTICLES OF ASSOCIATION - Company Law and Procedure Notes 2016

These are the domestic regulations, which regulate the conduct of a company. Section 7.

(1) of the Act provides that, “a company may have articles regulating the conduct of the company.” The wording of the subsection suggests that having articles of association is optional, i.e. that a company is at liberty to choose whether or not to have these articles.

However, no company can exist without articles such that where a company decides not to come up with its own articles, then the Standard of Articles in the First Schedule of the Companies Act will apply in default. This is confirmed by section 7(5) of the Act, which provides that, “the articles of a public company or a private company limited by shares shall be deemed to have adopted the regulations of the Standard of Articles except insofar as the articles exclude or modify those regulations.” This means that in the event of the company failing to come up with its own articles, the articles in the First Schedule will apply to the company.

Section 7(2) of the Act provides that, “the articles may contain restrictions on the business that the company may carry on.” The restriction referred to here is also attempted in section 22(3) of the Act which says, “a company shall not carry on any business or exercise any power that it is restricted by its articles from carrying on or exercising, nor exercise any of its powers in a manner contrary to its articles.” These 2 sections seem to suggest that a company may restrict its activities via its articles. The provisions of the Act are effectively altering the traditional purposes of articles of association in relation to the memorandum of association. The purpose of the memorandum of association (MOA) is to define the relationship of the company with the outside world. Significantly the memorandum of association defines the capacity of the company. On the other hand, the articles are the internal or domestic regulations, which govern the internal relations. The articles will regulate the manner in which the officers will exercise the various powers assigned to them, e.g. allotment of shares, appointment and removal of directors, issues concerning convening of meetings, etc. On the other hand, the memorandum of association is a more outward looking document. The articles tell us how the powers conferred by the memorandum of association are to be administered.

The company’s sources of power are the Companies Act itself and the memorandum of association. The articles ought to show how the powers given by the Act and the memorandum of association are to be exercised. Here the Act and the memorandum of association determine the capacity of the company.

How then should the articles define the power of the company as provided in sections 22(2) and 22(3) of the Act? To define capacity therefore, you have to refer to the memorandum of association, the Act and the articles since articles restrict the capacity of a company. The restrictions by the articles should have been placed in the memorandum of association, i.e. the Incorporation Form, as the memorandum of association and the Act are the source of power.

(i) The Legal Effect of the Articles

The articles of association constitute a contract or covenant, which binds each member to the company on one hand and each member on the other as well as between the members inter se. The Articles bind members only, i.e. members in their capacity as and not in any other capacity. It has been held that Articles create a contract, which binds each member to the company as well as members amongst themselves. In the leading case of Hickman v Kent (1915) Ch 881, the articles provided for resolution of disputes between members and the company to be referred for arbitration. The plaintiff brought an action against the company against the removal from the company. The court held that the plaintiff was bound by the clause in the articles, which bound him to refer the matter to arbitration as opposed to instituting legal action.

In Beattie v Beattie Ltd (1938) Ch 708, the dispute involved a director and the company. The director sought to have the dispute referred for arbitration under one of the articles. However, the court following Hickman above refused to grant the

application to refer the dispute for arbitration as the dispute was qua director as opposed to qua member.

The articles also constitute a contract between individual members (shareholders).

Normally the contract between the individual members would be enforceable through the company because the rights prescribed in the articles are not personal to the members.

The rights, which members enjoy, are derivative as they derive as a result of the company. To say the rights are not personal means they can only be enforced through the company.

The rule in Foss v Harbottle is that, as one would except, the plaintiff in an action to redress an alleged wrong to a company on the part of anyone, whether director, member or outsider, or to recover money or damages alleged to be due to it, is prima facie the company and, where the alleged wrong is any irregularity which might be binding on the company by a simple majority of members, no individual member can bring an action in respect of it. In other words, the company is normally the proper plaintiff in an action to recover loss or to enforce a duty owed to the company by directors or controlling members, and where the breach of duty can be condoned by an ordinary resolution of the members in a general meeting, no individual member or minority of members may sue.

And the appropriate agency to start an action on the company’s behalf is the board of directors, to whom this power is delegated as an action alleging that the loss suffered by the company has consequently diminished the value of his o r her shares.

A general meeting may be held so that the members may by ordinary resolution decide whether to sue or not. If such a meeting has been held and the breach of duty condoned, not only does this prevent a single shareholder from bringing an action, it may, depending on the circumstances also prevent the liquidator form subsequently doing so. It also follows that where the wrong may be ratified by a special resolution, and such a resolution is passed, no action will lie.

The rule is therefore, a combination of two principles;

(a) the proper plaintiff principle, and (b) the majority rule principle.

In Foss v Harbottle, two members took proceedings on behalf of themselves and all other members except those who were defendants against the directors of a company to compel them to make good losses sustained by the company owing to the directors buying their own land for the company’s use and paying themselves a price greater than its value.

Held, that, as there was nothing to prevent the company in its corporate character from taking the proceedings, if it thought fit to do so, the action failed.

The articles of a company as such do not constitute an enforceable contract between the company and an outsider. Outsider here means a person who is not a member or indeed a member who is acting in a capacity other than for that of a member. Therefore, even a director of a company will be treated as an outsider so that any right, which an outsider

seeks to enforce, must be enforced via a separate contract, which would confer rights different from the rights in the articles.

In Eley the Positive Government Security Life Assurance Co. Ltd, (1876) 1 Ex.D.88;45 L.J.Exch.451;34L.T.190;24W.R.338. Articles provided that Eley should be the solicitor to the company for life. When the company was incorporated, Eley became a shareholder. He was employed as solicitor for a time but subsequently the company ceased to employ him. Eley sued the company citing the articles of the company. Held, Eley was not entitled to damages for breach of contract against the company. The articles did not create a contract between Eley and the company. The court observed that what Eley was seeking were not his rights as a member but as a solicitor and there was no basis on which court would grant the relief sought.

A member of a company may enjoy a right alone or in common with other members of a company and the rule in Foss v Harbottle has no application where individual members sue, not in right of the company, but in their own right to protect their individual rights as members. In such a case a member can bring an action in his own name and may sue on behalf of him and other members, and the breach of duty owed to an individual shareholder cannot be ratified by a majority of shareholders. Thus in Pender v Lushington (1877) 6 Ch. D 70, a shareholder was able to enforce the article giving him a right to vote at meetings and compel the directors to record his vote.

In Wood v Odessa Waterworks Co. (1889) 42 Ch. D 636, a company declared a dividend and passed a resolution to pay it by giving to the shareholders debenture bonds bearing interest and redeemable at par, by an annual drawing, over 30 years. The articles empowered the company to declare a dividend “to be paid” to the shareholders. Held, the works “to be paid” meant paid in cash, and a shareholder could restrain the company from acting on the resolution on the ground that it contravened the articles.

A member has two types of rights, namely:

a) Personal rights which cover the incidence of the member’s shares;

b) Constitutional rights, i.e. members of a company are entitled to have their company separate or function according to the company’s articles of association, memorandum of association, i.e. the Incorporation Form and the laws of the land.

Any other rights which a member will seek to assert must be the subject of a separate Contract. Note the provision of section 7(3), which states that, “where a provision in the articles is inconsistent with this Act or any other written law, the provision is invalid to the extent of the inconsistency.”

25 (ii) Contents of the Articles

The contents of the articles are generally as provided in the Standard Articles in the First Schedule of the Companies Act with variations as regards the particular company in question. Such articles would include a provision on how to acquire shares.

There is always need to include a clause on arbitration so that disputes arising say between members can be resolved by less cohesive means provided by arbitration process such that the parties only resort to court process where arbitration fails. Bear in mind that the Standard Articles in the Act do not provide for arbitration. The articles would also usually contain a clause on borrowing power and limits on the extent of exercise of such power.

(iii) Amendment or Alteration of the Articles (section 8)

A company may, subject to the provisions of the Act and any other provisions in the articles, amend or alter the articles by passing a special resolution approving the amendment (section 8(1)). A special resolution is one, which requires a three-quarter-majority vote to be attained. Here the directors would have earlier proposed the amendment, which is then tabled before the shareholders for approval. Section 8(2) of the Act states that, “if a company passes a special resolution approving the amendment of its articles, it shall within 21 days after the date of the resolution lodge a copy of the resolution with the Registrar together with a copy of each paragraph of the articles affected by the amendment, in its amended form.”

According to section 8(3) “the articles have effect in their amended form on and from the day of their lodgment with the Registrar or such later date as may be specified in the resolution. The second link above, i.e. “such later date”, can cause problems because it is at variance with section 62(9) of the Act which requires the articles to have effect as amended on and from the date of their lodgment.

The alteration provisions relating to the articles specified in section 8(1) above are however, potentially problematic because they do not take into account the peculiar situation that would arise if and when the proposed amendment would entail the variation of any rights which are attached to a particular class of shares. Section 62(3) provides that, “if the articles expressly forbid any variation of the rights of a class, or contain provision for such a variation and expressly forbid any alteration of the provision, the rights or the provision for variation may not be varied except in accordance with the provision, or with the written consent of all the members of that class, or with the sanction of the court under a scheme of arrangement in accordance with section 234.”

On the other hand, the provisions of section 8(1) simply talk of passing a special resolution approving the amendments, i.e. by three-quarters members’ consent. This is a departure from the contents of section 62(3) hence causing conflict. According to section 62(3) you cannot achieve that amendment without obtaining the consent of all those with class shares. From a practical point of view, all the members of the class would have to

consent to the alteration, unless you seek the indulgence of the court to sanction the alteration.

16. PRE-INCORPORATION CONTRACTS (section 28)

These are contracts, which promoters would have entered into before the company is formed. What is the approach of the law on these contracts? You cannot enter into a contract with a non-existing company. Frequently however, promoters will enter into contracts on behalf of the company they are promoting prior to its incorporation, but that company will not be bound when it is eventually incorporated because the company had no contractual capacity as it did not exist.

Although a company is entitled to adopt contracts, which are entered before its incorporation, ratification is only possible if the company was in existence when the contract was made. Generally speaking therefore, a person who contracts or purports to contract on behalf of a non-existent company will be treated as if he were contracting on his own behalf. In Kelner v Baxter (1866) LR 2 CP 174, the plaintiff had delivered goods to the defendant. The goods had been ordered on behalf of the proposed Gravesend Royal Hotel Co. Ltd. The question arose as to whether the company was liable. It was told that the company could not be liable since it did not exist at the time but the defendant acting on behalf of the unformed company was held liable on the contract. The court state that “When the company came afterwards into existence, it was a totally new creature, having rights and obligations from that time, but no rights and obligations by reason of anything which might have been done before.”

By contrast, if the person entered into the contract signing his name and adding after his name the description of the office that he will hold when the company is incorporated, then no liability would arise as there was no contract. This was the position in Newborne Sensolid (Great Britain) Ltd (1954). In that case, the company purported to sell a quantity of ham to the defendant. The defendant refused to take delivery of the ham.

The company sued for breach of contract but as the company had not been registered until after the contract was concluded and as the plaintiff had signed his name together with some description as director, it was held that there could be no liability. The way of evading this rule is for the promoter to enter into a draft agreement providing that the company, when formed, shall enter into a similar agreement with the third party and that the liability of the promoter shall thereupon cease. But the draft agreement creates no binding contract between the company and the third party, so that each can, with the collision of the promoter, deprive the other of the expected benefit of the contract. The general rule is found in section 28(1) and (2) of the Act.

In order to circumvent the difficulty posed by contracts made by promoters prior to incorporation of companies, section 28(3) was enacted to provide that, “the company may not later than 15 months after its incorporation, adopt the contract by an ordinary resolution, and upon adoption, subject to subsection (4) –

a) The company shall for all purposes be bound by the contract and entitled to the benefits thereof as if the company had been in existence at the date of the contract and had been a party thereto; and

b) The person who purported to act in the name of or on behalf of the company shall cease to be bound by or entitled to the benefits of the contract.

Section 28(4) of the Act affords remedy to a third party as it allows him to make an application to the High Court to determine obligations under the contract as joint or joint and several or apportioning liability between or among the company and the person who purported to act in the name of or on behalf of the company, and upon such application the High Court may make an order it thinks just and equitable.

Under the repealed Companies Act, there was a provision that once a company had been incorporated, it had within 6 months to hold a statutory meeting at which adoption of pre-incorporation contracts would be considered and made among other items of discussion.

There is no longer such requirement in the new Companies Act though this meeting is for all purposes very important to adopt those matters earlier decided before the company was incorporated. In Re English & Colonial Produce Co. Ltd (1906) 2 Ch 435, a solicitor, on the instructions of the persons who afterwards joined the board of a company about to be formed, prepared the memorandum and articles of association of the company and paid the prescribed fees for its registration. Held by Buckley J and the Appeal Court, that he was not entitled to recover from the company the costs of preparation of the memorandum and the articles of association; but held by Buckley J (there being no appeal upon this point) that, as much as the company was under a statutory liability to pay the registration fees, he was entitled to recover the fees from the company

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