Association and the Contractual Relationship of the Members - Essay Example

Articles of Association and the Contractual Relationship of the Members S. 14 Companies Act 1985 s: 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 respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and articles" 1.0 Introduction: Every company incorporated by registration under the Companies Act must have a Memorandum and by virtue of Section 1 (1) of the Companies Act 1985 the memorandum must be subscribed by the persons who have the intention to form the organization. These persons are known as 'Subscribers to the Memorandum'. The Memorandum constitutes the company's charter with the outsiders dealing with the company and usually contains a number of statutory classes. The Articles of Association on the other hand are the regulations governing the internal management of the company. Section 7 of the Companies Act 1985 has given the option to the companies limited by shares to adopt Table A instead of filing separate Articles. It is established law that where there is a conflict between the Memorandum and Articles of Association the Memorandum prevails. 2.0 Character of the Memorandum and Articles of Association: Section 14 (1) of the Companies Act 1985 has given the character of a statutory contract for the Memorandum and Articles of Association of a Company. These documents have given rise to a contract between the company and the members of the company and among the members themselves. Thus the right of a company to make the calls on unpaid shares can be enforced by the company by means of the Articles. In the same way by using the Articles the member can enforce the entitlement for voting rights against the company and the pre-emption rights on a sale of his shares against another member can also be enforced through the Articles. This character of the Memorandum and Articles of Association is usually referred to as the Statutory Contract or Section 14 contract. The character of the Memorandum and Articles as a statutory contract was put to test in the case of Eley v. Positive Government Life Security Assurance Co1. It was provided in the Articles of Association of the company that Eley will be the solicitor of the company to transact all legal business of the company and shall not be removed from the office except for misconduct. Subsequently Eley became the shareholder of the company. When the company started taking advice from another counsel, Eley brought an action for breach of contract under the Articles. His claim was dismissed on the ground that the Articles represent a contract between the members and the company or between the members themselves. It was held, as a solicitor Eley cannot enforce the contract under the Articles and the decision was upheld in the appeal. The position would have been different had Eley brought the action in his capacity as a member. But in the whole case the capacity of Eley was never brought into consideration and no ruling was given in that respect. "The Eley decision is quoted in most legal reference books as authority for the proposition that articles can only give rights to a member in his capacity as a member." Michael Grffiths2 As observed by Lord Cairns LC in this case the Articles represent either a stipulation to the members or it provides instructions to the directors for the conduct of the business of the company. In either of the cases the Articles represent a document to be considered as specifying the contractual relationship between the company and its members and directors and there is no place for an outsider to intervene in the operations of the Articles. 3.0 Enforcement of the Rights by a Non-member of the Company: In the case of Hickman v. Kent or Romney Marsh Sheep-Breeders' Association3 the rights of the members under the Articles of Association were more clearly established. The judge in this case observed 'that no right merely purporting to be given by an article to a person, whether a member or not, in a capacity other than that of a member, as, for instance, as solicitor, promoter, director, can be enforced against the company'. According to this ruling, the position of the members with respect to the Articles of a company is made clear in that a member can enforce the rights given to him under the Articles, in his capacity as a member of the company. These rights may include the right to vote, right to receive the amount in the winding up of a company against his share capital and so on. But it must be remembered that such rights can be enforced only in his capacity as a member and not in any other capacity. Though this interpretation appears to be valid and being widely accepted, as Lord Greene MR observed on the operation of the provisions of section 14 (1) the provisions of this section are "the subject of considerable controversy in the past, and it may very well be that there will be considerable controversy about it in the future" 4 The validity of the ruling in the case of Hickman can be disputed on the basis of various arguments. Some are: 1. The judgment reads in to some new words of Section 14 which actually are not contained in the section. The applicability of Section 14 is simples as it merely states that the Memorandum and Articles bind a company and its members when registered. There are no caveats or conditions attached to the provisions of section 14 and hence it can be disputed that it is unacceptable to read caveats into the operation of the provisions of section 14. 2. The judgment in Hickman's case refers to the decision given in Eley's case. But the ruling grossly misinterprets the decision in the latter case. Eley had the option to sue in his capacity as member which is denied in the Hickman's case. 3. The judge in Hickman's case has disregarded the earlier decision in the case of Salmon v. Quin and Axtens Limited5 [.In this case the Articles of the company contained specific provision preventing the validity of the resolution of the directors if any of the two managing directors dissented form the resolution. The court had to decide whether provision in the Articles can be applied to prevent the passing of the resolution, since the power to prevent was given to managing directors who were non-members of the company. The judge in the Appeal court observed 'The articles forming this contract, under which the business of the company shall be managed by the board, contain a most usual and proper requirement, because a business does require a head to look after it, and a head that shall not be interfered with unnecessarily' This decision was later upheld by the House of Lords. The decision of the highest authority in allowing the enforcement of the right by a non-member of the company being the managing director had been disregarded in the Hickman's case. 4.0 Interpretation of the Judgment in the Hickman's case: The decision in the case of Hickman v. Kent or Romney Marsh Sheep-Breeders' Association is having practical implications in that the future drafting of the memorandum and articles of the association of a company has to be attempted with care. As an illustration we will consider the case of a joint venture company to be formed with an insurance company as a shareholder. With the official business of the company being property development, the insurance company investor wants all the future insurance business of the company to be offered to it and makes a provision in the articles of the company to this effect. Assuming that the company when formed uses another insurer, the insurance company who is the shareholder can not enforce the article, if the decision in the Hickman's case is to be followed. On the other hand if the provisions of section 14 are to be followed with its plain reading the insurance company can enforce the article to its benefit. 5.0 Beattie v E&F Beattie Ltd6: In this case the company's articles provided for the settlement of any disputes between the company and one of its members through the means of arbitration. A director was also a member bought an action for stay of the legal proceedings instituted against him concerning his conduct as a director on the grounds that as per the provisions of the articles the matter should be referred to arbitration. The court held that there was no contractual capacity for him to bring about the suit for stay in his capacity as a director under the provisions of the articles as the articles represent the contractual arrangement between the company and the members and not the director. The court further ruled that the articles are enforceable only with respect to matters concerning the issues of members of the company alone. This judgment is a milestone in establishing the privilege of the members to enforce their rights under the articles of association in various matters concerning their rights including the payment of dividend in cash as has been held in the case of Wood v Odessa Waterworks Co (1889) 42 Ch D 636 5.1 Woods v Odessa Woodworks Co7 This case is concerning the rights of the shareholders to demand the company to pay dividends in cash. Here the company declared a dividend and passed a subsequent resolution to commute the dividend in the form of debenture bonds to be issued to the shareholders with interest payable over a longer term. But the articles of the company empowered the directors of the company only to declare a dividend 'to be paid' to the shareholders of the company. Action brought by a shareholder to restrain the company from proceeding on the basis of the resolution on the basis that the articles intended only to make the dividend payments in cash by inclusion of the word 'to be paid' and issuing debentures in lieu of the dividend is against the members' right to receive dividend in cash was sustained. 5.2 Rayfield v Hands [1960] Ch.1: This is another important case that deals with the position of the articles concerning the membership rights. In this case the articles of the company provided that if a member of the company makes known to the directors, of their intention to transfer the shares, then, the directors are bound to buy them. "It was held this bound the director to take the shares. The action was concerned with the relationship between the plaintiff as a member and the directors in their capacity as members. It was not necessary for the company to be party to the action."8 The decisions in the cases of Beattie v E&F Beattie and Eley or more or less on similar grounds where in both cases the member was having a different role to play in the activities of the company. But the law has not given consideration to the point that the plaintiffs are also members of the respective companies and hence that they may be allowed to enforce their rights under the articles. Thus the law has made the position clear with respect to the membership rights and their enforcement under law. 6.0 The Nature of the Statutory Contract as Provided by the Articles: The complexities in the interpretation of the power of the articles to confer the rights on the members are further accentuated by the nature of the contract as envisaged by the articles. There are normally two parties to the contract with a third party gaining rights on the contract under occasional circumstances in the form of assignments under the contract. However company contracts are different from general contracts in that since the company consists of many members, it is important to ascertain the other party to the contract and also the precise time at which the contract can be enforced. "The provisions of Section 14 do not recognise the company as being party to the contract, thus ignoring its separate legal entity, and provides only that it is binding as if signed and sealed by each member" 9.Thus with the filing of the Articles, the shareholders are bound to the company and the company s bound by the Articles. This is so even though there is no statutory provision to for the company to be bound by the articles. However the position as regards to the enforcement of the rights of the members remains the same in that the shareholders can enforce their rights under the articles in their capacity as members. Whereas the articles represent a contract between members that can normally be enforced by the company only. The position is different if any member has a personal right to bring action against another member. It is exactly this nature of the article as a statutory contract that determines the enforceability of rights of members under the contract and has been the subject matter of several court cases connected with the execution thereof. It is also this nature that has made the provisions of S. 14 of the Companies Act 1985 a matter of continued discussions and debate. This has been the position even since the decision as early as in the case of Foss V Harbottle10 7.0 Difference between Standard Contract and the Statutory Contract: The articles in the form of a statutory contract are basically formed to define and regulate the owners' right in the company which is known as a separate legal entity. At the same time it also has a purpose of benefiting the shareholders by ensuring a fair distribution of profits by conducting the business in an ethical manner and by that process to ensure the continued relationship with the shareholders. This makes the statutory contract distinct from other standard contracts. The other contracts mostly deal with discreet one time transactions and there are defined remedies in case disputes arising from such contracts. The remedies are usually found in the provisions of the contract themselves as the nature of the transactions is fairly simple and straight. But it is not possible to treat the contractual obligations arising out of the articles in the same way as that of other general contracts as otherwise the longevity of the relationship between the company and the members would be affected if immediate solutions and remedies like 'setting aside on the grounds of misrepresentation, mistake, undue influence, or duress' (which remedies are available under general contracts) are provided for. It is true that "if the contract granted inviolable rights that parties could always litigate to protect, this would "fail to take account of the long duration and changing nature of the relationships involved."11 Even in case of disputes the courts do not have the power to provide any remedy in the form of alteration of articles. The courts while assuming a reasonable business efficacy can extend their jurisdictional authority to the extent of the plain wordings of the articles while implying the terms of any contract under dispute. Hence it is imperative that the disputes arising on account of the exercise and enforcement of the members' rights must first be addressed by the company's internal arrangements to settle the disputes amicably. In case if there is a necessity to alter the provisions of the statutory contract or the articles for that matter the members are at liberty to do so by passing a special resolutions subject to certain built in protections. 8.0 Section 33 of the Companies Act 2006: The provision contained in section 33 of the Companies Act signify the implications of the provisions of Sec.14 of the 1985 Act to the extent it states "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" Though this provision is newly worded the effect of the provision has not materially changed from the old provisions of s.14. Hence whatever observations have been made in this paper about the old provisions and the position of the articles vis--vis the members stand to apply to the new section 33 also. 9.0 Conclusion: According to Robert R.Pennington's Company Law (5th Ed) at p 727 (as quoted in the case of Ling v Ling12 the learned author is of the opinion that "The dividing line between personal and corporate rights is very hard to draw, and perhaps the most that can be said is that the court will incline to treat a provision in the memorandum or articles as conferring a personal right on a member only if he has a special interest in its observance distinct from the general interest which every member has in the company adhering to the terms of its constitution." Thus the memorandum and articles of association constitute a contract between the company and the members and the members inter se. The contact is deemed to set out the provisions relating to the conduct of the business with the members and also outsiders in the case of memorandum. Hence every member has a statutory right to have the covenants of the memorandum and articles duly followed in letter and intent. In the case of any circumstance when the members are aggrieved by either the company, or the directors, other members do not follow the provisions of the articles, then they have the remedy to enforce their rights to have the provisions of the articles observed by injunction or other legal means. However this right of members can be exercised only in their capacity as members even though they have other contractual relationship with the company in any other capacity. This situation only gives rise to the comment that the provisions of section 14 (1) of the Companies Act 1985 is "the subject of considerable controversy in the past, and it may very well be that there will be considerable controversy about it in the future" Bibliography: Ling v Ling High Court of Borneo http://www.ipsofactoj.com/ARCHIVE/1989/Part09/arc1989(9)-012.htm R.R.Drury, The Relative Nature of a Shareholders Right to Enforce the Company Contract, [1986] CLJ 219 Griffin, Company Law Fundamental Principles, p.71 Company Law Notes of cases http://www.sml.hw.ac.uk/buslm1/ComLaw2/companycases.htm A Practical Guide to the Memorandum and Articles of Association ICSA Publishing http://www.icsabookshop.co.uk/pdfs/readingroom/57.pdf Read More