Constrains of Altering the Articles of Association - Essay Example

Constrains of Altering the Articles of Association Articles of association are the rules and regulation that lay down procedures and methods of routine and other business of the company. Section 18(1) and (2) of Companies Act 2006 specifically provides that each company will get register its articles unless model articles of association become applicable in accordance with the provisions of section 20 of 2006 act. That is to say that a company has to adopt model articles when it does not register its own set of articles or for the matters where the company’s own articles do not provide any regulations. When the company frames and get registered its articles, then such articles cannot override the provisions of the companies act, the memorandum of association of the company, and provisions of any other statue unless repeal of the act permits such overriding provisions. Conversely where the provisions of companies act and any other legislation do not override the articles of association of a company, the company will follow its articles of association. To what extent this is true in the eyes of law and decisions made by different court is the subject matter that is being analyzed in this study. Section 21 of C A 2006 provides that the company has power to amend or alter or make addition to its own articles of association. But as described by Nicholas Bourne (page 68)1 this power of altering the articles of association is subject to under noted limitations or conditions: ‘a) A company cannot alter its articles to contravene the provisions of the companies act; b) Any alternation of the articles which clashes with a provision in the company’s memorandum is void; c) Any alteration of the articles which conflicts with an order of the court is void; d) If the alteration of articles involves an alteration or abrogation of class rights, then in addition to special resolution the company must follow the regime appropriate to variation of class rights. e) In addition to statutory restrictions, the power to alter a company’s article is subject to the principle that any alteration must be bona fide for the benefit of the company as whole.’ Bona fide for benefit for the company as a whole: Various courts have upheld this principle of bona fide for the benefit for the company a whole. If the alteration is for the benefit solely for an individual shareholder or for group or a class of shareholders and not in the interests of the company, the alteration of such articles should be considered bad at law. In Allen v. Gold Reefs of West Africa (1900) Lindley, M R (page 671)2 stated that “the power thus conferred on corporation to alter the regulations is limited only by the provisions contained in the company’s memorandum of association. It must be exercised 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. But if they are complied with I can discover no ground for judicially putting any other restrictions on the power conferred by the section than those contained in it.” The above statement of Lindley, M. R. has made two things very clear for corporations to follow. First any article framed by any corporation (if they have not adopted model articles of 2006 companies act) has to be within the parameters of constitution of the company and that is the company’s memorandum of association. Article framed, adopted or altered in accordance the provisions of company law will not ultra vires the framework prescribed under the memorandum of association. It is also important to point out that the question of article framed, adopted or altered being ultra vires cannot be made to depend upon further question whether a certain article is or is not for the benefit of company. ‘Benefit or no benefit has really no bearing upon the question of ultra vires.’ (WR Perciva Parker, page 95)3 The legality of the article is a primary condition; and it is legal when it is within the framework of memorandum of association. The question of benefit to the company as a whole is to be considered only after the article is considered legal (that is as per the memorandum). The power of altering the articles is limited by the fact that there should be nothing in the altered articled which is inconsistent with memorandum of association. Anything can be done by altering the articles which is not forbidden by the memorandum of association expressly or impliedly. But the scenario is changing with introduction of revolutionary CA 2006. So far the memorandum of association is considered superior and authoritative than the articles of association. But this authority has been challenged by the new provisions of sec.17 (1) of CA 2006 that states that ‘unless the context otherwise requires, references in the Companies Act to a company’s constitution include a) the company’s articles.’4 These provisions might have been inserted as the Memorandum of Association does not now fully describe the constitution of the company. The effect of such changes will bring the results only on operation of CA 2006 in near future. So far the situation is that the articles cannot be amended by challenging the authority (even if it is reduced in contents) of the memorandum of association. It may be noted that section 21 of CA 2006 contains the provisions to alter the articles of the company and these powers can be exercised through a special resolution. Though the contents of MOA has been greatly reduced by CA act 2006, it can still be said that the memorandum is superior and changes in the articles cannot ultra vires what ever is the remaining authority of memorandum of association The second aspect of the observation of Lindley, M R is that article has to be for the benefit of company as a whole. The statutory right to adopt or altered an article cannot be exercised in a manner that would tantamount as a fraud on minority shareholders. The power must be exercised bona fide in the interest of the entire company and not for one or few privileged sections. The expression “for the benefit of the company as a whole means for the benefit of shareholders as a general body. Its effect should not be such to discriminate between majority shareholders and the minority shareholders so as to give the former an advantage of which the later are deprived. There must be honesty in what is being done.”(Greenhalgh v. Ardene Cinema Ltd., p.1120)5 Articles bona fide for the benefit for the company as a whole can be framed, adopted, or altered only in terms of following three propositions: The article should not be for the benefit of a particular member or class of shareholders. It is important that the article is for the equal good of the entire team of members or shareholders as a whole in a fashion that its burden or benefits accrue to all members or shareholders in similar manner. The article should not provide privileges to some shareholders and depriving others of their rights say by increasing their liabilities. There may be a situation where some rights might have to be sacrificed for the sake of benefit of the company as whole and not for benefit of a specific member or a class of shareholders. Special resolution to alter or amend any article must be passed in good faith for the benefit of the company as whole. Good faith should work in entirety for the company and not for the disadvantage of some members. Principle of equity and trust: Once a person becomes a shareholder or a member of a company, the company extends an unwritten trust in such member or shareholder that the affairs of the company shall be carried on as per the articles of association formulated at the time of his/her becoming member or shareholder of the company. Any alteration, addition or further adoption of articles shall be on the basis of equity and justice to all sections of existing members or shareholders. Company or any of its officers will not destroy this trust in the shareholder imposed by the company. Principle of equity prevails and nothing shall be done with ulterior motives. The principle of equity prohibits the trustee to make profits out of such trust. But there can be relaxation to these rules of principle of equity. A company may frame or amend rules and regulations destroying such trust when such adoption or amendments of articles provide equitable profits or benefits to shareholders. At the same time ‘equity has no power to relax its own strict rule further than and inconsistently with the express relaxation contained in the articles of association. A shareholder is entitled to compliance with the articles. A director accepts office subject to and with the benefit of the provisions of the articles relating to directors.’ (Andrew Hicks and S H Goo, page 335)6 It is important to understand an inference that accrues from the principle of equity. The liability of members or shareholders cannot be increased either by asking them to contribute more capital or otherwise by simply altering the articles of association. For doing so the consent of members is required. ‘Articles may be so altered as to have retrospective operation, e.g., the insertion of a lien clause so as to give the company a lien on shares of members for debts incurred both before and after the insertion of a clause. (Allen v. Gold Reef of West Africa)7 But alteration should not be such as to throw an increased liability on shareholders, more than they agreed when they became shareholders. To provide safeguard and uphold the principle of equity it was held in James v. Buena Ventura Nitrate Grounds Syndicate Ltd., (1896)8 that ‘validity of what has already been done by the company cannot be affected by a subsequent alteration of articles. A company cannot alter its article so as to change the directors’ remuneration with effect from a date prior to the date of special resolution. Further section 21 of the CA 2006 merely lays down a procedure that articles can be altered through special resolution. ‘When all the shareholders are interested in a company entered into an agreement that modifies the articles of association, but was not drafted as a resolution and also not passed in general meeting, the article could nevertheless be deemed to be effectively modified. This is on the basic principles of company law is that all the shareholders of a company acting together can do anything intra vires of the company.’ (Cane v. Jones)9 There may be a mistake in the already drafted article. In true application of principle of equity and trust even that mistake, whether clerical or otherwise, can only be rectified by altering the article by special resolution. ‘It cannot be set right by application to court.’(Scott v. Frank F. Scott (London Ltd.)10 In other words court order is not supposed to jeopardize the privilege of shareholders of equity and trust. However under UK Companies laws (CA 2006 and earlier) there has always been danger of misuse of the power by the directors given to them by articles and association. There is a risk that such misuse may destroy the very fabric of principle of equity and trust imposed by shareholders into the management with regard to articles of association. ‘In UK, the statutory board of directors has relatively large powers under the articles of association. The board can micromanage the company and question the authority of management. These powers are supplemented by relatively minor statutory constraints in the area of company law, because the main principle of UK Company and security market laws is disclosure of information. The exact contents of these constraints are not clear. The fact that traditional company law is to a large extent a judge made law- a set of loosely defined guidelines made concrete by courts after the facts – can undermine the efficiency of law in directing managerial behaviors.’(Petri Mantysarri, page 401)11 Word Count: 2011 References: Read More