Contractual Effect of Memorandum and Articles of Association - Coursework Example

Company Law Contractual Effect of Memorandum and Articles of Association 1 The word ‘company ‘has been derived from the combination of two Latin words, com and panis .The word ‘com’ means ‘together’ and the word ‘panis’ means ‘bread’. Thus initially the word company refers to an association of persons who took their meals together. In Halsbury’s Law of England(1) the term ‘company’ has been defined as a “collection of many individuals united into one body under a special domination ,having perpetual succession under an article form, and vested by the policy of law with the capacity of acting in several respects as an individual ,particularly of taking and granting the property ,of contractual obligations, and of legal proceedings, enjoying certain privileges and rights ,according to the designs of its institution ,or the power upon it, either at the time of creation or at the subsequent period of its existence. A company will also be governed by its own Memorandum and Articles of Association. Now we‘ll have brief discussion about these two concepts which are considered to be the life of a company. Memorandum of Association This is the most important document in the company as it set out the constitution of a company and it is the foundation on which the structure of the company is based. In other words it may say that the identity of the company is based on this. It prescribes the name of the company, its registered office, objects and capital. It also defines the extent of its powers concerning to the matters relating to its function or otherwise. The memorandum is in fact a charter of the company. ------------------------------------------------------------------------------------------- 1.Halsburry of Law of England Editorship by Lord Hailsham of Marylebone, 1907 2 A company can exercise only such powers which are either expressly stated in the memorandum or as may be implied there from including matters incidental to the powers so conferred. A company must act within and not outside the scope of its memorandum. Any transaction which is outside the ambit of the powers of the company shall be ultra virus and void. Articles of Association The articles of association of a company are the internal regulations which govern the management of the internal affairs of the company. As it meant for internal affairs, the members have full control and may by resolution alter them as they think fit so long as they do not exceed the limits defined by the memorandum. In other words Articles of Association form the basis of a covenant /contract that regulates the company’s internal procedure and set out the rights of the shareholders as conferred by their ownership. Contractual effect of Memorandum and Articles of Association Memorandum and Articles of the company when registered, have binding forces as they bind the company and its members to the same extent as if they have been signed by the company and its each member. In other words, the memorandum and Articles of the company when registered, bind the members to the company and the company to its members, but onin the capacity of members of the company and not in any other capacity such as directors etc. This clause is incorporated in Sec.14 (1) of the 3 Company Law 1985. i.e. Sec.14 (1) of the Company law 1985 says that “Subject 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.” The same clause is incorporated in the Companies Act 2006 in a similar perspective, hence reiterating the importance of this clause in day to day affairs of any company. Para 33(1) of Companies Act 2006 reads, “The provision of a companies 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 members to observe those provisions.” From the above explanation in the sec.14(1) and Sec.33(1) it can be drawn that both sec.33(1) and sec.14(1) accepts the binding nature of the members to the memorandum and Articles amounts to a legal contract to towards the company. Now we consider the contractual nature of such rights under Sec. 14 of the Companies act 1985 and consider how they differ from common law contractual rights. The Section 14 and how it differs from other contracts As said above, it is given in the Sec.14 that there is binding nature exists between the company and the members as they sealed and signed and also there is a covenant between them .The section creates a 4 contract which forma the basis of legal relations between the company and its members inter se. It is well organized however that this so called statutory contract differs in an umber of significant respect from a standard contract. The memorandum and the Articles are the statutory documents of the company and as such ,are also governed by the statute which controls them .Statutory provisions to which the contract is subject include provisions authorizing the Alteration of the memorandum and Articles of Association by special majority only(2). Unlike normal contract which would require the consent of all parties to the agreement to alteration of its term, the statutory contract is therefore entered into on term which are alterable by a 75% majority. A statutory contract also different from other contracts in that it constitutes what has been called the frame work of a long term relationship between the contracting parties.(3) Contractual effect of Memorandum and Articles of Association The Articles and memorandum of the company constitute the contract which is binding on members in their relations to the company. Each member in his capacity as a member is bound to the company by the Provisions of the Articles and these provisions constitute a legal contract between the member and the company. This assumption is well explained in ------------------------------------------------------------------------------------------- 2. Sec.4 and 5 of companies Act 1985 3.R.R Drury the relative nature of the shareholders right 1986 CLJ 219,246 5 the case Bradford banking Company Vs Briggs(4).The cause of action of the case was the Articles of the company provided that the company shall first lien upon each share for debts due to the company. The share holder deposited the share with the bank to secure an overdraft. It was held that since the provision of the Article constitutes a contract between the member and the company, the right of lien of the company shall prevail over the right of the bank. Intervention of Court The court regards the Articles as commercial documents which should be construed so as to give them reasonable business efficacy. The court has recently held that the term can not be implied in to the articles to give them business efficacy. Nor can rectification of the Articles be ordered by the court even if the terms of the contract do not accordingly reflect the intervention of the parties. Although now it is accepted that the company can enforce the section 14 contract against the member and that member can enforce ift against each other. There are limitations on the right which members can enforce. In Hickman’s case(5) Asbury J commented that it was clear from many authorities that shareholders as against their Company can enforce and restrain breach of its regulations. In this case the issue was whether the plaintiff was bound by an arbitration clause ,either under an Article of the defendant’s association ,constitution or in that his application -------------------------------------------------------------------------------------------- 4. Bradford banking Co. Vs Briggs 1886 12 Apples 29 5. Hickman Vs Kent or Romney Marsh Sheep breeders Association 1915 1 ch 881 6 for his membership of the association ,once accepted ,constituted a submission to arbitration ,as defined by Arbitration A Act sec.4 1889. In this case it was held that Hickman’s accepted application was such a submission and directed that the dispute be referred to the Arbitration. In same way In pritchard’s case(6) .The Article provides that on incorporation the company should enter into an agreement with the vendor of the mine under which the purchase of mine from him would be funded partly in cash and partly in fully paid shares. The Article were signed by the vendor who received the stated number of shares ,when the company went into liquidation the vendor brought an action on the question of whether the article constituted a contract in writing with him so that the shares could be considered as fully paid. it was held that the Articles could be considered as a contract between the company and vendor as the articles of Association are simply a contract as between the shareholders inter se in respect of their rights as shareholder. Members Right The decision in Hickman’s case is generally accepted as authority for the rule that the statutory contract only confers as a member in his capacity as a member ,sometimes referred to insiders right not any outsiders capacity sauce as his position as a solicitor or director of the company.* In this case Astbury J. analyzed the previous case law as ------------------------------------------------------------------------------------------- 6. Pritchard Case 1873 8 ch APP 956 7 membership rights and concluded that an outsider to whom rights purport to be given by the Articles in his capacity as such outsider, whether he is or subsequently becomes a member, cannot sue on those articles treating them as contract between himself and the company to enforce those rights. These rights are not part of the general regulations of the company applicable alike to all shareholders and can only exist by virtue of some contract between such person and the company. This view invited so many criticism and have not been uniformly applied by the courts particularly in cases involves shareholder directors.* But in Salomen Vs Quinn and Axten(7). It was held that the article form a contract between members it is normally only enforcing through the company unless the member has a personal right. This decision was inconsistent with the decision of Hickman’s case. Shareholder director s has not been able to rely on an arbitration given in the articles. Company Law excluded the capacity of a director as a member i.e. a director of the company as a member is always an exception.. This clause is explained in the famous case Beattie VS E & F Beattie Ltd(8). In this case it was held that a dispute between the company and the member in his capacity as a director would not be within the terms of such articles even when the director was a member. This decision resorted to the provision that though the director is a member of the company he is considered as an outsider. In this case the court of appeal applied what it look to be the decision in Hickman’s case. ------------------------------------------------------------------------------------------ 7. Salomen Vs Quinn and Axten 1909 AC 442 (Right to veto) 8. Beattie Vs E&F Beattie Ltd 1938 ch 708 8 The directors occupy a very crucial position in corporate business as they have to play a key role in the management of the company’s business. The role of directors well explained in the case Imperial Hydropathic Hotel Vs Hampson(9) and it was held in the case that directors are described sometimes as agents, sometimes as trustees, and sometimes as managing partners. But each of these expressions are used not as exhaustive of their powers and responsibilities ,but as indicating useful points of view from which they may for the moment and for the particular purpose be considered. Outsider’s Right Generally speaking, a company is not bound to outsiders. But the question is who can be considered as outsiders as per the provision of memorandum and Articles. The term “outsider” signifies a person who is not member of the company even if he is a director of or of a solicitor to the company i.e. the Articles do not confer any contractual right even upon a member in a capacity other than that of a member. Regarding the role of outsiders ,prof.Wedderburn(10) opined that a member can compel the company not to depart from the contract with him under the Articles even if that mean indirectly the enforcement of outsider’s rights vested in either third parties or himself so long as ,but only so long as he sues qua member and not qua outsider. Till this we were discussing about the binding nature of the members to the company which is constituted as a legal contract between ------------------------------------------------------------------------------------------ 9. Imperial Hydropathic Hotel Vs Hampson 1882 23 ch D1 (right to hold office) 10. Prof.K.W Wedderburn Share holders right and rule in Foss Vs Harbottle 9 them. Now we’ll explore the importance and the scope of this binding character which forms a legal contract in the case of majority and minority shareholders. This provision is illustrated in another case Eley Vs Positive Government security Life Insurance Co(11). In this case, the Article contained a clause that Eley ,a member of a company , should be the solicitor to the company and should not be removed from his office unless he misconducts himself. But later he was removed and appointed another solicitor .Eley sued the company for the breach of the contract. But his suit was dismissed since there was no contract independent of the article and the provision contained in Article being binding between company and members; the same could not be enforced against an outsider i.e. the solicitor. By referring the courts application of the ‘outsider rights’ Restrictions suggested by Astbury J in Hickman’s case have been inconsistent Prof. Gregory(12) also approved the view taken by Prof. Wedderburn. As per his opinion, it is difficult to reconcile Hickman’s case with the same of the earlier cases. However the general view that the section confers the contractual effect on a provision in the memorandum and Articles only in so far as it affords rights or impose obligations as a member qua member(13). ---------------------------------------------------------------------------------------- 11. Eley Vs Positive Govt. Security Life Insuarance Co. 1876 Ex D 88 12. Prof.Gregory The section 20 of Contract Article 1981 44 MLR 526 13. Gower’s Principles of Modern Company Law 5th edition 1992 p.284 ,646 10 Outsider’s right –Gold berg Theory(14) Let’s discuss about outsiders right as per the views laid down by Gold berg. According to Gold Berg the outsiders right is aright or power bestowed by the memorandum and Articles on a person otherwise than in his capacity as a member of the company. Every solicitor who has received instruction which shown that he is enjoying the particular rights and powers in the company e.g.: as its governing director, for life or until a specific age or till resignation unless the memorandum and Articles are earlier amended. Prof. Goldberg resorted to the Sec.20(1) of Companies Act 1948.He said that only effect of the sub section was considered in earlier cases, not the contract which made independently of the Articles through the terms there of implied wholly or partly from the Articles. For there is no dispute that the contract embodied in the memorandum and Articles nor that a member can enforce all the rights given to him and is liable to perform but only the obligations imposed on him by that contract.. Prof. Wedderburn pointed out that the court will enforce the outsider’s right. As against this view Gold berg laid down two conditions to fulfill the enforcement of outsider’s right, they are , 1. the suit is brought by one or members in their capacity as members against the company and members opposed to them. --------------------------------------------------------------------------------------- 14. Prof. Goldberg The enforcement of outsider’s right under sec.20 of Contract Article 1948 (1972) 35 MLR 362 11 2. the enjoyment of outsiders right incidental to the exercise by a particular organ of the company of a power vested by the Act or by the Company’s memorandum and Articles in that organ. He expanded his view by exemplifying the case Hayes Vs Bristol Plant hire Ltd(15). In this case the main issue was whether the director to be a share holder. The decision of the Court that it made no difference and that the mere fact that the plaintiff was a shareholder gave his the right to apply for injunction restraining his fellow directors from excluding him from their meetings in contravention of Articles. Prof Gold berg opined that plaintiff was seeking to ensure that the organ which exercised the powers confided to the board should be the organ specified in the articles ie the board of directors acting in the manner and containing the members laid down in the articles and incidentally in this case the plaintiff‘s outsiders rights as a director was upheld. The distinction between this case and Brown Vs La Trinidad(16) was the specification of board contained in the articles was itself charged by due process. Apart from this case Re Dale and Plant Ltd’s case(17) also witnessed the effect of Goldberg theory. In this case the company’s article appointed the plaintiff‘s secretary for five years. Before those years had elapsed the company was wound up .The plaintiff was a member of the company and lodged a proof in the winding up for damages for breach of contract included in the article. Thus only issue was the plaintiff, whether or --------------------------------------------------------------------------------------------15. Hayes Vs Bristol Plant hire Ltd 1957 1 All ER 685 16. Brown Vs La Trinidad 1888 37 Ch D1 17. Re Dale and Plant Ltd’s Case 1889 61 L.T 206 12 not ,was entitled to enface the outsiders right .The issue could not be incidental to any question of the company’s secretarial works being carried out by the appropriate organ of the company because the company has ceased to exist. The proof was allowed. There was a second case of Re Dale Plant Ltd ‘s case. In this case the director proved for damages for breach of a ten year service contract. The second case exactly that described by Goldberg and the proof was allowed. Majority and Minority shareholders Rights Like any other institution a company is run by democratic process and administration of its affairs is carried on by resolution of Majority shareholders. It is therefore says that the majority of the members enjoy the supreme authority to exercise the powers of the company and generally to control its affairs and the minority shareholders have to concede to the majority decision. But there have to exist a proper balance of rights of majority and minority shareholders for a smooth functioning of the company. The principle that the will of the majority should prevail over the will of the minority in matters of internal administration of the company is well defined in the very famous case Foss Vs Harbottle(18) and this principle is known as rule in Foss VS Harbottle. From this we can infer that all the actions which are supported by majority shall be binding on the minority. Since the binding nature exists between the majority and Minority -------------------------------------------------------------------------------------------- 18. Foss Vs Harbottle 1843 2 Hare 461 67 ER 189 13 there will obviously a legal contract also exists as per sec.33 (1) of Company’s Act 2006.But it is to be noted here that no suit against such action would lie at the instance of the minority. This point is illustrated in the case Macdougall Vs Gardiner (19) and it was observed in this case that if the thing complained of is a thing which, in substance, the majority of the company are entitled to do, or something has been done irregularly which the majority of the company are entitled to do regularly, or if something has been done illegally, which the Majority of the company are entitled to do legally, there can be no use having litigation about it, the ultimate end of which is only that a meeting has to be called, and then ultimately the majority gets its wishes. Here also the aspect of binding nature of the members as a legal contract and the aspect of a statutory contract differs. From the provisions and case laws discussed above, it can be seen that in order to redress a wrong done to the company or to recover damages alleged to be due to the company, the action should be brought by the company itself and not by its members. But in a statutory contract is, as mentioned in previous Para, normally between two parties, with third parties occasionally gaining rights. So the question normally comes up that if this is the meaning of a contract, how can we accept the binding nature of the members to the company as a legal contract since it does not involve the basic rules of the contract. But this uncertainty is tried to be tackled out in another case -------------------------------------------------------------------------------------------- 19. MacDougall Vs Gardiner 1875 1 ch D 13 14 Pender Vs Lushington(20) that there can be two parties in the contract and one of the party can sue in his name for damages. In this case it was observed that a member of a company whether he votes with the Majority or the Minority, he is entitled to have his vote recorded- an individual right in respect of which he has a right to sue. Prof. Wedderburn explained this point that damage done to the company by outsiders may only be remedied by corporative actions .As the courts are reluctant to interfere in internal management, this resulted in majority role .The courts have used this to justify not infringing the company’s affairs, giving the majority power to put a member litigating when a breach of the Articles has occurred. Now we’ll discuss whether the right of a member to vote can be considered as a contract or not. For this, first we’ll have to explore the nature and scope of Statutory control Regulations. The nature of Statutory Control Regulations There are three major issues that the law must regulate the company’s best interest .the minority and majority, shareholder’s interest, and the problem of proprietary interest. The major problem is that a share provides a right in property and there for the attached vote is also a property right. Thus the shareholder can exercise his vote in anyway he likes notwithstanding any personal interest that conflict with the interest of the company --------------------------------------------------------------------------------------------20. Pender Vs Lushington 1877 6 Ch D 70 15 In this aspect in Welton Vs Saffery(21) it was held that a shareholder can even enter a voting agreement creating personal obligation enforceable in the courts. It is a valid personal agreement but would not become a regulation of the company or be binding on the transferees of the parties to it or upon new or non assenting shareholders. Conclusion As said in previous Para, the nature of the statutory contract is quiet different from a normal contract, in that it binds a potentially large group of individuals in relationship where their property rights are necessarily qualified by the rights of others. Further this company is to long term prosperity through the combined interest in what is a separate legal entity. Moreover the company can not contract out of the regulation imposed by law. The law attempts to give as much autonomy to the members to resolve disputes without the damaging recourse to the courts Whatever the discussions comes up in this field there is still a question arises that does it give the memorandum and Articles contractual effect only in so far as they confers right or obligations on the member in his capacity of member or does it give contractual effect on the director in the capacity of the member _ This is the only reason Lord Greene MR(22) said of this provision that it had been” 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”*Obviously this is a matter of serious discussion. ------------------------------------------------------------------------------------------- 21. Welton Vs Saffery 1897 Ac 299 p.331 22. Lord Green in Beattie Vs Beattie 1938 Ch 708 Bibliography Books and Authors 1. Anson’s Law of Contract edited by Gues AG Oxford University Press ,London 2. Cain T.E, Charles worth Charleswoth’s Company Law, The modern company law review, Vol.30 No.1, p.107-108 3. Farrer, J, Hannigon,B Farrar’s Company Law 4th ed.Butterworth’s ,London 4. Goldberg The enforcement of outsider’s right under sec.20 of the contract Act 362-374 Oxford Blackshell publication 5. Gregory ,Roger The sec.20 of contract ,Modern Law review 44(5), 526-540 publ.Oxford Blackshell 6. Griffin, s The fundamentals of Company law 1996 2nd edn Pitman publishing 7. Grower Grower’s Principles of Modern contrat 5th edn 1992 p.284,646 8. Mayson,S.W French,D,Ryan,C, Mayson,FrenchAnd Ryan’s Company Law 1998 15th edn Blackstone Press ,Lonon 9. Oliver, M.S And Marshall E,A Company Law 1994 12th edn M&E Handbook series 10. Prentice G.N The enforcement of outsider’s right 1980 179-185 Sweet &Maxwell ,London 11.Wedderburn K.W Shareholders Rights and the rule in Foss vs Harbottle 194-215 Cambridge University Press ,London 12. Woolman S Woolman’s Contract 1994 2nd edn Sweet &Maxwell Statutes 13. The companies Act 1948 14. The Companies Act 1985 15. The Companies Act 2006 Articles 16. Drury R.R The Relative nature of a Shareholders rights to enforce the company contract 17. Goldberg The controversy on the sec.20 of Contract revisited 152-166 1985 48 MLR 158 18. Gregory, Roger The sec.20 of Contract Act 1981 44 MLR 526 19. Smith R.J Minority shareholders 1978 41 MLR 147 20. Wedderburn K.W Shareholders right and the rule in Foss Vs Harbottle 1957 CLJ 193 Table of cases 1 .Beattie Vs E&F Beattie Ltd 1938 ch 708 2. Bradford banking Co. Vs Briggs 1886 12 Apples 29 3. Brown Vs La Trinidad 1888 37 Ch D1 4. Eley Vs Positive Govt. Security Life Insurance Co. 1876 Ex D 88 5. Foss Vs Harbottle 1843 2 Hare 461 67 ER 189 6. Hayes Vs Bristol Plant hire Ltd 1957 1 All ER 685 7. Hickman Vs Kent or Romney Marsh Sheep breeders Association 1915 1 ch 881 8. Imperial Hydropathic Hotel Vs Hampson 1882 23 ch D1 9. MacDougall Vs Gardiner 1875 1 ch D 13 10. Pender Vs Lushington 1877 6 Ch D 70 11. Pritchard Case 1873 8 ch APP 956 12. Re Dale and Plant Ltd’s Case 1889 61 L.T 206 13. Salomen Vs Quinn and Axten 1909 AC 442 (Right to veto) 14. Welton Vs Saffery 1897 Ac 299 p.331 Read More