The Basis Of The Contract Between The Company And Its Members - Case Study Example

The Basis Of The Contract Between The Company And Its Members The articles are said to form a contract between a company and its members and the members inter se. in terms of enforcement, however, this contract is an unusual one.’ Discuss. Introduction A company is a separate legal entity and is competent to enter into contract. The shareholders of the company are called its members who contribute funds for its capital. This financial transaction for acquisition of shares of the company by its members forms the basis of contract between the company and the members through an instrument called Articles of Association setting out the terms and conditions of the contract. Once the shares are acquired, the continuation of contract between the said parties is governed by the articles. However this contract is unique in that it is different from the contracts entered into during the course of commerce for purchase and sale of goods etc. In the latter case, enforcement of contract arises when the one of the parties commits breach of terms and conditions of contract. This paper seeks to examine the special nature of contract by a company with its shareholders and the manner in which it is enforced between them and among the members. Section 14 of the Company Act 2006 (CA) makes the articles of association, on registration of the company, to become a contract between the company and members and it has been observed by Stein LJ in Bratton Seymour service Co ltd v Oxborough1that “it is a statutory contract of special nature with distinctive features”2 Within the perspective of company law, it is of special nature because the terms of contract can be varied by special resolution and its enforcement by the members is limited to a certain extent and no outsider has any rights. And section 33(1) of the CA provides for a number of ways to be different from a normal contract. The provisions of constitution of a company bind the company and its members in a manner as if there are covenants on the part of the company and on the part of each of its members to comply with those provisions. This position emerges once the company is registered as set in section 33 (1) of the CA. It, therefore, follows that provisions in the articles are enforceable by the company against its members, by a member against another member, and by a members against the company limited to their membership rights of attending meetings, voting, eligibility for dividend and to assert the rights to ensure that the company is managed as per the constitution. Usually there will be a condition in the articles to provide for referring by the company to arbitration disputes between the company and members. A company can enforce compliance of this obligation. This is supported by the decision in Hickman v Kent or Romney Marsh Sheep-Breeders’ Association3 where the court upheld the relevant clause in the articles for arbitration. As the member can only bring action against the company, dispute with the company in the capacity as a director although a shareholder too, court declined stay in Beattie v E & F Beattie Ltd.4 In the case of an action by a member against a member for enforcement of the articles, the court in Rayfield v Hands 5 approved that a member could insist on an obligation of a member to acquire shares of that member as spelt out in the articles. As already mentioned, a member’s right against the company being limited to the extent of their personal membership was established in Wood v Odessa Waterworks co 6where the plaintiff member had sought to enforce his constitutional right for dividend payment in cash instead of in the form of bonds. A member’s right to have his vote recorded was upheld in Pender v Lushington.7 In another case Quin & Axtens Ltd v Salmon8, court refused to entertain two directors’ plea that was inconsistent with an article providing for any resolution in which the defendant Salmon or another managing director Axtens dissented. The two of them were managing directors of the plaintiff company and had delegated business of the company to other directors of the company. As the two managing director had been holding bulk of the company’s shares and in view of the said proviso in the articles prohibiting any resolution in which either of the managing directors dissented. First, the other directors passed a resolution to acquire or letting out premises which specifically had been prohibited without the either of the director’s consent by the articles. Since Salmon dissented, the shareholders passed similar resolution at a subsequent EGM. This is what was considered by the House of Lords as inconsistent with the articles and injunction was granted for Salmon for restraining the company from acting on the resolutions. In Re HR Harmer Ltd9, shareholder sons of the company’s founder were held to have the right as members of the company to insist on running the company in accordance with the board’s resolutions which the founder had been disregarding assuming that he had the power to do so. The two shareholder sons were also the directors of the company. However, outsiders cannot invoke the articles to enforce their rights. This was held in Eley v Positive Government Life Assurance Co ltd. 10 The plaintiff who was the company’s solicitor tried to enforce the article that provided for continuation as solicitor for life except for the reasons of misconduct. His contention was not upheld as he was an outsider. The scope of the outsider right is so wide that it even includes matters related to the remuneration rights of the directors contained in the articles. It is based on the premise that articles does not constitute a contract between the company and the directors. They accept the office of the directorship based on articles to providing for an implied term of service contract. This was pointed out in Re New British Iron Co, ex p Beckwith.11 Similar decision was made in Swabey v Port Darwin Gold Mining Co.12 In this, it was held that the “implied term was subject to prospective alteration in the normal way of any article”. In Re Richmond Gate Property Co ltd13, the member who was functioning as managing director was held to have no right to demand remuneration as per contract or on the basis of quantum meruit. Although he worked as managing director and the article had provided for determination of his remuneration as they thought fit, the company went into liquidation before any remuneration could be fixed. The court recognised his right as a member and though there was contract, since no remuneration had been fixed, he was not entitled to a quasi-contract. However in Graven-Ellis v Cannons Ltd [1936] 14 , the plaintiff was held to have been entitled to remuneration on the basis of quantum meruit since there was no contract of employment. When the plaintiff sought to apply different set of rule of doctrine of equitable rectification which is not part of contract law, to the company’s articles, the court of appeal rejected his claim in Scott v Frank F Scot (London ) Ltd 15 although it was pleaded that articles were inconsistent with the founders’ intentions. In a 1992 decision relating to Bratton Seymour Service Company Ltd v Oxborough16considered a land mark case, it was held no implied term could be incorporated into company’s articles. Lord Stein opined as ‘Just as the company or an individual member cannot seek to defeat the statutory contract by reason of special circumstances such as misrepresentation, mistake, undue influence and duress and is furthermore not permitted to seek rectification, neither the company nor any member can seek to add to or to subtract from the terms of the articles by way of implying a term derived from extrinsic surrounding circumstances.’17 However in a subsequent decision of 2000 in Equitable Life Assurance Society v Hyman18, which did not have reference to the above Bratton Seymour case, it was held that an implied term could be deemed incorporated into the company’s articles. But this was not in favour of the defendant director in that the implied term was not to misuse the wide powers granted to directors. In this case, by virtue of wide discretionary powers the directors had enjoyed in matters of payment of bonuses to the insurance policies of company’s members, they gave more bonuses to some policyholders on their taking of some polices. Lord Steyn opined that articles should be assumed to have an implied term that directors could not exercise their discretionary powers in such away as to deprive the company of substantial value. The distinction between the two decisions of the same judge is that in the former the implied term was in extrinsic circumstances whereas in the latter it is a merely a constructional implied term.19 Thus the articles once registered binds the company and its members as if each one of the members has signed individually under seal and it follows that each one of them is expected to comply with the provisions of the articles. This special feature makes the articles to become a contract of statutory nature between the company and its members20 which even the court cannot rectify even if the contents do not accord with the current intentions of the members as held in Scott v Frank F Scott (London) Ltd. 21 The articles though a statutory contract is regarded as a business document and should be construed to have business efficacy by which the language of the articles can be taken to mean in preference to that which would prove to be impractical.22 It has been held that money due to the company by its members under the articles is a specialty debt vide St Johnstone Football Club Ltd v Scottish Football Association Ltd 1965 SLT 171.23 wherein fines were imposed exercising powers conferred under the articles. As seen above, contractual force is limited to the relationship with the company as members as shareholders and it does not apply to the provisions governing their relationship as directors.24 The shareholders may deal with the company with their own interests in any manner they like by contract but such contracts by members create personal obligations and they do not become regulation of the company. Thus, such contracts outside the articles are not binding on the transferees or new shareholders or non-assenting shareholders. Thus, although a provision in the articles restricting the company’s statutory power to alter the articles is not valid, an agreement outside the articles between the company and the shareholders in regard to their exercise of voting rights on a resolution to alter the articles, need not be invalid.25 The power to alter the articles by special resolution is statutory and hence it cannot be restricted or modified by a provision in the articles and the company also cannot contract itself out to alter the articles. As seen above, however, conferring special voting rights to a specified class of shares which would result in restriction of the power to alter the articles cannot be construed to deprive the company to alter the articles.26 If the articles of association provides for a share qualification to become a director, it does not constitute a contract to take shares merely by becoming a director.27 But the articles may constitute a contract to take shares if it provides that every founder member holding a founder’s share should apply for and take a prescribed number of ordinary shares.28 But at the same time, a statement in the prospectus that the directors will buy all the unsubscribed shares does not constitute a binding agreement enforceable against them to buy those shares.29 In this connection, it maybe mentioned that articles of association can be modelled on the basis of the format prescribed by the Secretary of State which the company may adopt in its entirety or partly. However, any amendment of model articles will not affect the registration of the company after the amendment which includes alteration or repeal. A company must register its articles if the model articles does not apply.30 The objects clause in the memorandum protects the creditors as long as the transaction is not ultra vires as they are void at common law and as such it cannot be ratified by the company even by unanimous votes of the shareholders.31 In Ashbury Railway Carriage and Iron Co Ltd v Riche32 , the company was meant to make and sell or lend or hire, railway carriages and wagons and all kinds of railway plants and fittings, machinery, rolling stock, to carry on the business of mechanical engineers and general contractors. As such it repudiated a contract with Riche for financing the railway line in Belgium. As it was ultra vires the constitution, the House of Lords upheld the company’s repudiation of the contract. According to Lord Wedderburn, every member has personal right under section33 of CA 2006 to ensure that the company is run as per the articles except those identified as internal procedures.33 Prentice has stated that only those of the articles conferring specific power to company have contractual effect.34 Goldberg states that a member of the company is contractually entitled to ensure that the company is run by the particular organ of the company mentioned in the Act, the memorandum of association or the articles of association.35 The directors or the company is answerable to the members for the way it has functioned, in the absence of specific provisions in the articles or any collateral agreements between the company and the members.36 Conclusion The brief discussion above would show that the articles of association in common law has a unique position to define the contractual relationship between the company and its members and members inter se. In the normal contract compared to the one formed out of the articles of association, it is easy to enforce the contractual provisions by the aggrieved party against the defaulting party. In the case of company, the articles is a multiparty agreement wherein the rights of party is statutorily defined whereas in a normal commercial contract under common law, the enforcement is determined by the terms and conditions in the contract itself. The contract enforced through interpretation of articles of association is, therefore, an unusual one. Bibliography Books Hicks Andrew and Goo S.H., 2008, Cases and Materials on company law Ed 6, Oxford University Press. Cases Andrews v Gas Meter Co [1897] 1 Ch 361, CA Ashbury Railway Carriage Iron Co Ltd v Riche [1875] LR 7 HL 653 Ayre v Skelsey's Adamant Cement Co Ltd (1904) 20 TLR 587; affd (1905) 21 TLR 464, CA. Beattie v E & F Beattie Ltd [1938] Ch 708 Bratton Seymour service Co ltd v Oxborough, [1992] BCLC 693 Brown's Case (1873) 9 Ch App 102 Bushell v Faith [1970] AC 1099, [1970] 1 All ER 53, HL. Bushell v Faith [1969] 2 Ch 438, [1969] 1 All ER 1002, CA (affd [1970] AC 1099, [1970] 1 All ER 53, HL). BWE International Ltd v Jones [2003] EWCA Civ 298, [2004] 1 BCLC 406 Eley v Positive Government Life Assurance Co ltd [1876] 1 EX D 88 Equitable Life Assurance Society v Hyman [2000] 3 All ER 961 Folkes Group plc v Alexander [2002] EWHC 51 (Ch), [2002] 2 BCLC 254 General Phosphate Corpn v Horrocks (1892) 8 TLR 350. Graven-Ellis v Cannons Ltd [1936] 2 KB 403 Greenwell v Porter [1902] 1 Ch 530 Grundt v Great Boulder Pty Gold Mines Ltd [1948] Ch 145, [1948] 1 All ER 21, CA, Hickman v Kent or Romney Marsh Sheep-Breeders’ Association [1915] 1Ch 881 Holmes v Lord Keyes [1959] Ch 199 at 215, [1958] 2 All ER 129 at 318, CA, per Jenkins Malleson v National Insurance and Guarantee Corpn [1894] 1 Ch 200 Pender v Lushington [1877] 6 Ch D 70 Puddephatt v Leith [1916] 1 Ch 200 Quin & Axtens Ltd v Salmon [1909] AC 442 Rayfield v Hands [1960] Ch 1 Re HR Harmer Ltd [1959] 1 WLR 62 Re Moore Bros & Co Ltd [1899] 1 Ch 627, CA; Todd v Millen 1910 SC 868. Re New British Iron Co, ex p Beckwith [1898] 1 Ch 324 Re Richmond Gate Property Co ltd [1965] 1 WLR 335 W Robert Batcheller & Sons Ltd v Batcheller [1945] Ch 169 at 177, [1945] 1 All ER 522 at 531 per Romer J Russell v Northern Bank Development Corpn Ltd [1992] 3 All ER 161, [1992] 1 WLR 588, HL Scott v Frank F Scott (London) Ltd [1940] Ch 794, [1940] 3 All ER 508, CA. Scott v Frank F Scot (London) Ltd [1940] Ch 794 St Johnstone Football Club Ltd v Scottish Football Association Ltd [1965] SLT 171 Swabey v Port Darwin Gold Mining Co [1889] 1 Meg 385 Towcester Racecourse Co Ltd v The Racecourse Association Ltd, [2003] 1 BCLC 260 Walker v London Tramways Co (1879) 12 ChD 705 Wood v Odessa Waterworks co [1889] 42 Ch D 636 Journals Goldberg G D, 1972,”The enforcement of outsider rights under section 20(1) of the Companies Act 1948”, 35 MLR 362 Prentice G.N., 1980, “The enforcement of outsider rights”, 1 Co Law, 179 Wedderburn K.W, 1957, "Shareholders' Rights and the Rule in Foss v. Harbottle" C.L.J. 194 Others Constitution of the registered company, available at 18 December 2009 Halsbury's Laws Of England/Companies (Volume 7(1) (2004 Reissue) Paras 201-1000; Volume 7(2) (2004 Reissue) Paras 1001-2008)/2. Companies Regulated By The Companies Act 1985/(7) The Memorandum And Articles Of Association/(I) Effect Of Memorandum And Articles/A. In General/376. How Far Articles Constitute A Contract. Read More