Principles of Company Law - Case Study Example

Law Business and Organisations Articles of association of a company play an important role in day to day working of the company as it formulates and prescribe all rules and regulations to run the company. Companies limited with guarantee have to register articles at the time of incorporation and those are supposed to be as close to Table C of Companies Act 2006 as possible. Companies limited by share may adopt table A with or without modifications. In case these companies limited by shares do not adopt Table A or adopt Table A with modifications, then these companies have to register their articles of associations either at the time of incorporation or at later date. Articles of association often get altered keeping in order keeping them updated with changing legal and business scenarios. However, alterations of articles are subject to certain restrictions and limitations that a company has to follow. These restrictions and limitations are discussed and critically analyzed in this write up. Articles of association of a company can be altered or modified through the passage of a special resolution as permitted under section 21 of the Companies Act, 2006. Further a company can also enrich its articles of association with such further conditions and requirements that are required to be complied with before altering the articles of a company. It is up to the company to lay down procedure that may be more stringent than mere passing of a special resolution. However there are certain restrictions or limitations on alteration of articles of association of a company as described here under: 1. The alteration has to be bona fide, in good faith, and for the benefit of the company as a whole. 2. Alteration of articles should not violate or override any provisions of memorandum of association. 3. Alteration of articles will be invalid if it breaches the provisions of any statute enacted by the parliament. 4. The articles of association cannot be altered to increase the liability of a member in any way without the consent of members. The company has obtained powers under the Companies Act to alter the articles only for the bona fide benefits of the company as a whole. For example if a section of members forming majority get the articles altered for the benefit of that section only and not for the minority section, the alteration is not bona fide but will be considered as bad at law. ‘Bona fide for the benefit of the company’ as whole is an expression that is be considered in generality of the interests of the company and not specifically for one section of members or shareholders of the company. At the same time ‘for the benefit for the company as a whole’ is a subjective issue to be considered separately for each and every alteration and no general meaning can be drawn for all types of alterations of articles. Some articles may be general in nature but may not be for the benefit of all the members of shareholders of the company. In Greenhalgh v Ardrene Cinemas Ltd., Evershed MR stated that ‘bona fide for the benefit of the company as a whole’ means ‘the corporators as a general body. That is to say, a case may be taken of an individual hypothetical member and it may be asked whether what is proposed, is in the honest opinion of those who voted in its favour, for that person’s benefit.’ (Evershed MR, 291)i In the case of Allen vs. The Gold Reefs of West Africa (1991) it was held that “the power conferred must, like all other powers, be exercised subject to those general principles of the law and equity which are applicable to all powers conferred on majorities and enabling them to minorities. It must be exercised, not only in the manner required by law, but also bona fide for the company as a whole, and it must not be exceeded.’(Lord Lindley MR)ii The basic objective of the alteration should be the benefits of entire company even for that a specified member or a class of members is targeted. For example ‘in the case of Sidebottom v Kershav Leese & Co. Ltd.(1920), a minority shareholder in the company carried on a business that was competing with the company. It was proposed to alter the company’s articles to insert a clause whereby a shareholder who competed with the company would be required to transfer his shares at a fair value to the directors. It was held that the alteration was valid even though it was carried out specifically against one particular member. The clause in question could apply in relation to any member.’(Nicholas Bourne, page 69)iii The idea is that power conferred upon the company to alter the articles should not be misused in a manner that it constitutes a fraud on the minority shareholders. The rule is that all the members must get benefit from the alteration. It is necessary to display that alteration is equally good for all members so that benefits and burdens of alterations fall upon all the members in similar fashion. There should not be discrimination between members by conferring benefits on some and taking away the rights of other members. The company should exercise the power to alter the article of association in good faith, even if good faith of alteration works to the disadvantage of few shareholders. If the alteration of articles appears to be not made in good faith, the same can be challenged in the court of law. ‘A minority shareholder, even with only one share, can obtain an injunction to prevent a proposed act by the directors which would be ultra virus the company. The court will grant a remedy if the directors or management, in breach of their fiduciary duties to the company, have committed a fraud on minority. In this contest, fraud means grossly inequitable conduct, not necessarily amounting to a criminal offence.’(Larry Mead and others, page 287)iv A shareholder on becoming member of a company enters into a sort of contract with the company at the existing articles of the company. Accordingly it will be treated as breach of contract if alteration to articles is made without the permission of members. That is the reason the law provide for adoption of a special resolution when articles are required to be altered. This does not mean that a company cannot alter its articles. A company is legally empowered to alter the articles. In fact court cannot issue an injunction, on application of a member, to prevent the adoption of a new article. But if a breach of contract is committed, the company will be held liable for damages to the other party of the contract. ‘By effecting alteration in its articles a company cannot defeat or escape from its contractual obligations.’(Southern Foundries (1926) Ltd. Vs. Shirlaw)v In Southern Foundries case, Lord Portervi said “A company cannot be precluded from altering its articles thereby giving itself powers to act upon the provisions of altered articles- but so to act may nevertheless be a breach of contract if it is contrary to a stipulation in a contract validly made before the alteration. Nor can an injunction be granted to prevent the adoption of new articles and in that sense they are binding on all and sundry, but for the company to act upon them will none the less render it liable in damages if such action is contrary to the previous engagement of the company.” There may be certain rare circumstances where the company may be precluded from altering the articles. As has been held in Baily v. British Equitable Assurance co.vii by House of Lords that ‘the principle is of general application and even a shareholder is presumed to know that the rights conferred by the articles are subject to the power of alteration provided by the law and he cannot complain unless he can show that the alteration sought to be effected is either (1) a breach of a separate contract made with him or with his class or (2) that it is not for the benefit of the company as a whole.” Another limitation for alteration of articles of association is that such alteration cannot be inconsistent with the memorandum of association. The article of association is a subordinate document to memorandum of association. The memorandum is treated as constitution of the company. On the other hand articles of association establish the rules and regulations to achieve the objectives of the company. The main constitution document for a company is memorandum of association. Therefore articles cannot be altered in any way that is inconsistent with memorandum. ‘Any action undertaken by the company beyond the scope of its memorandum is ultra vires, but if any thing is ultra vires of the articles it does not necessarily mean ultra vires of the memorandum.’(Arun Kumar and others, page 77)viii Alteration of articles should not result into an increase the liability of a shareholder or member in any way unless it is agreed upon by the all members. Section 25 of CA 2006 bars the effects on members of alteration of articles that has taken place after the acquisition of membership if such alteration results into increase in the liability of the member to contribute to the capital of the company or otherwise makes member liable to make payment of some money. However, such an alteration to articles of association is possible if members agree to such an alteration of articles increasing their liability. There may be a situation where all the shareholders interested in a company enter into an agreement that alters the articles of the company, but the company has not passed any special resolution to adopt such alteration. Under such circumstances, the articles of association would deem to have been effectively altered or modified. This is because the basic principle of the company law is that all shareholders of a company acting together can adopt anything intra vires the company. If such agreement results into enhancement of the liabilities of existing shareholders on alteration of articles of association, then such alteration of the company’s articles of association would be valid even though the liability of the shareholder is increased. There is no bar to alter the articles with retrospective effects. But such alteration should not have the effect of increasing the liabilities of members that is more than what they contracted for at the time of becoming members. In the case of James v. Buena Ventura Nitrate Ltd.ix It was held that validity of what has already been done by the company cannot be affected by a subsequent alteration of the articles. For example it is not possible to increase the managerial remuneration of directors with effect from a date that is prior to the date of special resolution. However a mistake in the articles of a company can be rectified by passing special resolution (Scott vs. Frank F Scott (London) Ltd.)x In nutshell the companies are supposed to utilize the power provided to them under law to alter the articles of association in absolute good faith and for the benefit of the company as a whole. The provisions of memorandum, companies act and other statutes can not be violated, and at the same time the articles will not any effect of increasing the liabilities of shareholders unless agreed upon by the shareholders. Word Count: 2019 References: Read More