Company

Company law: Are the company articles of association enforceable in law?

Articles of Association Under Companies Act

Shareholders and members

The terms ‘shareholder’ and ‘member’ are interchangeable. Any subscribers to the memorandum become members on registration of the company, even if the company fails to enter their names in the register of members. Not all companies issue shares, therefore the term ‘member’ is more appropriate. All companies with either shareholders or members are formed under the statutory regime of the Companies Act 2006 and subscribe to the memorandum and the articles of association.

Who has what rights under the articles of association?

The articles provide rights to members and rules, by which, the directors must run the company. A reasonable question arises of who may enforce the rights of the articles. The articles provide rights to a member of the company, only in his or her capacity as a member. The Companies Act 2006 clarifies the company constitution, binds the company and its members, and allows enforcement of the covenants on the company and each other.

Effect of the company’s constitution

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.

Broadly, the following two legal relationships are created: the enforcement of covenants against the company and the enforcement of covenants between members.

The enforcement of covenants between members

The case law over the previous 150 years has developed the main principles on how the company’s constitution binds the company and its members, generally the articles of association are a matter between the shareholders inter se, or the shareholders and the directors. It should be noted the articles are not enforceable by third parties.

Members and fiduciary duty

Members of the company in law have no fiduciary duty to each other. Shareholder agreements may attempt to circumvent a member’s free right to vote in any manner they see fit, and the courts favourably look upon the members of a company forming a legal contractual relationship employing the articles of association.

Generally, a member may take any action or vote in any way for their own benefit without regard to other members on the stringent foundation they do not flout the rules in the articles or contravene any duties or provisions of the Companies Act 2006 under which the company was formed. A member has capacity to enforce the provisions in the articles of association; third parties, even if connected with the company had no similar rights of enforcement.

Members are not bound to each other and have no duty of care imposed by either the articles of association or by the Companies Act 2006. External share agreements may impose a fiduciary duty, for example in Halton International Inc & Anor v Guernroy Ltd [2006] EWCA Civ 801.

Members v members

The Companies Act 2006 unambiguously states the company’s constitution binds the company and each member. The Act is silent on the articles of association forming covenants with each member. 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.

Rayfield v Hands

The question of ‘are members’ rights enforceable against other members’ was addressed in Rayfield v Hands [1960] Ch 1.

Mr Rayfield held 725 fully paid ordinary shares of £1.00 each in Field-Davis Ltd, which operated as a building contractor. Gordon Hands and two other directors held 2,125 of £1.00 ordinary shares. The articles of association contained several provisions restricting the transfer of shares in the company.

‘(6)         No shares in the company shall be transferred to a person not a member of the company so long as any member of the company may be willing to purchase such shares at a fair value.

(9)          The directors may at any time in their absolute discretion refuse to register any transfer of shares.

(10)        The number of directors of the company shall not be more than four. The following persons shall be the first directors of the company, namely:—[the defendant] Alfred William Scales and Alfred Frederick Scales both of 172, Burnt Ash Lane, Bromley, Kent, builders.

(11)        Every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at a fair value, but subject to the above no person shall hold more than one thousand shares in the capital of the company.

(12)        In the event of death of any director his shares are to be taken up equally between the remaining directors who will pay a fair value therefor together with all moneys due to the deceased up to the time of his death.’

Some 14 years after incorporation, Mr Rayfield informed the other members of his intention to invoke article 11 and transfer his shares to them. The members contended that article 11 did not create a binding contract, Vaisey J said that while the word ‘shall’ clearly imports compulsion and obligation, the word ‘will’ indicates as it seems to me a resultant prospective eventuality, in which the member has to sell his shares and the directors have to buy them, each being under an obligation to bring that eventuality into effect.

In the opinion of the judge the construction of article 11 and the words formed a contract or quasi-contract between members, and not between members and directors.

The principal of a quasi-contract between members being formed by the articles of association extends to a company limited by guarantee, this may have repercussions for many sports clubs who may, without any knowledge, enter into contracts with other members.

Enforcing covenants against the directors

The Companies Act 2006 specifies the duties the directors owe the company and its members. Company directors now operate under statutory law, but it should be noted that the legislative provisions do not endeavour to replace the existing common law. In principle the general duties form a code of conduct to control behaviour as opposed to controlling decision making. The duties are fiduciary and aim to stop directors placing their interests before the company and prevent negligence. The duties are derived from equitable and common law rules.

The courts have enforced duties owed by directors to the company by common law and equity, the Companies Act 2006 and the implementation of the general duties of directors attempted to codify the existing judgments into legislative propositions. The statutory duties owed by the directors are to the company only. There are limited cases where the directors owe common law duties to the members, when dealing with their proprietary rights.

[“source=law.bloomsburyprofessional”]

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Loknath Das

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