The company constitution
This article is based on UK law as at 1st April 2007, unless
otherwise stated.
Every company will have two documents that comprise its
constitution: a memorandum of association and articles of
association. Both will usually keep to a fairly standard format,
but the detail of what they say can assume great importance. Big
changes are due in this area in October 2008 as a result of the
Companies Act 2006.
Memorandum
A company’s memorandum might be the least regarded of its key
documents, rarely looked at save by pedantic lawyers. Nonetheless,
historically it has played a crucial role: a company has only been
able to do those things its memorandum says it can (unlike a
“natural person”, who has complete freedom to do what they like
unless the law says otherwise).
As a result, the memorandum, and more specifically its objects
clause, will usually be drawn in very broad terms. It is likely to
start with a description of what it is intended the company will
actually do: run an airline in the case of British Airways; operate
a bank if HSBC. After that, there will usually be a list of 20 or
30 subsidiary objects or powers going well beyond what the company
might ever contemplate doing.
The memorandum will also set out the company’s name in full, and
state whether the registered office of the company is to be in
England and Wales, Wales alone or Scotland. Lastly, it will give
the initial amount of the company’s share capital.
The point of the objects clause has been to exclude the
possibility of a company acting ultra vires, that is
beyond its proper powers, potentially putting the directors who
authorised the offending action at risk of breaching their
duties.
(Ultra vires actions once carried risks for lenders,
too – leaving them with no enforceable security and no way of
recovering their money if the company became insolvent. That
problem was largely solved by legislative changes providing that if
a third party, for example, a bank lending money, acted in good
faith, it was not to be prejudiced by any deficiency in a company’s
constitution.)
Shareholders have been able to take action to stop directors
acting outside the company’s objects and directors have,
potentially at least, been personally liable when they do.
Under the Companies Act 2006, however, the position is very
different. After one failed attempt at reform in 1989, the Act cuts
through the legal undergrowth and simply (with effect from October
2008) removes the objects wholesale from the memorandum, along with
most of the rest of the document. The memorandum is reduced to a
bald statement that the initial subscribers wish to form a company
and agree to become members and take at least one share each. It is
no more than it says: a 'memorandum' of that initial agreement and,
beyond that, it has no useful purpose.
Only if the articles contain some specific restriction will the
company be limited in its actions. That will be the case with a
company that is a charity, where the objects will at least be
restricted to a charitable purpose, and it may also apply to a
joint venture company where the parties to the joint venture may
want to specify the purpose for which they have come together and
funded the company. In general, though, a company will be able to
be formed and used for any legal purpose without anyone worrying
whether it has the right objects or powers in its constitution.
One note of caution: directors need to use these unfettered
powers to promote the success of the company, not for some
extraneous purpose (the section on Directors' duties). So transactions that have no
commercial benefit, such as gifts or a guarantee of another’s
liabilities, might still be vulnerable.
It is not only new companies that are affected by the change.
Come October 2008, all existing companies will have their
constitutions automatically amended. Everything apart from the
basic agreement to form the company and take shares will be lifted
from the memorandum and dumped into the articles. Once there, it
can be amended or deleted as the shareholders wish, and many will
no doubt want to get rid of the lengthy objects clauses as a first
step.
Articles of association
The articles of association, the second part of a company’s
constitution, comprise its internal regulations or by-laws. They
set out both the way the company is to be run and the rights
between shareholders. It is the articles that deal with subjects
such as the rights attached to each class of share, the quorum for
a meeting and the way to transfer shares. With effect from October
2008, they also contain any restrictions on what the company can do
(whether imported from the memorandum or inserted afresh).
Companies legislation sets out a model form of articles known as
Table A. (There are alternative models for a company limited by
guarantee and other types of company.) Many private companies will
use Table A as the basis for their articles and make a few
amendments to suit their particular circumstances. A company’s
articles may thus comprise a page or two of these amendments and
otherwise incorporate the statutory Table A by reference (often not
setting it out in full, leaving shareholders to find a copy
elsewhere).
The Companies Act 2006 brings in new model forms of articles for
a variety of different types of company. Designed for the 21st
century, they are shorter than the old versions and drafted in
plain English.
Larger or public companies are more likely to exclude Table A
and instead set out the entirety of their articles in one document.
In practice, even they will follow Table A in many instances, but
the changes will be more sophisticated when compared with those
used by a private company.
You can put in your articles whatever you want, subject to one
proviso: you cannot go against the law. For example, the Companies
Act says a company can only pay a dividend if it has distributable
profits, and the articles cannot improve on that. Similarly,
statute says that shareholders can always remove a director by
passing an ordinary resolution – the articles can make it easier to
get rid of a board member, but they cannot contradict the statute
by making it more difficult.
Stock Exchange or AIM traded companies must comply with certain
rules as a condition of being listed. And if the articles of a
fully listed company have any 'unusual features' they must first be
approved by the UK Listing Authority (that is, the Financial
Services Authority).
It is often said that the articles are a contract between a
company and its members. When you become a shareholder you do so
subject to the terms of the company’s articles – now and in the
future. You will have the opportunity to vote on any change but,
once 'passed', a change, whether you approve of it or not, is, in
principle, binding. The corollary is that a shareholder can go to
court to stop a company acting in a way that is contrary to its
articles.
Just as you can put into your articles what you want, you can
change them at any time. To do so, requires a special resolution
(see the OUT-LAW guide to Company
Meetings). Changes, however, will be open to challenge if they
cannot be justified as being in good faith or are partisan. If a
majority of shareholders are motivated by malice and push through a
change harmful to the minority, a court might overturn the change
as not being in the interests of the company as a whole.
A company’s articles are a public document. They must be filed
at Companies House. So they are not the place to put details that a
private company might want to keep confidential – a financial
return to be enjoyed by a shareholder, for example, or detailed
voting arrangements. Shareholders in joint venture companies or in
private equity investments might opt to keep these details private.
That might mean that a company’s articles do not tell the whole
story of the relationship between shareholders and their company –
other documents might be needed for the full picture.
Board of directors and board committees
It is worth highlighting one provision found in most articles
(using here the wording from the proposed new Table A, effective
from October 2008): “the directors are responsible for the
management of the company’s business, for which purpose they may
exercise all the powers of the company”. (For more information see
the section on Directors' duties.)
That encapsulates the directors’ authority, the basis for the
power they exercise. It protects them, and the company, from
interference by shareholders in the day to day management of the
company. If the shareholders do not like what the directors are
doing, they can remove them or, less drastically, pass a special
resolution giving them a particular direction. Or they can change
the articles to limit the directors’ powers. Neither course of
action is commonly seen in practice, though an implied threat by
shareholders to remove directors can have the desired effect.
Just as shareholders effectively delegate the management of a
company to its directors, those directors, acting together as a
board, will be permitted by the articles to delegate day to day
decision making to individual executive directors and to committees
of the main board. Some committees may be a permanent feature,
required by governance considerations – for example, remuneration
or audit committees – others may be more ad hoc and formed to see
through a particular deal or issue.
Delegation to individual executive directors may be by means of
board resolution but executives’ service contracts may also set out
clearly what their duties are and what authority they have. (See
the section on Directors' service
contracts.)
