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Articles of Association essay

Company law (University of London)

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All companies have a constitution, however there is confusion in regards to the

enforcement of articles. Discuss. (100m) (S33)

Introduction:

A company’s constitution is divided into the AOA and MOA. The articles of association
contain the internal rules of the company, which state the organizational structure of the
company, allocate power to and between the organs of a company, and prescribe procedures
for decision-making. In Company Act 2006, S33 provides that all members are bound by the
company’s articles. It is legally enforceable and binding.

Every registered company must have an article of association. If it does not, the
default article will apply. The issue to be concerned here is whether problem still exists after
the passing of Company Act 2006. CA 06 has remedied some of the flaws of the CA85,
however some still remain.

Under the old law, the model article can be found under Table A but now it is stated in
S19 CA06, which provides the detail guide on a company’s administration. It consists of
appointment of directors, removal of directors, entry into investments, division of profits,
etc. Under the old law, there is a one-size fix all approach. It was the same articles for public
and private companies. This was subjected to much criticism. The new law remedied this
problem and created 2 separate articles for public and private companies, where articles of
private company is shorter or less formal set of rules from the public company. Among
examples are Art.70.

Several provisions in the model article that are relevant here will be assessed. Article
3 of model article provides that the directors are responsible for the management of the
company’s business, for which purpose they may exercise all the powers of the company
subject to AOA. Although it is stated that all members are bound by AOA, Articles that
purport to override certain statutory rights or powers have been held to be void and
unenforceable. In Re Peveril Gold Mines Ltd, the courts held that an article, which purported
to limit the statutory right of a shareholder to wind up the company under S82 CA06 was
held to be void.

Besides that, Article 4, which concerns shareholders’ reserve power, states that the
shareholders may direct the directors to take or not to take specified action by special
resolution. In Howard v Ampel Petroleum, however, the courts held that directors still have
the power to make decisions that go against the wishes of majority. For example, in the
managing of surplus profits. director has the power to either invest or return surplus profits
as dividend to shareholders as per Art 30 and Art 70. If the director makes the shareholders

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unhappy, he can be removed under S168. Despite this, decisions made by the directors will
still stand.

In relation to the amendment of AOA, Section 21 CA 06 allows the amendment to be

made by special resolution. In Common law, however, amendment must be made in good
faith, as per Lindley MR in Allen v Gold Reefs. where Lindley MR held that amendment must
be bona fide for the benefit of the company as a whole. However, this attracted criticisms
such as Meagher JA commented in Gambotto v WCP that ‘these words have beguiled and
confused the courts ever since’. Cases like Greenhalgh and Sidebottom showed that this test
will be difficult to be applied where the company as an entity is not impacted by the
amendment, such as squeeze out cases.

It must be noted that when entrenched provision as provided in S22 CA 06 applies, a

specified provision may only be amended or repealed only if the conditions are met, or
procedures are complied with. The whole purpose is to protect the minority parties through
special voting rights, managerial position, higher dividends and others. These rights cannot
be removed ordinarily but require the consent of those involve.

The other area of AOA that remain problematic is the enforcement of articles. As
provided in S33, the provisions of a company’s constitution bind the company and its
members to the same extent. Unfortunately, the enforcement of this statutory contract is not
straightforward as per Susan McLaughlin in Unlocking. The discussion here can be divided
into enforcement by the company and by members.

For enforcement by company, the case to be assessed is Hickman v Kent. Here, the
company was permitted to enforce the arbitration clause in the articles because the dispute
between the member and the company related to membership rights. However, the company
cannot enforce provisions in the articles against a member if the provision relates to the
rights of the member in the capacity of outsider such as director or solicitor. This can also be
seen in Bisgood v Henderson’s Transvaal Estate.

In relation to the enforcement by members, the courts in Rayfield v Hands held that
Mr Rayfield could enforce the article against the members who were ordered to take the
shares. There is no issue with this. The mooting point here is on the cases concerning
enforcement of outsider rights and cases concerning internal irregularities.

It is unclear until today on the law regarding enforcement of outsider rights. The more
widely held view appears to be that a member cannot sue to enforce outsider rights. In
Beattie v E Beattie, the court held that EB could not enforce the article and insist on
arbitration as this was not an issue between the company and himself as a member, but in

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the capacity of director who deemed as an outsider. The same goes to Elly v Positive
Government (1876) where AOA provides that Elly is named Co solicitor. When the position
was not given, Elly sought to enforce articles as a solicitor but the courts did not allow it as a
solicitor was an outsider. The cases of Browne v La Trinidad and Hickman v Kent are also
commonly cited in support of the restriction on enforcement of outsider rights.

A contrary view was reached by HOL in the case of Salmon v Quinn & Axtens. Here, a
director and shareholder of a company sought to enforce a veto (outsider right) given to him
as managing director in the articles. The HOL permitted him to enforce the outsider rights as
a member. Lord Westerburn argued that this case establishes that mem

bers can indirectly enforce outsider rights in the articles by suing as members by requiring
the company not to depart from the contract in the articles.

According to Gideon Shirazi in “To What Extent does the S33 Contract Differ from an
Orthodox Contract?”, there is no reason why the courts in Beattie and Hickman chose to
ignore the decision in Quinn & Axtens and placing the emphasis on the Hickman decision. In
fact, in Beattie, although it was held that the AOA clause was not enforceable, the Master of
the Rolls suggested that ‘had the action been framed as a member-director action in which
the central issue was a member suing to enforce the articles which had the tangential effect
of enforcing an outsider right, rather than a director-member action in which the
enforcement of the director’s rights were central rather then tangential, the action might
have been successful.

Lord Wedderburn in his article “Shareholders Rights and The Rule in Foss v
Harbottle” also of the opinion that every member has a personal right to see the company
running according to the articles, except those already identified as concerning the internal
proedures only and this view has been broadly accepted by other academics such as Gregory,
Goldberg and Drury.

Although there are contrasting opinions such as Professor Gower’s who favours the
traditional interpretation of S33 (the Eley school of thought), Anthony Nwafor explains that
these contrasting niews are unhelpful as it is based on a theory of law, rather than substance
and it fails to take into account cases such as Salmon.

However, Anthony Nwafor, in his article ‘The Unending Debate on the Contractual Effect
of the Company’s Constitution – A Comparative Perspective”, believes that Lord Wedderburn’s
proposition in practice onlyscratches the surface of the reforms actually needed; the implications
of s.33 are limited in practice and commercially unrealistic for only shareholders alone have a

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constitutionalcontract with the company and directors do not, given that directors are the
“pillars” of acompany.

It is noteworthy that the Company Law Review has also recommended that individual
shareholders should have the right to enforce all provisions in a company’s constitution both
against the company itself and against other members unless the constitution expressly
provides otherwise. Unfortunately, however, the proposal was shelved by the legislature and
no change has been brought yet.

Just when the law is already complex and confusing in this area, GD Goldberg and Dr
Prentice suggests a third school of thought. In their article, “The Controversy on the Section
20 Revisited”, a middle ground was suggested. It was argued that a member has a contractual
right to have the affairs of the company conducted in a manner consistent with the AOA; the
key question here is whether the company acted constitutionally or not. If the company has
not acted constitutionally, the member can then enforce the statutory contract to ensure that
the company does so, even though this may also incidentally enforce an outsider right. Other
than this, no further enforcement of outsider right is permissible.
In regards to the enforcement of internal irregularity, generally, it cannot be enforced
by member if a majority of the member condones to the irregularity. This is shown in Grant
v UK where directors acted in breach of restrictions imposed by AOA, individual shareholder
cannot bring an action as the matter was an internal irregularity and it had been ratified by
an ordinary resolution. Mellish LJ in MacDougall v Gardiner also stressed the importance of
respecting majority rules and not engaging the courts in matters internal to a company at
the suit of an individual shareholder.

However, the court in Pender v Lushington reached a contrary decision, focus on the
rights of shareholders. Here, the court held that the individual shareholder was entitled to
an injunction preventing the company from acting contrary to the resolution.

Due to the different approaches adopted by the courts in different cases, Susan
McLaughlin in Unlocking commented that a great deal of uncertainty remains as to which
rights stated in the articles can be enforced by members and, consequently, it is impossible
to provide a comprehensive definition of the personal rights of a shareholder.

In Conclusion: Under the CA 85, there was a problem in regards to model articles and
enforcement of articles. However at present, the problems with model articles have been
solved but there is still a problem with enforcement.

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