Articles of Association: An Overview
Articles of Association is a document which prescribes the rules and bye-laws for the general management of the company and for the attainment of its object as given in the memorandum It is a document of paramount significance in the life of a company as it contains the regulations for the internal administration of the company’s affairs.
The articles of association are a subsidiary to the memorandum of association of the company. They define the rights, duties, powers of the management of a company as between themselves and the company at large. Further, they also prescribe the mode and form in which changes in the internal regulation of a company may be made from time to time. The articles of association of a company must always be in consonance with the memorandum of that company and being subordinate to the memorandum; they cannot extend the objects of a company as specified in the memorandum of the company.
In the case of Naresh Chandra Sanyal v. Calcutta Stock Exchange Association Ltd, the Supreme Court provided that the articles of association of a company also establish a contract between the company and its members as well as between the members. This contract governs the ordinary rights and obligations incidental to the membership in the company.
Articles of association are like the partnership deed in a partnership. They particularly provide for matters such as the making of calls, forfeiture of shares, directors qualifications, the procedure for transfer and transmission of shares and debentures, powers, duties and appointment of auditors.
Meaning of Articles of Association
The Articles of Association can be seen as a rule book within a company. This is in a document form and is a part of the company’s constitution alongside the memorandum. This document contains internal detailed governing aspects of the company’s organisation. These include shares, (issue and rights attached to them) the conduct of the company meetings and the role and powers of the directors. The Articles detail rules which govern the conduct of directors, the rights of the shareholders and the relationship between the two.
The articles of association set out how the company is run, governed and owned. The articles can put restrictions on the company’s powers – which may be useful if shareholders want comfort that the directors will not pursue certain courses of action, at least without shareholder approval. By default, however, the Companies Act 2006 gives a company unlimited powers.
In addition to the articles, which is a public document, the shareholders may enter into a shareholders’ agreement to augment the articles in relation to the running, governance and ownership of the company that they want to keep out of the public domain.
Importance of Articles of Association
Under sec 36, the memorandum and the articles when registered, shall bind the company and its members to the same extent as if it had been signed by them and had contained a covenant on their part that the memorandum and the articles shall be observed.
With respect to the above section, the importance of articles of association can be summed up as follows:
1) Binding on members in their relation to the company- the members are bound to the company by the provisions of the articles just as much as if they had all put their seals to them.
2) Binding on company in relation to its members- just as members are bound to the company, the company is bound to the members to observe and follow the articles.
3) Neither company, nor members bound to outsiders- articles bind the members to the company and company too the members but neither of them is bound to an outsider to give effect to the articles.
4) Binding between members inter se- the articles define rights and liabilities of the members. As between members inter se the articles constitute a contract between them and are also binding on each member as against the other or others. Such contract can be enforced only through the medium of the company.
Contents of the Articles of Association:-
Each limited liability company must have articles of association. They are the company’s internal regulations, which bind the company, its administrative bodies, management and auditors. The articles of association must be complied with in the same manner as the Limited Liability Companies Act.
The formulation of the articles of association is of great importance from the point of view of the company’s activities. Articles of association that are not suitable for the company’s purposes may decrease the benefits, which the shareholders can obtain from the company. It is recommendable to pay due attention to the contents of the articles of association already during the company's founding phase, because the amendments thereof always require at least two-thirds (a qualified majority) of the votes and of the shares represented at the general meeting of shareholders. In practice, significant amendments always need to be agreed between the shareholders. Moreover, amendments always result in Trade Register costs as the amendments become effective only following registration in the Trade Register.
The articles of association must include provisions regarding the following:
1) Company name
The company name of a private limited liability company must include the words “limited liability company” or the abbreviation “limited / Ltd” (in Finnish “osakeyhtiö” / “Oy”, in Swedish “aktiebolag” / “Ab”). If the company intends to use its company name in two or more languages, the names in other languages must be stated in the articles of association.
2) A Finnish municipality as the company’s place of business
A company may practice its activities in several places and also abroad, but its registered place of business can only be in one Finnish municipality. The company’s registered place of business is of significance, as the general meetings of shareholders generally need to be held in the municipality of the place of business and any legal actions against the company need to be brought to the court of the municipality in question (forum domicilii).
3) The company's field of activity
The term "field of activity" refers to the fields in which the company carries on its business activity. Any activity, which may be pursued legally in the form of a limited liability company, can constitute the company’s field of activity. A company can have several fields of activity, but they must all be registered. Although legislation is silent about how precise the definition of the field of activity needs to be, inexact and unnecessarily extensive definitions should be avoided. The definition of the field of activity has legal significance when assessing the competence of the company’s organs to take care of company matters. Moreover, the field of activity is of importance when evaluating the use of company assets. The field of activity may also consist of a general field of activity. Definitions of the field of activity, which are too narrow, can cause extra costs and inconvenience, as the expansion of the company’s activity requires for the articles of association to be amended correspondingly and for the changes to be registered with the Trade Register.
In addition, the following provisions may be included in the articles of association:
4) Share capital
The minimum amount of a private limited liability company's share capital is 2,500 euros. The minimum amount of a public limited liability company’s share capital must be at least 80,000 euros. The share capital can be stated either as a fixed amount or as minimum and maximum amounts. In case the share capital has been defined as minimum and maximum capital, it can be increased and decreased within these limits without a need to amend the articles of association.
5) Nominal value and number of shares
If the nominal value is defined in the articles of association, all shares must have the same nominal value.
6) Number of members of the board of directors and auditors as well as the possible deputy members, or the minimum and maximum number thereof. The number of the members of the board of directors and auditors, as well as the possible deputy members and their term of office may be stated in the articles of association. The number of the members may also be stated as a minimum or maximum amount. At least one of the members of the board of directors must have his/her place of residence in the EEA, unless the National Office of Patents and Registration of Finland grants the company a permission to deviate from this requirement. Legally incompetent or bankrupt natural persons or a legal person cannot be members of the board of directors. In addition, the articles of association may include special provisions concerning the eligibility of a board member and a deputy member.
There may be more than one auditor. The competence of an auditor is regulated in the Auditing Act [5.1.7 Audit]. In case only one auditor has been elected and the auditor is not an auditing KHT or HTM-firm approved in accordance with the Auditing Act, then at least one deputy auditor must be elected in addition.
7) Notice of a general meeting of shareholders
The articles of association may stipulate the manner in which and when the notice to the annual general meeting of shareholders must be given. The notice may be given e.g. by announcement in a newspaper or by a written notice delivered to the persons who have been entered in the share and shareholders’ registers. If not mentioned in the articles of association, according to the Limited Liability Companies Act, the notice must be issued in private limited liability companies no later than one week prior to the date of the general meeting, or the special date of registration stated in the articles of association, and no earlier than two months prior to the date of the general meeting or the registration date.
8) The agenda of the annual general meeting
The articles of association may state the agenda of the annual general meeting. Matters, which according to mandatory law provisions must be considered at the annual general meeting, shall also be included on the agenda.
9) Accounting period of the company
According to the Auditing Act, the accounting period of the company may be a calendar year or any other period of twelve (12) months. The accounting period may be shorter or longer than this period when the company's activity is being set up or closed down or when the time for the financial statements is being changed. The maximum length of the accounting period is eighteen (18) months.
10) Supplementary provisions
The Limited Liability Companies Act provides several legal alternatives, the use of which requires supplementary provisions to be inserted into the articles of association. Regulating the matter in the articles of association is usually a prerequisite, if the company wishes to derive a legal benefit from the alternative. For instance, a redemption right does not relate to a share, if the matter has not been stated in the articles of association (a so-called redemption clause). Nevertheless, the inclusion of such regulations in the articles of association is entirely voluntary. The use thereof depends on whether the company wants to utilize the alternative provided by legislation.
11) Other provisions
In addition to mandatory provisions, the shareholders may also quite freely include other provisions in the articles of association. The other provisions may not, however, contradict the mandatory principles provided by the Limited Liability Companies Act, e.g. by limiting the transferability of the shares in another way than by way of a redemption or consent clause as provided by law. These voluntary provisions may concern e.g. following matters:
# appointment of a managing director
# the manner of calling the general meeting;
# nomination of the chairman of the general meeting or election of a director of the board;
# minimum attendance at the general meeting;
# expansion of the scope of the tasks of the general meeting to cover e.g. decisions on transfers of or mortgage on fixed assets, or on floating charges;
# determination of the majority required for resolutions adopted by the general meeting above the ordinary;
# withdrawal of the decision power of the chairman in the event of equal votes so that the outcome may be determined e.g. by the drawing of lots;
# an arbitration clause, which binds the company, the shareholders, the board, the supervisory board, a member of the board and a member of the supervisory board, the managing director and the auditor with the same effect as an arbitration agreement.
The articles of association may contain entrenchment provisions. However, this concept of entrenchment was not present in the Companies Act, 1956. The word entrench means to establish an attitude, habit, or belief so firmly that change is very difficult or unlikely. Thus, an entrenchment clause is the one which makes certain amendments either impossible or difficult.
The company has the discretion to include entrenchment provisions in its articles of association. Such provision may relate to the effect that specified provisions of the articles may be altered only if conditions or procedures as that are more restrictive than those applicable in the case of a special resolution, are met or complied with. An entrenchment provision can be made at the time of incorporation of the company, or after the incorporation of the company by way of an amendment to the articles of association of the company.
The format for the articles of association of a company must be in the manner prescribed by the form provided in Schedule I of the Companies Act, 2013.
Usually, the articles of association of a public limited company are prepared by taking good professional advice and are very carefully prepared from the beginning. It is only the private limited companies which have to keep a check on the following while drafting the articles of association:
1. The Companies Act, 2013 provides for the model articles for a company under section 5. Thus, it is to be remembered that even though there is the use of the words such as ‘preparation of articles’ while getting a company incorporated, it only means an adoption of the model articles as provided by the act with a few modifications as the promoters may insist.
2. As much as possible, the promoters must refrain from any additions, changes, alterations or deletions in the model articles provided by the act. This is mainly because, Schedule I of the Companies Act, 2013, from table – to the table – , provides for the forms for articles of different type of companies. Thus, more or less the model articles contain the required contents for a particular company. Additions or alterations must only be done if it is necessary to have a new regulation in the articles of association, or if a new regulation is a must for promoting the company.
3. The additions, changes or alterations which are made to the model articles, must be done with careful scrutiny of the provisions of the Companies Act, 2013.
Alteration of articles
Section 31 empowers every company to alter its articles at any time with the authority of a special resolution of the company and filing copy with the Registrar. Since it is a statutory power a company will not be deprived of the power of alteration by a contract wit anyone.
The power of alteration of articles conferred by sec 31 is almost absolute. It is subject only to two restrictions-
It must not be in contravention with the provisions of the Act.
It is subject to the conditions contained in the memorandum of association.
The proviso to sub-section (1) says that an alteration which has the effect of converting a public company into a private company would not have any effect unless it is approved by the Central Government.
1) Alteration against memorandum- in Hutton v. Scarborough Cliff Hotel Co, a resolution was passed in a general meeting of a company altered the articles by inserting the power to issue preference shares which did not exist in the memorandum. It was held inoperative. However, after Andrews v. Gas Meter Co Ltd this view has been changed where a company was allowed by changing articles to issue preference shares when its memorandum was silent on the point. The power of alteration of art is subject only to what is clearly prohibited by the memorandum, expressly or impliedly.
2) Alteration in breach of contract- a company may change its articles even if the alteration would operate as a breach of contract. If the contract is wholly dependant on the articles, the company would not be liable in damages if it commits breach by changing articles. But if the contract is independent of the articles, the co will be liable in damages if it commits breach by changing articles. Thus in Southern Foundries Ltd v. Shirlaw, where a Managing Director was appointed for a term of ten years, but was removed earlier under the new articles on amalgamation with another company, the company was held liable for breach of contract.
3) Alteration as fraud on minority shareholders- an alteration must not constitute a fraud on the minority. It should not be an attempt to deprive the company or its minority shareholders of something that in equity belongs to them.
4) Alteration increasing liability of members- no alteration can require a person to purchase more shares in the company or to increase his liability in any manner except with his consent in writing.
Thus, the power of alteration should be exercised in absolute good faith in the interest of the company.
It is a settled company law principle that the articles of association of a company cannot override the provisions of the Companies Act, 2013. Further, the articles of association of a particular company are also bound to observe the memorandum of association of the company as the articles are subordinate to the charter which is the memorandum of the company as well as any other company law in force at that time. Thus, it is of primary importance that when a company is being incorporated, and the articles of association of the company are being prepared, the same must be done in consonance with memorandum of association, the Companies Act, 2013 and any other company law which is in force at that time.
1. A.K. Majumdar and Dr. G.K. Kapoor, Taxmann Company Law And Practice, 12th Ed., Taxman Allied Services Pvt. Ltd., 2011
2. Dr. Avtar Singh, Company Law, 14th Ed., Eastern Book Company, 2005
3. N.D. Kapoor, Elements of Mercantile Law, 29th Rev. Ed., Sultan Chand & Sons, New Delhi, 2008