Using a company to run a business is often the most advantageous structure to use when compared to the sole trader and partnership models. It can provide tax benefits, help protect shareholders and directors from liability and offer a flexible format for obtaining investment. At the end of March 2019, there were about 4 million companies registered at Companies House (see further https://www.gov.uk/government/publications/incorporated-companies-in-the-uk-january-to-march-2019/incorporated-companies-in-the-uk-january-to-march-2019).
This guide looks at the role and function of a company’s articles of association.
Articles of association
Every company must have articles of association. The articles act as a rulebook setting out regulations for the internal affairs of the company. They form a type of contract between each of the shareholders and the Company.
Companies are free to create their own bespoke set of articles (within the scope of company law generally). In the absence of doing so companies are automatically incorporated with a standard set of articles called Model Articles as set out in the Companies Act 2006. The Model Articles for a private company limited by shares can be found here https://www.gov.uk/government/publications/model-articles-for-private-companies-limited-by-shares/model-articles-for-private-companies-limited-by-shares#part-3-shares-and-distributions-1. Companies will often use the Model Articles as a base, and adapt and add to its provisions to ensure it is fit for purpose for the particular business and its ownership and management structure.
The Model Articles are divided into five sections:
Interpretation and limitation of liability (articles 1 and 2)
Here various terms are defined, and rules of interpretation established that apply to the rest of the document (article 1). Article 2 indicates that a shareholder who has paid for their shares in full (including any premium) has no further liability to contribute to the assets of the company in respect of those shares. This is an important concept for most companies limiting the liability of the shareholders to the payment due on their shares.
Directors (articles 3 to 20)
Directors are responsible for the day to day management of the company. This section sets out how the directors should conduct themselves, hold meetings, make decisions and avoid conflicts of interest. It also covers rules concerning the appointment and removal of directors.
Shares and distributions (articles 21 to 36)
The Model Articles envisage a simple share structure of one class of ordinary share. These shares have one vote per share and equal rights to distribution in relation to income (dividends) and other distributions e.g. a capital distribution on winding up. This section also covers the process for the transfer of shares, which under the Model Articles is largely unrestricted save that the registration of a share transfer is at the discretion of the directors.
Decision making by shareholders (articles 37 to 47)
Shareholders as the owners of the company hold the ultimate decision making power. This section sets out how the shareholders should conduct themselves, hold meetings and make decisions. Certain decisions are reserved to the shareholders (rather than the directors) such as the amendment of articles and the issuing of shares on a non-pre-emptive basis.
Administrative arrangements (articles 48 to 53).
A catch all section dealing with items such as insurance and indemnities for directors, company seals and the means by which communications will be made.
Amending the Model Articles
There are a number of areas in a company’s articles that commonly get supplemented. A few of these are summarised below. Please contact us to discuss your requirements in more detail:
- Where a more complex share structure is required different classes of shares can be created and defined in the articles. For example, where shareholders are contributing to a company in different ways, perhaps by working in the business compared to investing capital, different classes of shares with different rights can be desirable. Common classes of types of shares are, ordinary shares, preference shares and non-voting shares. Shares can be given enhanced or no voting rights. They can also have varied rights to dividends and other distributions. For example a preference share may entitle the holder to a percentage of the profits each year in preference to the other classes of shares.
- The basis upon which shares can be transferred. Under the Model Articles shares transfers can only be registered at the discretion of the directors. Whist In exercising the power, the directors must act in good faith in a manner that promotes the success of the company, it is often desirable to provide a clearer and more comprehensive procedure for the transfer of shares. A common addition is to stipulate that a shareholder wishing to sell their shares must first offer them to the existing shareholders. There is typically a mechanism for determining the fair or market value of these shares. This seeks to strike a balance between the interests of the selling shareholder looking to exit the company and the other shareholders who may not want a third party becoming a shareholder. Other related articles include allowing family members to be transferred shares freely and for shares to be automatically offered to the other shareholders on the happening of certain events e.g. death, bankruptcy or breach of contract.
- Providing for the sale of the company as a whole. Often referred to as “drag along” and “tag along rights”. Drag along rights allow a majority of the shareholders to sell their shares to a buyer and “drag” along the remaining shareholders on the same terms. This ensures that a minority shareholder cannot hold the majority to ransom on a sale. A buyer will often want to ensure that they are purchasing the entire issued share capital of the company. Tag along rights on the other hand allow a minority shareholder to “tag” along with any sale of shares that the majority of shareholders may be considering.
Cheyney Goulding is a firm of solicitors in Guildford, Surrey. We frequently advise companies, shareholders, directors and investors on articles of association. When reviewing a company’s articles it is also crucial to consider the terms of any shareholders’ agreement. Shareholders’ agreements and articles of association should be drafted in such a way as to complement one another ensuring they do not conflict and that between them the internal affairs of the company are regulated in such a way that is fit for purpose and reflects the wishes of the shareholders.
This guide is for general information only and does not constitute legal advice. If you would like to discuss anything in this article please get in touch.
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Cheyney Goulding LLP, law firm in Guildford, UK