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Having week before last examined the issue relating to the appointment of Receivers over the Grand Bahama Port Authority, this week we will turn our attention to the main internal constitutional documents of a company – the articles of association and memorandum of association. Most of our readers from the reactions we received from the previously mentioned article seem to have understood the most fundamental principle of modern company jurisprudence which is that a company – once incorporated becomes an artificial or juristic legal entity having its own life and existence, separate and distinct from its members. We commonly refer to this as corporate personality from which flows the principle of limited liability. Thus a company being a corporate personality has its own constitution. The constitutional documents of a company are its memorandum of association and articles of association. When shareholders subscribe their names or sign these documents, something happens which has far-reaching legal ramifications that are ordinarily appreciated. Thus we will consider how the internal structure and rules of the company are formed and enforced through the operation of the function of the section 11 Contract and Shareholder’s agreement. See section 11 of the Companies Act 1992 Statute Laws of The Bahamas. The articles of association are the internal rules of the company as they form the basis for much of the way the directors, the shareholders, and the company interact. Thus the core function of the articles is the allocation of power between the general meeting and the board of directors. However, the Companies Act 1992 and settled principles of common law have added supplementary provisions to enhance the operation and application of the articles of association. Thus subject to overriding statutory provisions and policy considerations, the members of a company are free to adopt whatever rules and regulations they wish to govern their relationship (including powers and duties of the board of directors), and these rules and regulations are contained in the articles of association, supplemented as necessary by any shareholder’s agreement. The memorandum of association on the other hand is an outward looking document addressed to the general public. It informs the general public of the company’s name, its share capital, the address of its registered office, the object of the company and a statement that the liability of its members is limited thus underscoring the principle of limited liability which flows from the principle of corporate personality.
Let us now examine the contract of membership in a company, which is embodied by provisions of section 11 of the Companies Act 1992, no doubt one of the most important provisions of our Companies Act. According to the provisions of section 11 of the Companies Act 1992:
"… Subject to the provisions of this Act, the memorandum and articles, when registered, bind the company and its members to the same extent as if they respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles."
The effect of the above provision is that it is a statutory contract, which was introduced to automatically bind the shareholders and the company together to observe the constitution of the company. See the case of Hickman v Kent or Romey Marsh Sheep-Breeder’s Association (1915) 1 Ch 881. Notice the unique nature of this odd contract created by section 11 of the Companies Act 1992. It is an odd contract as it can be varied without the consent of all the parties to it by special resolution and it is odd also in that it binds future members. For instance when new members join the company by buying shares, the constitution will automatically bind them to observe the pre-existing constitution. Hence, it obviates the necessity or possibility of renegotiating the rules every time a new shareholder arrives. One of the advantages of the above is that it facilitates the development of the share market as the shares are more transferable where they come with a fixed set of rights. Thus the legal relationship between the company and its members as well as the rights and duties created by the memorandum and articles of association must be viewed within the context of the statutory contract created by section 11 of the Companies Act 1992. The contract between the members of a company and the company itself which is created by the Companies Act 1992 section 11 embodies the contents of the company’s memorandum and articles construed literally in accordance with the normal rules for interpreting contracts and it follows that no additional terms may be implied by the court to give business efficacy to the contents of the memorandum or articles, nor can the courts hold that any of the provisions of the memorandum or articles are void or voidable for mistake, misrepresentation, undue influence or other invalidating cause. See Bratton Seymour Services Co. Ltd. v Oxborough (1992) BCLC 693. However, the court will not give effect to any of those provisions which conflict with the Companies Act 1992, or which are contrary to the law or public policy generally. See the case of Princess of Reuss v BOS (1871) LR 5 HL 176. In essence the memorandum and articles constitute a contract between the company and each member. Thus each member in his capacity as a member is bound to the company by the provisions in the articles. Furthermore, although s. 11 does not state that the articles bind the company to the members but only the members to the company, the company is regarded as bound to each member in his capacity as member to observe the provisions in the articles. Note further that the memorandum and articles are also by reason of case law a contract between the members themselves. Thus one member can sue another if that other fails to observe a provision in the memorandum or articles. There is no need to call upon the company to sue. See for example the case of Rayfields v Hands (1958) 2 All ER 194. But see the conflicting position of the court in the case of Quin & Astens Ltd. v Salomon (1909) 1 ch. 311 where Farewell LJ found that the contract was unenforceable between members against the seemingly more correct finding of Vaisey J in Rayfield v Hands (1960) ch 1 to the effect that there was a contract inter se which was directly enforceable by one member against another. It is suggested that the issue be clarified by allowing all rights in the constitution to be enforced against the company and the other members unless the constitution provides otherwise.
The complexity of this area of Company Law stems from the fact that when we talk of the question of enforcement of this statutory contract (created by section 11) in Company Law context – we are actually talking of whether the breach complained of is a wrong to the company or a wrong to the individual as far as the issue of a member wishing to enforce the contract against the company is concerned. Generally speaking, individual shareholders are not empowered to initiate proceedings for a wrong to the company. This is known as the rule in Foss v Harbottle (1843) 2 Hare 461. Only the company through its organ (the board or general meeting) can enforce such a wrong. However, if a shareholder is to be able to enforce the contract against the company directly, they must be trying to enforce a personal right. The following are a list of rights the courts have in the past considered personal in nature. These included:
- Voting rights
- Share transfer rights
- A right to protect class rights
- Pre-emption rights
- The right to be registered as a shareholder and obtain a share certificate
- The right to enforce a dividend that has been declared and to enforce the procedure for declaring the dividend
- The right to have directors appointed in accordance with the articles.
Note – Other procedural rights such as notices of meetings. Space and time will not permit us to discuss the above seriatim. See, however, the cases of MacDougal v Gardner (1875) 1 ChD 13 and Pender v Lushington (1877) 6 ChD 70.
Note also that the articles of association deal with many of the practicalities of running the business of a company. Primarily, they provide for two organs to operate the company – i.e. the general meeting and the board of directors. One of the greatest powers of the general meeting is contained in the Companies Act 1992 which gives members the right by simple majority vote (more than 50% of those who vote) for the resolution/to remove a director for any reason whatsoever. The board is given the power to run the business of the company and the power to decide whether to distribute any surplus profits to the shareholders in the form of dividends. Although technically the general meeting declares the dividends, however, it cannot do so unless the board recommends a dividend. But the right to a dividend and voting rights etc. are individual and personal rights not affected by the rule in Foss v Harbottle (1843). For instance, in Edwards v Haliwell (1950) the rule concerning voting at a union meeting was broken. Two individual members obtained a declaration invalidating a resolution. Jenkins LJ stated:
"The personal and individual rights of the membership of each of them have been invaded by a purported but invalid alteration… In those circumstances, it seems to me that the rule in Foss v Harbottle has no application at all, for the individual members who are suing sue not in the right of the union but in their own right to protect from invasion their own individual rights as members."
Thus some rights are personal and others not. But in all these, we hold strongly to the view that the court should not interfere in the internal affairs of the company. In private companies, where conflicts are likely going to arise and where some shareholders may be holding their shares via employment in the company, the tendency of one member being ousted from the board is often common. If the right of employment is not embodied in the article, the mere cessation of employment will automatically lead to the end of the member in active participation in the management of the affairs of the company. It is in this regard that members entering into joint venture business should further seek to protect their interest by shareholder agreements. Agreements between shareholders have become an increasingly common feature of Company Law. Shareholders agreements are agreements between shareholders themselves and this can be used to guarantee future and continuing participation in the management of the company, otherwise a member who was part of the subscribers of memorandum of association and had employment in the company can be removed from the company because employment is not a right via membership of the company and may not be covered by the contract of membership under section 11 of the Companies Act 1992. See Elley v Positive Government Security Life Assurance Co. (1861).
A share is a bundle of rights that can be bought and sold and entitles the shareholder to meetings, participation in sharing of dividends if and when declared, etc. In private companies like in public companies, holding a share does not entitle or guarantee the holder to participation in the management of the company. Even the right to sell and transfer shares is in most private company context subject to a right of pre-emption – i.e. offering the shares first to those other members of the company. A shareholder, as a result of his ownership of a share can also agree to exercise the rights attached to the share in a particular way. For example, shareholder A can agree with B that he will exercise his votes in favour of shareholder B if B stands for election to the board. It is also quite possible for shareholder A to agree to sell his shares to shareholder B only, should he decide to sell them. The shareholder agreement is no doubt a relatively easy way to achieve agreement and enforcement. Its other advantage includes the fact that it is private and one can easily identify who one would wish to transact with, eg. a large shareholder can transact with him only. A shareholder can therefore secretly contract to control the majority voting rights in a company without owning a majority of the shares. Note however that one of the disadvantages of a shareholder’s agreement is that it does not bind the new owner of the shares. Once a party to a shareholder’s agreement sells them on, the new owner has no obligations under the shareholder’s agreement. Therein lies the fundamental distinction between the way section 11 contract operates to bind future shareholders to the company’s constitution and shareholder agreement under which the new owner of shares has no obligations.
Note also that new articles can be drafted for member approval, which take into account the use of new technology, as follows:
- Notice of meetings of shareholders can be sent by e-mail;
- Voting on a poll can be done electronically;
- Proxies can be appointed by e-mail;
- Board meetings can take place through a series of video conferences or telephone calls from the chairman.
I take this opportunity to wish all my readers locally and internationally a happy Christmas and I do express my appreciation of all their support, comments and criticisms of this column. |
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