The Articles and Shareholder Agreements

Question 1

Which section states the nature of the articles as a contract between the company and its members?

Answer 1

s33 CA 2006

Question 2

s33 CA 2006?

Answer 2

A company’s articles constitute a contract which is binding on the company and the members themselves:

“The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions.”

Question 3

What is the general rule?

Answer 3

Usual rules of contractual interpretation apply there are some important exceptions

Question 4

Important differences of articles to normal contractual interpretation?

Answer 4

• Cannot imply terms from extrinsic circumstances (Bratton Seymour Service Co [1992])
• Court has no power to rectify articles (Scott v Frank F Scott Ltd [1940])
• As long as the article in question is clear and unambiguous and not ‘commercially absurd’, the court will not interfere to rewrite the article, even where the outcome is “improbable”

Question 5

Sugarman v CJS Investments LLP [2014]?

Answer 5

Held that the literal interpretation of an article which gave each member of a housing management company one vote regardless of the number of shares held (which correlated to the number of flats leased) had to be applied, even though the effect of this was that a member with one flat had the same voting power as another member with 66 flats.

Question 6

Case for terms to be implied where necessary for proper construction of the Artciles?

Answer 6

Equitable Life Assurance Society v Hyman [2002]

Question 7

Equitable Life Assurance Society v Hyman [2002]

Answer 7

Lord Steyn held that the articles should be read as containing an implied term that the directors would not exercise their discretion ‘in a manner which deprived the guarantees of any substantial value’

Question 8

Can the member sue/be sued by the company?

Answer 8

YES
General principle is that any member has the right to enforce the terms of the articles against the company under s 33, and the company is also under s 33 entitled to enforce and restrain breaches of the articles against its members.

Question 9

Wood v Odessa Waterworks Co (1889)

Answer 9

• Articles allowed the directors, with the sanction of the shareholders, to declare a dividend ‘to be paid’ to the shareholders.
• Company passed an OR proposing to pay no dividend but instead give the shareholders debenture-bonds.
• On the application of a shareholder, the court granted an injunction to prevent the company from acting on that resolution as it was inconsistent with the articles.

Question 10

Pender v Lushington (1877)

Answer 10

Where an individual member’s rights have been infringed that member may bring a personal action to enforce those rights even where the conduct complained of may also constitute a wrong to the company itself.

Question 11

In what type of capacity do articles create a contract between the company and the members?

Answer 11

Only create a contract between the company and the members in their capacity as members, and not in any special or personal capacity. They also do not give any rights to a person who is not a member.

Question 12

Eley v Positive Government Security Life Assurance Co Ltd(1876)

Answer 12

FAILED as E was seeking to enforce rights under the articles in his capacity as a solicitor (an outsider), which was not possible because he had no standing to do so.
The articles can only be enforced by shareholders (insiders) in relation to shareholder specific rights.

Question 13

Can members sue each other?

Answer 13

A member may sue another on the contract created by the articles without joining the company as a party.

Question 14

Case for members being able to sue one another on the Articles?

Answer 14

Rayfield v Hands[1960]

Question 15

Rayfield v Hands[1960]

Answer 15

Articles provided that any member who intended to transfer shares was bound to inform the directors “who will take the said shares equally between them at a fair value…”
R was a member who brought an action seeking to compel the defendants (the three directors of the company, who were also members as required by the articles) to purchase his shares in accordance with this provision of the articles.
The court declared that the defendants were bound to purchase the shares.

Question 16

What is a shareholders agreement?

Answer 16

A contract entered into between the shareholders.

Question 17

Advantages of shareholders agreements over Articles?

Answer 17

1) Normal contractual rules apply, so unlike the articles (which can be altered by special resolution – s 21 CA 2006), a shareholders’ agreement can only be altered if all shareholders agree.
2) The provisions of a shareholders’ agreement may also be enforceable by injunction.
3) Private agreement – contrast the articles which are a public document, registered at Companies House.

Question 18

Effect of a shareholders agreement?

Answer 18

Although a company cannot bind itself not to exercise its statutory powers, an agreement not to do so by shareholders is binding

Question 19

Case for shareholders agreements being binding on the shareholders but not on the company itself?

Answer 19

Russell v Northern Bank Development Corpn [1992]

Question 20

Main disadvantage of a shareholders agreement?

Answer 20

Binding only on those shareholders who signed up to it, and not anyone who takes a transfer of shares or joins the company as a new member on a new issue of shares at a later date.

Question 21

How can you get round the SHA only binding those who originally signed up for it?

Answer 21

Often dealt with by requiring the new shareholders to join an existing shareholders’ agreement by executing a “Deed of Adherence”.