Is your company’s constitution fit for purpose?

A common theme which is shared among many business owners and directors in the UK, operating as a private limited company, is that they often have no idea what their company’s constitution contains, let alone where to find it.

A company’s constitution contains the governing rules on how a company can operate. It primarily includes the ‘Memorandum of Association’, which is adopted when the company is incorporated with its initial shareholders, and the ‘Articles of Association’ which specify how a company must be run, governed and operated.
What requirements are there for companies?

It is a statutory requirement that all registered companies have Articles of Association, and in the absence of a company adopting bespoke Articles, a set of default Articles, known as the ‘Model Articles’ apply. The Articles of Association are a public document, and can be found on the Company’s online file at Companies House.

In addition, the Shareholders may enter into a ‘Shareholders Agreement’ to supplement the Articles, which contains details about the running, governance and ownership of the company that they may want to keep out of the public domain. Unlike the Articles, the Shareholders Agreement is a private document, as there is no requirement to file it at Companies House.

From a practical perspective, both shareholders and directors must operate within the scope of the company’s constitution. In particular, during their management of the company, directors are under a general duty to ‘act within powers’ which requires them to specifically comply and make decisions in accordance with the company’s constitution. Despite this, we often come across situations where directors have unknowingly been acting outside of the authority of the Articles. The reason for this: they are unaware what their company’s constitution contains.

What are the consequences of not registering your company correctly?

The consequences of breach of directors’ duties can be severe. Remedies can include an award of damages in respect of any loss the company has suffered, and also the setting aside of the transaction, restitution and account of profits. Breach of directors’ duties may also be grounds for the termination of a director’s service contract or disqualification as a director. In some circumstances a company’s creditors or shareholders could potentially having the right to pursue directors personally for any losses they have suffered.

How can companies avoid these consequences?

In order to avoid this, both directors and shareholders should re-familiarise themselves with the company’s constitution. The Articles can be obtained from Companies House, and the shareholders themselves should be able to confirm if any supplemental agreements, such as Shareholders Agreements, have been entered into.

In addition, a review should be undertaken to ensure that the company’s constitution is still fit for purpose in the context of its current operations and structure. Key provisions, such as those relating to the transfer of shares should be considered to ensure that they are adequate in the context of the current shareholders, or whether any bespoke provisions need to be adopted to deal with special or unusual circumstances. For example, it is often the case that customised pre-emption provisions are included in either / both the Articles and the Shareholders Agreement which provide that sale shares must be offered to the existing shareholders first, before being offered to unrelated third parties. This provides the shareholders with control as to who holds shares in the company. Other bespoke provisions, amongst other issues, relate to board and shareholder decisions, the transmission of shares on death, and the forced sale of shares in an exit situation.

For further information about this topic, please get in touch info@ts-p.co.uk