Articles of Association and Shareholders’ Agreements

GALogosmallWhen you register a company, you must have articles of association. These are the rules about running the company that shareholders, officers, directors and company secretaries have to adhere to.
A shareholders’ agreement is an agreement entered into between shareholders of a company and regulates their relationship and actions.
The articles of association and the shareholders’ agreement should between them cover the most important, if not all, of the constitutional issues of the company and the day-to-day operation of the company.  This short article is intended to give an insight in to some of the key areas often covered by these two documents, some differences between them, and also how the two interact.
It is possible to include virtually anything you can think of in either the articles of association or the shareholders’ agreement. Some of the more common areas addressed in one or other of the documents include the following:-
.   The object and scope of the company
.   Procedures for calling and holding director and shareholder meetings and their respective powers within the company
.   Procedures for the issue and transfer of shares (including pre-emption rights and restrictions on transfer)
.   Procedures for the appointment and removal of directors
.   Funding or other contributions that are to be made to the company at the outset and in the future
.   Any agreed dividend policies
.   Any restrictive covenants that will be placed on shareholders and/or directors
.   Protection for minority shareholders by setting out things that can only be done with the consent of all shareholders
.   How to deal with any disputes or deadlocks between the parties
.   Confidentiality clauses

Professional advisors will often have different ideas about which areas should be covered in the articles of association and which in the shareholders’ agreement.  However, the truth is that the majority of areas (but not all) can be included in either document and it is a personal decision for the parties involved.
There are important differences between the two documents and these should be borne in mind when considering what information should go in which document.  A few of the key differences are as follows:
1. Articles of association are public documents and any member of the public is entitled, and able to, view their contents at any time. In comparison, the shareholders’ agreement is a private agreement between the parties involved and no third party has a right to view it. The articles of association, and any changes to them, must be registered at the Companies Registry as they are open to public inspection. The loss of privacy must be weighed against the advantage that third parties may be deemed to have notice of the articles of association.
2. Articles of association only require 75% of the shareholders to agree to vary the terms of the articles (subject to limited exceptions). A shareholders’ agreement would require 100% to agree to amend its contents. For this reason, minority shareholders often prefer to enter in to a shareholders’ agreement for peace of mind.
3. Articles of association are governed by statutory law and there is a comprehensive body of company law that governs how a company should be run. Therefore the articles must comply with this law. On the other hand, shareholders’ agreements are governed by contract law and so can contain almost any private arrangement the parties wish to formally agree; like any other contract. This difference also has a major impact when it comes to remedies or enforcement options where a party breaches either document. A breach of the shareholders’ agreement gives rise to contractual remedies, notably damages (which may be difficult to quantify). An action breaching the company’s constitutional documents is, as a general rule, invalid. For example, a transfer of shares to a third party in breach of pre-emption requirements in the articles of association is likely to be held as invalid.
4. New shareholders in the company are automatically bound by the articles of association when they buy shares in the company. However, they are not automatically bound by the shareholders’ agreement. Therefore, if the identity of the shareholders (or a section of them) will change frequently, to avoid having to keep re-executing the agreement, the important provisions which are intended to bind all of the shareholders should be included in the articles of association.
It is important to avoid conflicts between the two documents. Either document can prevail depending on the stated intention of the parties. In practice, it is common to provide that the shareholders’ agreement will prevail and this will be enforceable as between the parties.  This is largely because in practice, parties tend to spend more time drafting and negotiating bespoke terms for a shareholders’ agreement.
In summary, in most companies it is preferable to have a shareholders’ agreement in addition to the articles of association and careful consideration should be given to the contents of both. However, their contents, the importance of them and the level of detail required will vary hugely from company to company.
One final point, and quite possibly the most important, is to remind all parties that they must be fully aware of their rights and obligations under the articles of association and the shareholders’ agreement at all times. It is surprising how many times these are only reviewed when things go wrong!

If you would like more information regarding articles of association and/or shareholders’ agreements please email James via james.peterson@gillakaster.com or call on 01752 203520.

 

 

 

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