The purpose of a company's articles of association
A company's articles of association (Articles) set out the rules that the officers of the company must follow.
Every company must have a set of Articles and can choose to have a bespoke set of Articles tailor-made to the specific company or use the 'Model' Articles, which are a set of standard Articles prescribed by the Companies Act 2006.
The Model Articles cover a range of topics such as:
- The appointment and removal of directors;
- The powers of directors;
- The decision making of shareholders;
- The issue of shares;
- The payment of dividends; and
- The winding up of the company.
Whilst the Model Articles can be useful for simplicity and are cost-efficient, they are commonly not appropriate for many companies, particularly as a company grows and circumstances change.
Common scenarios where the Model Articles are inadequate
Many companies have specific needs that the Model Articles do not meet.
There are innumerable scenarios where the Model Articles are not sufficient.
Below are some common examples where this is the case.
Multiple classes of shares
Suppose a company proposes to allot shares to a new shareholder or investor.
In that case, it is common for the company to want to give the incoming shareholder different voting and dividend rights to protect the power balance in the company.
The Model Articles only provide for one class of share, with equal rights.
Separate classes of shares can be created which confer different rights to dividends, capital and voting.
See our previous blog post on different share classes and 'alphabet' shares here: The ABCs of Alphabet Shares
Sole director companies
Recent case law has raised doubt as to whether the Model Articles are suitable for companies where there is a sole director in place.
Model Article 11(2) provides that the 'quorum' for a directors' meeting must never be less than two.
A quorum is the minimum number of directors required to attend a directors' meeting in order for decisions made at the meeting to be valid.
This article is contradicted by Model Article 7(2), which states that if a company only has one director, then that sole director has the power to make decisions on behalf of the company.
Until judicial clarity is received, the safest approach is to amend the provisions of the Model Articles if the company has a sole director.
You can read more about this in detail in a blog post we published: Model Articles and Sole Directors – A Warning Note
Pre-emption rights
Pre-emption rights give existing shareholders the right to purchase new shares that are being issued by a company.
This means that if a company wants to issue new shares, they must first offer them to their existing shareholders in the same proportion as their current holding before they can offer the new issues of shares to a third party.
The purpose of pre-emption rights on the issue of shares is to
protect existing shareholders from dilution, where each share will
represent a smaller percentage of the company's equity.
Under the Model Articles and the Companies Act 2006, the
pre-emption rights on a fresh issue of shares is an automatic
right.
However, this provision can be removed in its entirety, or if
multiple classes of shares are in issue, prescribed as a right for
certain classes of shares only.
There are no pre-emption rights relating to a transfer of shares
under the Model Articles, meaning a shareholder can transfer their
shares to whomever they wish at any price.
It is common to require increased control over this by including specific provision in the Articles.
For example, a requirement to offer the shares to be transferred to a company's current shareholders first or any transfer to be at market value.
How to amend your company's Articles
To amend the Model Articles, shareholders must vote and pass a special resolution approving the new Articles and make the appropriate filings with Companies House by the prescribed deadline.
A special resolution means a majority of at least 75% of the company's shareholders must vote in favour of adopting the new Articles.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.