THE ARTICLES OF ASSOCIATION AND SHAREHOLDER’S AGREEMENT

[Excerpts from Mr Chigbo’s recent book…"Company Law and Practice in the Bahamas "]

Section 9 of the Companies Act seems to create the impression of the existence of contract and shareholders’ agreement.  But see the case of Bushel v Faith (197)) AC 1099.  While Companies often have very complex organizational structures, hoever, at the core of every corporate structure is the Articles’ allocation of power between the general meeting and the board of directors.  It is this allocation of power that is the core function of the articles of association.

Sections 70 to 83 of the Companies Act 1992 deal with the general meetings, setting out procedures for meetings and voting at meetings.  Sections 84 – 105 deal with the office of the  directors providing for the appointments, meetings, duties, termination, resignations, removal, delegation of  their duties, etc.  For instance Section 92(1) of the Companies Act, 1992 provides that:

The members of a company may by a resolution at an extraordinary general meeting, remove any directors from office.

also provides that:

A director of a company shall cease to hold office when

(a)        he dies or  resigns
(b)        he is removed in accordance with Section 92 (mentioned above) or
(c)        he becomes disqualified under Section 87 or 88.  Sections 87 and Section 88 deal with disqualified director e.g. a person being disqualified and hence prohibited by (Section 3(2) of the Companies Act, 1992 i.e. to the effect that no person who is under the age of majority [ie a minor] or has been found to be of unsound mind by a tribunal in The Bahamas or elsewhere, or is an undischarged bankrupt, may join in the incorporation of a company under the Companies Act, 1992.  Section 88 of the Companies Act, 1992 deals with Directors disqualified by Court i.e. to the effect that the Registrar may make an application to the Court that a person is unfit to be concerned in the management of a public company – the Court may order that that individual may not be a director of the company or, in any way, directly or indirectly, be concerned with the management of the company.  This may occur as a result of the person undergoing a term of imprisonment or/and where the person has been adjudged a bankrupt.

Section 92 which gives members the right by simple majority at an extra ordinary general meeting to remove a director for any reason whatsoever is a significant power of the general meeting.  The general meetings role, at least in theory, is to act as a residual control on the board by meeting once a year and checking on the performance of the board.  See Sections 70 and 71 of the Companies Act, 1992 which provide for general meeting and extraordinary general meeting. The primary power wielding organ is, however, the board, i.e. the board of directors:  Section 84 provides:

Subject to any unanimous shareholder agreement the directors of a company shall –

(a) exercise the powers of the company directly or indirectly through the employees and agents f the Company; and

(d) direct the management of the business and affairs of the company.

Hence, subject to the provisions of the Companies 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 the articles.

Most problems that often arise in private companies stems from a lack of clear understanding of the important significance of the provisions of section 11 that seem to create what is commonly referred to as a statutory contract among the shareholders inter parties and with the company as well.  This is called the section 11 contract or as in English law the section 14 contract.  See section 14 of the English Companies Act 1985.

The rather odd statutory contract 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 March Sheep-Breeder’s Association (1915) 1 Ch. 881.

It is an odd contract as it can be varied without the consent of all the parties to it by special resolution and also binds future members.  When new members join the company by buying shares, the constitution will automatically cause them to observe the pre-existing constitution.  As such, it removes the possibility of renegotiating the rules every time a new shareholder arrives especially with respect to public companies.  This no doubt facilitates the development of the share market as the shares are more transferable where they come with a fixed set of rights. It is this statutory contract and the question of of participation in the management of the company and the incidental issue of minority protection that have remain  discombobulating to company law practioners in advising their clients in small and close-nit companies that shareholders form with expectation of continuing participation in the management of the companies and with expectation of using the company as a means of employment.  Practioners have often failed to advised their clients that being a shareholder in a company does not guarantee continuing participation in the day to day business of the company.  They failed to advised on the effects of shareholding and the possibility of being excluded from management position in the company albeit while one remains a shareholder in the company.  The amount of shares a shareholder holds in the company plays a critical role in this context.  Hence the concept has been referred to as the doctrine of corporate democracy.

Principle of Corporate Democracy

It has been suggested that only the company can sue for a wrong done to the company.  This is not as easy as said above:  This will likely lead to some complex issues in company law and will be discussed elsewhere.  Suffice it to say that the fundamental question for determination remains whether the wrong or breach complained of is a wrong to the company or a wrong to the individual?  This concerns a central aspect of company law i.e. majority rule.

As a general rule however, individual shareholders are not empowered to initiate proceedings for a wrong to the company.   See Companies Act, 1992.  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.

If a shareholder is to be able to enforce the contract against the company directly, they must be trying to enforce a personal right.  Lord Wedderbum (1957) in an article on Foss v Harbottle (1843) set out a list of rights the courts have in the past considered personal in nature.  These included:

See also the case of Edwards v Haliwell.  This area of Company Law is beset with some degree of confusion.  But see the divergent views in the case of  MacDougal v Gardner (1875) 1 Ch D 13 and Pender v Lushington (1877) 6 Ch D 70.

In Elley v Positive Government Security Life Assurance Co (1876) 1 Ex D 20 the articles contained a clause that ensured that a particular member of the company was appointed as the company’s solicitor.  The member was not appointed as the company’s solicitor and sued for breach of contract.  The court found that he could not rely on breach of that clause in the articles as the cause of his action, as there was no contractual relation between the member as solicitor and the company.

Note also the concept of shareholders’ agreement which may be in the nature of agreements between shareholders themselves (that is, all of the shareholders or just some of them) or between the company and shareholders (that is all of them or just some of them).

The agreement usually concerns the exercise of power in a given situation.  For example, to only allow an increase in the authorized share capital of the company if all the parties to the shareholders’ agreement agree, or to exercise votes at the general meeting in a particular way.  The key advantage of a shareholders’ agreement is that it is easily enforceable against another party to the agreement (see the case of Puddephatt v Leith (1916) Ch 200).

In small to medium-sized companies, it is also common to add the company to the agreement for security.  Companies may however be limited in what they can agree to do.  For example, in Punt v Symons & Co Ltd (1903) 2 Ch 506 the court held that a company could not contract out of the right to alter its articles.  (See Section 29 Companies Act, 1992).  This means in effect that a provision of a shareholders’ agreement that binds the company not to alter its articles will not be enforceable, but see a seemingly contradictory decision in the case of Russell v Northern Bank Development Corporation (1992) BCLC 431 where the House of Lords considered a shareholders’ agreement where the company agreed not to increase the share capital of the company without the agreement of all parties to the shareholders’ agreement.  The company did attempt to increase the share capital of the company and one of the shareholders who was a party to the shareholders’ agreement objected and attempted to enforce the agreement.  The statutory conflict here was between the agreement and C.A. 1985 section 121 ( U.K. ) that allows companies to increase their share capital if their articles contain an authority (see the Companies Act).  The articles of the company did provide for such an authorization.  The House of Lords found that the company’s agreement not to increase its share capital was contrary to section 121 and, therefore, unenforceable.  However, the court did not declare the whole shareholders’ agreement invalid, just the company’s agreement not to increase the share capital.

This meant that the shareholder who objected could not enforce it against the company but could enforce it against the other members.  As all the members of the company were party to the shareholders’ agreement this has the same effect as if the company was bound.  The shareholders could not vote to increase the share capital      

It should be noted that shareholders’ agreement are a useful way for shareholders to create more certainty about the enforceability of certain rights they have agreed to.  The courts have long recognized this and have been willing to enforce such agreements.  Complications occur where the company is joined as a party to the agreement, as it may not be able to limit its activities where a statutory provision is at issue.  However, we always advise clients in a small, close-nit or family company/business to use the instrumentality of a shareholders agreement to secure a better protection of their interest in the company especially where they intend to participate in the management [or day to day running] of the company or where they anticipate using the company as a means of employment.  Where such shareholders agreement exist and any issue subsequently arises, the determination of such issues will be based by reference to not only the ordinary principles of company law and the constitution of the company [ie the articles and memorandum of association], but also be a reference to the shareholders agreement in determination of the rights and duties of parties in the event of future conflict or disagreement.

Clement Chigbo, lawyer and chartered arbitrator practices as a registered associate with the law firm of CF Butler & Associates, Nassau , The Bahamas.  He is currently a tutor and doctoral/PhD candidate at the university of Aberdeen , U k.  Opinions, comments and criticisms and suggestions on his articles are welcome. He may be contacted at lawscholar2006@yahoo.com, clemsweiss@hotmail.com