Articles of Association

Articles of Association. Where shareholders’ disputes begin and end.

Every company must have a constitution, a rulebook if you like; and, as you probably know, this rule book is called the Articles of Association or just the “Articles”.

Articles are fundamental to the peace of mind of a majority shareholder. As lawyers we are often accused of making things complicated, in this brief I explain why Articles are fundamental in straightforward terms.

Every majority shareholder has a duty not to unfairly oppress a minority shareholder. If he/she/it does, the most likely consequence is a court order for the minority to have its shares bought out by the majority at a fair price. Avoiding the costs and stress of that kind of order (as well as the worst excesses of such an order) is difficult, once a minority has been oppressed. An adverse order may be avoided if the majority surrenders to an independent valuation of the minority shares. However, there is almost no form of appeal to such a valuation and, believe it or not, reasons are rarely given in decisions by a valuer. Just because the valuation is high, and therefore hard for the majority shareholder or the business to fund, is bad luck. The financial burden of the decision is binding. This is why so many shareholder disputes end up at trial.

One way for a majority shareholder to avoid these risks is to get the company’s constitution right before letting a minority shareholder in. Good Articles will set out:

• The powers of directors, most notably the powers
  • To manage the business alone or
  • In board meetings, and
  • That are reserved to directors of the majority shareholder.
• The rights of shareholders, (almost always called Members’ rights) most notably
  • To appoint the board
  • To receive dividend
  • To agree a purchase of another business
  • To agree a sale of assets or shares in the business.
  • Which members receive surplus assets on a sale, or similar, and in which order.
• What happens if a minority shareholder leaves the business either as a director or employee. i.e. is he deemed to offer his shares for sale.

Good Articles cover a fourth subject:

• Disputes between shareholders including
  • Compulsory mediation
  • How a minority share is valued if the dispute cannot be resolved.

When an owner or a group of owners have total or very substantial control, that is the time to make sure the rulebook is written in their favour. So, the Articles should be reviewed before:

• appointing a director
• taking on new shareholders
• setting up a subsidiary
• buying a business or
• creating a Holding Company (most often for tax purposes).

Incidentally, in addition to getting the Articles right it’s really key for majority owners to have control of the bank mandate and who goes on it and how persons can be removed.

Some lawyers advise parties to make a shareholders’ agreement. They can help but, in my experience, these are rarely decisive. They are subject to negotiation and often drafted by the company’s lawyers at a time when no one is acting for either shareholder.

Restrictions carefully placed in Articles have three positive effects for a majority shareholder.

• They will limit a minority shareholder’s rights. For example, they may limit a minority shareholder’s right to vote on key aspects of the company’s business, or to appoint directors or receive dividends. A minority shareholder can’t easily complain that he is being treated unfairly if the majority shareholder is following the rules. Simply put, limiting rights adds to the majority shareholder’s power and limits the risk of dispute.
• The rules will subdue the value of the minority shares if ever a buyout is ordered, so limiting rights will limit any ultimate cost.
• The rules can govern how disputes are dealt with and the basis of a minority valuation.

Sadly, shareholder disputes are very common indeed. So, take a little time to reconsider the Articles of your company. It might save you a lot of sleep and a lot of money in the future and, if you feel you need any help on any shareholder issue including Articles, just call us.