This article is based on UK law as at 1st February 2010, unless otherwise stated.
Anyone forming a company puts their name to two documents: a memorandum of association and articles of association. The former is now not much more than a formality; the latter comprises the company's constitution.
The memorandum is now a bald statement that the initial subscriber wishes to form a company and agrees to become a member by taking at least one share. Beyond that, it has no useful purpose.
Up until October 2009, it was all very different. Unlike a natural person, a company did not have complete freedom to do whatever its directors wanted. It was, instead, restricted to those things its memorandum, and more specifically the objects clause of its memorandum, said it could do. Anything else would be ultra vires, that is beyond its proper powers, potentially putting the directors who authorised the offending action in breach of their duties.
All that was swept away by the Companies Act 2006. Now, a company can do anything lawful – unless its articles say otherwise. (In some cases, there will be good cause to be prescriptive. Where a company is a charity, the objects will at least be restricted to a charitable purpose; where a joint venture company is formed, the parties may want to specify the purpose for which they have come together and funded the company.)
Two notes of caution:
The articles of association are a company's internal regulations or by-laws. They set out both the way the company is to be run and the rights between shareholders. It is the articles that deal with subjects such as the rights attached to each class of share, the quorum for a meeting and the way to transfer shares.
Companies legislation sets out a model form of articles for a private company and for a company limited by guarantee. The latest versions date from October 2009 and are shorter than the previous forms known as Tables A and C respectively. For the first time, there is also a model form of articles for a public company. All are drafted in plain English.
Tempting as it may be to use these model forms, they won’t suit every company. The private company articles, in particular, are designed for a small owner/manager enterprise and will not be right for larger companies with more complex ownership structures.
Many older private companies will often still be using the old Table A as the basis for their articles, with a few amendments to suit their particular circumstances. Public companies, by contrast, and some larger private companies, are more likely to dispense with all model forms and instead to set out the entirety of their articles in one bespoke document. Your articles can say whatever you want, subject to one proviso: you cannot go against the law. For example, the Companies Act says a company can only pay a dividend if it has distributable profits, and the articles cannot improve on that. Similarly, the right of shareholders to remove a director by passing an ordinary resolution must be upheld: the articles can make it easier to get rid of a board member; they cannot make it more difficult.
Stock Exchange or AIM traded companies must comply with certain rules as a condition of being quoted. And if the articles of a fully listed company have any ‘unusual features’, they must first be approved by the UK Listing Authority (that is, the Financial Services Authority). It’s often said that the articles are a contract between a company and its members. When you become a shareholder you do so subject to the terms of the company’s articles – now and in the future. You will have the opportunity to vote on any change, but once the vote has gone through, it will be binding on you, whether you agreed or not. The corollary is that a shareholder can go to court to stop a company acting in a way that is contrary to its articles – the ‘contract’ binds both sides. Just as you can put into your articles what you want, you can change them at any time – provided a special resolution is passed. (See: Company meetings, an OUT-LAW guide.) Changes, however, will be open to challenge if they cannot be justified as being in good faith or are partisan. If a majority of shareholders are motivated by malice and push through a change harmful to the minority, a court might overturn the change as not being in the interests of the company as a whole.
A company’s articles are a public document. They must be filed at Companies House. So they are not the place to put details that a private company might want to keep confidential – a financial return to be enjoyed by a shareholder, for example, or detailed voting arrangements. Shareholders in joint venture companies or in private equity investments might opt to keep these details private. A company’s articles, in other words, may not tell the whole story of the relationship between shareholders and their company – other documents, such as a shareholders’ agreement, might be needed for the full picture.
More detail about directots can be found in our guide on Company personnel, and information about their duties and responsibilities can be found in our guides on Directors' duties. Directors also have a major role to play in Corporate governance. But for now it’s worth highlighting one provision found in most articles (using here the wording from the new model articles): ‘the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company’.
That encapsulates the directors’ authority, the basis for the power they exercise. It protects them, and the company, from interference by shareholders in the day-to-day management of the company. If the shareholders do not like what the directors are doing, they can remove them or, less drastically, pass a special resolution giving them a particular direction. Or they can change the articles to limit the directors’ powers. Neither course of action is commonly seen in practice, though an implied threat by shareholders to remove directors can have the desired effect.
Just as shareholders effectively delegate the management of a company to its directors, those directors, acting together as a board, will be permitted by the articles to delegate day to day decision making to individual executive directors and to committees of the main board. Some committees may be a permanent feature, required by governance considerations – for example, remuneration or audit committees – others may be more ad hoc and formed to see through a particular deal or issue. (See: Board committees, an OUT-LAW guide.)
Delegation to individual executive directors, or to an executive committee may be by means of board resolution. Executives’ service contracts may also set out clearly what their duties are and what authority they have.