The Articles of Association of a company ("Articles") are a key constitutional document which every company is required to have in place on incorporation and throughout its existence. Articles lay down the framework of how a Company is to be governed. Companies can opt to use standard, untailored Model Articles of Association[1]. However, where there is, or there is likely to be, more than one shareholder it is important to consider the rights and responsibilities of those shareholders and ensure that the Articles correctly reflect how the company is to be governed. Shareholder rights and responsibilities stem from a variety of areas, including the Companies Act 2006, the Articles and any Shareholders Agreements (or similar) that may be entered into – this blog will discuss the importance of tailoring a company's Articles appropriately.
Protecting Shareholder Rights
Tailored Articles play an important role in safeguarding shareholder rights and can provide a framework for fair decision making within a company. It is possible for a company to have different classes of shares (e.g. "A ordinary shares" and "B ordinary shares"). By outlining the rights and privileges associated with different classes of shares in the Articles, the parameters of shareholder involvement can be established from the outset. This can include specified voting rights or different dividends entitlements attached to each share class.
Individual shareholders can also be designated the right within the Articles to appoint a director to the Board of the company. This can allow certain shareholders to maintain a certain level of control over the make-up of the board but will only be possible if it is clearly stated within the Articles (or Shareholders Agreement, as discussed later in this blog).
With standard Model Articles, all shares will have equal rights when it comes to matters such as voting or distribution of dividends, so it is important to consider this point in line with the specific intentions of the shareholders and directors.
Defining Roles and Responsibilities
Shareholders can be assigned specific obligations under the Articles – creating a form of contract between each shareholder and the company, as well as each shareholder and the other shareholders.
Shareholders are required by the Companies Act 2006 to vote, or to decide not to vote, on resolutions of the company. This can include approving significant changes such as the removal of a director or amendment of the Articles. Decisions such as these can be voted on at a shareholder meeting (referred to as General Meetings) or by Written Resolution where appropriate. If the Articles of a company are not tailored, the default position will be that all shares will carry the right of one vote per share. This may not represent the intentions as to how the company is to be run and should be considered when incorporating a company (or by anyone intending to take up shares in a company). For example, it may be the intention that shares be issued that do not carry any voting rights (such as those issued to certain employees) or even that some shares have enhanced voting rights.
The roles of shareholders can be as specifically or as generally laid out in the Articles as required, but it is important to consider any potential impact from the outset and to bear in mind that as the business grows, the needs of the business and the arrangements between shareholders are liable to change. It is a common issue for private companies to be incorporated or to introduce additional shareholders (often employees) and fail to consider amendments that may be required to the Articles to cater for this and that can lead to problems further down the line.
It is possible to amend or replace Articles. However, it is important to note that to amend or replace Articles, the standard position is that a 'Special Resolution', being the approval of the holders of 75% of the issued shares will be required (meaning amendments that are not approved of by this majority will be blocked).
Conflicts
Shareholder disputes can arise for a number of reasons. Some shareholders may disagree with the decisions made by directors on company affairs, or even disagree with other shareholders on the best route to take. Minority shareholders can feel as though their best interests are not adequately considered, and personal disputes – particularly where shareholders are family members – can lead to decisions being blocked. These issues can erode trust among shareholders and result in internal conflicts that negatively impact the company's performance.
Articles can outline how decisions are to be taken and may even set out specific mechanisms for resolving shareholder disputes (although that may more regularly be set out in a Shareholders Agreement and, on that, see below). Establishing clear procedures for dispute resolution, although not always appropriate, can help prevent conflicts from escalating and encourage shareholders to seek amicable solutions.
Exits and Shareholding Changes
For most companies, the shareholders / shareholdings will change over time. This can include shareholder 'exits', where they transfer their shares and cease to be a shareholder (which can be particularly significant if it is the majority shareholder deciding to sell their interests), or when new shareholders come onboard, either by buying or being allotted shares.
Tailoring provisions within the Articles to facilitate a smooth exit of a shareholder, or to ensure a clear understanding as to how new shareholders can join the company, is a measure that ensures the continued stability of the company. Implementing clear and well-defined mechanisms, such tag-along and drag-along rights, pre-emption rights and good/bad leaver provisions can regulate the process of a shareholder's departure and give comfort to the remaining shareholders.
Tag-along and drag-along rights provide mechanisms for minority shareholders to join a majority sale share or to force minority shareholders to sell, respectively, helping to ensure fairness and unity in exit transactions in cases where the majority shareholders wish to transfer control of the company.
Pre-emption rights (on allotment) can grant existing shareholders the ability to maintain their proportional ownership by ensuring the opportunity to acquire new shares to be issued before they are offered to external parties.
Pre-emption rights can also apply on a proposed transfer of shares – by providing that if a shareholder wishes to transfer shares then they must first be offered to existing shareholders (or certain of them) to purchase, or to the company itself to buy back. Some transfers can be explicitly exempt from pre-emption rights, for example if the articles allow for the permitted transfer of shares between family members. It is also possible to provide that shareholders require to offer their shares for transfer in certain circumstances (such as their ceasing to be involved with the running of the company / being an employee or director, becoming bankrupt / entering liquidation or even on death).
Without specifically including a provision that requires shares to be offered round in certain circumstances, that would not apply (noting that there are certain pre-emption on allotment rights in the Companies Act 2006[2]). So, for example, an employee who takes up shares in a company but who then resigns as an employee to join a competing business would likely be able to hold on to their shareholding (which may not be what the remaining shareholders would wish) unless agreement can be reached separately with them.
Good leaver/bad leaver provisions outline the circumstances under which a departing shareholder is categorised as a 'good leaver' or a 'bad leaver', each triggering specific consequences. A good leaver may be entitled to receive the 'fair value' of their shares or enjoy favourable buyback terms. Bad leaver provisions may come into play when a shareholder leaves for reasons considered detrimental to the company, such as a breach of contractual obligations or competition with the business. Bad leaver provisions often result in a less favourable share valuations. These provisions not only incentivise commitment to the company but also provide a structured framework for handling exits, helping to maintain stability of the company.
By tailoring these provisions to the unique needs of the company and its shareholders, the Articles create a structured framework for shareholder changes, mitigating potential conflicts and disruptions.
Shareholder or Investment Agreement
It is important to note that Articles are publicly available online at Companies House. While some may wish for all rules governing the shareholders to be within the Articles and to be accessible to all, it may be appropriate for some regulations to be within a specific Shareholder or Investment Agreement.
Shareholder or Investment Agreements are specific contracts drafted to regulate the rights and obligations of shareholders and the company. These would be a private document entered into between the parties and would not require to be registered at Companies House unless they affected the Articles. It is possible to amend the agreement going forward with the agreement of the parties to that document, and it is generally a requirement that all incoming shareholders adhere to the agreement.
Conclusion
It is important to consider the Articles of your company and the role that they play in governing shareholder actions and relationships. Clearly defining rights and responsibilities of shareholders is important to ensure that the company is run as intended, to also minimise any potential disputes and to help ensure the continuity of the business. Shareholder or Investment Agreements are also an option to address these matters, and your solicitor will be able to advise you whether tailored Articles or a Shareholder Agreement (or both) is the best option for your company, discussing the pros and cons for the specific needs of your company.
How Brodies Can Help
If you would like to discuss anything raised in this blog in more detail, please get in touch with a member of the corporate and commercial team or your usual Brodies contact.
[1] The Companies (Model Articles) Regulations 2008
[2] Section 561 Companies Act 2006
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