The articles of association are the rules and regulations of a company framed for the purpose of internal management of its affairs. The articles of association of a company are subordinate to and are controlled by the memorandum of association.
Lord Cairns observed in this regard “The memorandum as it were the area beyond which the action of the company cannot go; inside that area the shareholders may make such regulations for their own government as they think fit”.
Section 12 of that Act provides that the articles shall be:-
(a) In English language
(c) Divide into paragraphs numbered consecutively, and
(d) Signed by each subscriber to the memorandum in the presence of at least one witness, who shall attest the signature and add his occupation and postal address.
Contents of the Articles:
- Adoption of preliminary contracts
- Number and value of shares
- Allotment of shares
- Calls on shares
- Forfeiture of shares
- Alteration of capital
- Share certificates
- Conversion of shares into stock
- Voting rights and proxies
- Directors and their appointments
- Accounts and audit
- Winding up
Section 13(1) provides that a company may by special resolutions alter or add to its articles. Section 13(2) provides that any alteration or addition so made in the articles shall subject to the provisions of this Act, be as valid as if originally contained therein.
Limitations on Power to alter Articles
The following are the legal restrictions on a company’s power to alter its articles:-
(a) The alteration must not be inconsistent with the provisions of the memorandum. This means that an alteration to include a clause, which contravenes a provision in the company memorandum, is of no effect.
(b) Under section 13(1), an alteration which contravenes a provision in the Act is null and void. For example, articles cannot authorize a company to purchase its own shares.
(c) The alteration of the article must be made in good faith for the benefit of the company as a whole.
(d) The alteration of articles must not constitute a fraud on minority.
(e) Section 24 provides that no member of a company shall be bound by an alteration made in the articles after the date on which he became a member if and so far as the alteration requires him to take or subscribe for more shares than the number held by him at the date on which the alteration was made, or in any way increases his liability as at the date to contribute to the share capital.
(f) An alteration in the articles which causes a breach of contract with an outsider will be inoperative.
(g) The alteration must not sanction anything which is illegal.
Legal Effect of Articles
Section 22 provides that the article shall, when registered, build the company and the members there of to the same extent as if they respectively had been signed by the company and by each member, and contained covenants on the part of each member, to observe all the provisions of the articles.
The effect of these provisions is to constitute through the articles of a company a contract between each member and the company. The effect and the implications of this section may be appreciated by considering how the articles bind:-
(a) Members to the Company
Each member of the company is bound to observe the various provisions of the articles as if he had actually signed the same.
Case Law: Hickman vs. Kent (1957)
The articles provided for the reference of disputes between a member and the company to arbitration, if a share holder brought an action in court against the company in connection with a dispute between the company and himself in his capacity as a member. It was held that the company was entitled to have the action stayed, as the articles amounted to a contract between the company and Hickman to refer such disputes between them to arbitration.
But a dispute between the company and a director in his capacity as a director would not be within the terms of such articles even if the director was also a member (Beattie vs. E & F. Beattie Ltd, 1938).
(b) Company to the Members
The company is bound to the members by the various provisions contained in the articles. The company can exercise its rights as against any member only in pursuance of and in accordance with the articles. Any member is entitled to sue the company to prevent any breach of articles which would affect his rights as a member of the company. Thus where a right is conferred by the articles on a shareholder to vote at a company meeting, the chairman of the meeting cannot deprive him of his right.
Case Law: Wood vs. Odessa Water Works Co. (1889)
The articles of association of the defendant company provided that “the directors may, with the sanction of the company at a general meeting, declare a dividend to be paid in cash to the members”. Instead of paying cash dividend to the shareholder, an ordinary resolution was passed to give them debenture bonds. The plaintiff, a member sued the directors for acting on the resolution. The directors were restrained from acting on the resolution on the ground that “to be paid” mean to be paid in cash and the debenture bonds proposed to be issued were not payment in cash.
The articles provide that the directors may with the sanction of a general meeting declare a dividend to be paid to shareholders, prime facie that means to be paid in cash.
(c) Members Inter-se
Articles do not constitute express agreement between the members of the company. Yet each member of the company is bound by the articles on the basis of implied contract to the other members. The articles regulate the rights of the members’ inter-se but such rights can be enforced only through the company.
Case Law: Ray field vs. Hands (1960)
Article II of the articles of association of Field-Davis Ltd provided: “Every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at a fair value. Ray field, a member, sought to compel the defendants, the three directors of the company to purchase his shares in accordance with this provision. The court declared that they were bound to do so. The relationship here is between the plaintiff as a member and the defendants not as directors, but as members.
(d) Company to Outsiders
Articles do not constitute any contract between the company and an outsider. An outsider is not entitled to enforce the articles against the company for any breach of right that is conferred on him by the articles.
Case Law: Eley vs. Positive Government Life Assurance Company (1876)
The articles of the company provided that Eley should be a solicitor of the company for life and should not be removed from his office except on account of misconduct. He was also a member of the company. Eley acted as a solicitor of the company for sometime but ultimately the company discontinued his services without any allegation of misconduct. He sued the company for damages for breach of the contract.
It was held that the action was not maintainable because the right which he attempted to enforce was conferred upon him in a capacity other than of a shareholder.