Private company articles of association

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Private company articles of association

Standard articles downloaded upon company incorporation risk various disputes arising which could damage the profitability of your company and result in costly litigation. We work with founders, investors and new shareholders across a range of sectors to enshrine protection in the articles to stop disputes arising.

We specialise in working with private companies, family businesses and owner managed businesses, understanding the personal relationships and delicacies behind each business’s management.

The options available when drafting articles of association

The options open to you will depend upon the split of shareholder voting power and your role. We have picked out some situations where we have implemented bespoke articles to address specific concerns of the founders, investors or new shareholders.

I do not want to offer shares to all shareholders

You will be forced to offer new share issues to all shareholders unless you have implemented changes to dis-apply the rights given to all shareholders by law. Dis-application of rights (often called pre-emption rights) is a common area for review and adaption in model articles.

If you use the model articles supplied without amendment, the existing shareholders of the company will be able to block any issue of shares where the shares have not been offered to the existing shareholders pro-rata to their shareholdings. This can prove to be a big problem for the founders and investors when seeking to grow the business.

Articles of association: I do not want to treat all shareholders equally

All shareholders with the same class of shares have to be treated equally with regard to dividend, voting and capital rights. This means, for example, that you have to vote the same dividend to the same type of shares – if you only have one class of shares owned by people who should receive different rates of dividends you have a problem.

If you want to differentiate between shareholders you will need to create separate share classes and set out the rights in the articles. Standard articles do not deal with different share classes.

If you ignore the articles you may face costly and time consuming court claims from aggrieved shareholders, exposing the company to unwanted public exposure, and in turn diminishing share value – we help you avoid this be preparing bespoke articles with different share classes to reflect the various roles that shareholders can play in the business.

Advising on privacy in the articles of the association

The articles are a public document open for all to see. If you want to keep the governance of the company private you will need to include provisions in a shareholders agreement which is a private agreement not accessible to the public. We can advise you on what has to be included in the articles and what can be reserved for a shareholders’ agreement.

Advising on conflicts between the shareholders agreement and articles of association

We are often instructed to advise shareholders or founders where the articles conflict with the shareholders’ agreement. Once the agreements are in place it can be difficult to change them if that right has not been reserved – this is something we think about for you to avoid unwanted issues later down the line. A shareholders’ agreement can provide for a streamlined exit procedure for shareholders, saving the management team time and hassle in the event of a disagreement.

New regulatory rules impose requirements on private companies to prepare and submit a public register detailing the shareholders of the company. This is to provide shareholder transparency. This requirement can be onerous. The document is public, and a shareholders’ agreement can be the key to keeping the management of the company from out of public sight.

Limiting dilution in the articles of association

How you go about preserving dilution will depend upon the classes of shares in issue, date of incorporation of the company and your shareholder power. If you do not follow the correct procedures set down by law you may find that the there are no limits on dilution.
What does dilution mean? Dilution means that any new issue of shares will reduce your shareholding in the company, in turn reducing the value of your shares, and the dividend entitlements which you may be entitled to receive.

For example, if you held 10 shares out of a 100 you own 10%, but if 20 new shares are issued to either an existing shareholder or a new shareholder you will own 10 out of 120 which is 8.33%. Dilution can be managed but only if you have reserved the powers in either the articles and/or the shareholders’ agreement.

I want to be able to control who can acquire shares from exiting shareholders

Without specific drafting there will be no control for shareholders on whose hands the shares end up in. Control rests with the directors in standard articles.

If the shareholders do not want to rely on the decisions of directors they need a procedure set out in the articles dealing with the sale of shares – such clauses are common but do require specific tailoring of standard articles.

Company articles: blocking powers or powers of veto

Minority shareholders carry little influence individually and will be bound by the decisions of majorities, however unfair or unreasonable such decisions of the majority may be. However, with bespoke articles drafted to require consent from minorities to major decisions the minorities can be empowered to protect their investment.

There are court routes for the minority shareholder to explore to protect their investment. But, court actions are not the desired fall back because they are costly, time consuming, and may not bring the desired result. It is much more commercial to avoid risk by protecting rights at the time of investment.

Dealing with conflicts of interests in articles of association

By law, directors can vote on matters where they are conflicted. This can be a huge problem for the shareholders if the company is being run in an oppressive manner. The directors can enter into contracts where they are in conflict and cause the company loss.
If you want to prevent this the articles will need to include disclosure rules which need to be especially drafted in as they are not part of the standard procedures under company law. If you want to control the board you will need to include drafting to give you that control – this is where we can advise. We often deal with appointment of board advisors and powers to appoint substitute directors.

How to deal with employee shareholders in the articles of association

Shareholders cannot be forced to sell their shares unless set out in the articles. There will be no distinction between shareholders. Deficiencies with the standard model articles often come to light when a shareholder leaves for “bad leaver reasons”, such as gross misconduct, and you discover that he can retain his shares.

Other problem areas which are solvable with the right drafting are making sure if you want to sell for a substantial gain you can bind the other shareholders into the sale and proceed to receive the return of value.

Articles of association: dismissing a director

Without specific rights set out in the company’s articles, the shareholders’ right to remove a director is lengthy and fraught with complexities. A shareholder wishing to dismiss a director will have to:

  • Call a general meeting of the company, with at least 28 days’ clear notice, giving reasons for the director’s dismissal – time consuming and administratively onerous; and
  • Convince at least 50% of the company’s shareholders that the director should be dismissed.
    Commercial expediency required in these situations means that you will suffer problems if your articles and/or shareholders’ agreement do not provide for faster routes of dismissal than those provided for under the standard articles.

Minority protection rights in articles of association

By law, shareholders holding requisite percentages can enforce certain rights in relation to the company. The list of these rights is not exhaustive. The rights afforded by law are often not applicable to the nature of your business or the likely issues to be faced by the minority shareholder.

This can be resolved with a bespoke set of articles of association, setting out key protections for the minority shareholders, for example including the right for the minority shareholders to:

  • Appoint a director;
  • Dismiss a director;
  • Force the directors of the company to take action, or refrain from taking action in certain circumstances;
  • Initiate an exit route, e.g. a company buyback in the event of a dispute; or
  • Force the directors to disclose certain dealings of the company, force an audit, or seek disclosure of the company’s accounts.

Protecting the value of your minority stake

Often, a key problem for the minority shareholder is preventing a director from taking action which is likely to damage the value of the minority shareholder’s investment and share value.

Imagine a director selling off assets below market value to a family member or company in which the director is a majority shareholder. The company will not realise the profit it should have.

The articles of association can give the shareholders of the company veto rights to prevent a director taking such action and force the director to account to the company for any loss incurred by the company, or profit made by the director.

Company articles: I want to bring in investors

Attracting investors will usually require a change to the articles. Investors usually hold different shares to the founders. Seeking investment can be made more attractive to an investor if the company can offer the tax efficient SEIS or EIS. To comply with the two schemes, the articles do require amendment.

If you do not have compliant articles tax relief for your investors will be withdrawn by HMRC. We can review the articles of association to ensure that your business can comply with the SEIS and EIS requirements for private company articles.

Company articles: I want to amend the articles

A company can amend its articles by the members passing a special resolution, i.e. 75% of the members voting in favour of the amendment. A company’s articles can also be amended through conduct.

For example, if the articles permit share transfers to spouses, and then members transfer shares to siblings or parents, it could be argued that the articles had been amended. The picture is not always clear, and a court is unlikely to find that a company’s articles have been amended through conduct where the conduct is not consistent.

Company articles: court interference

A court is not likely to interfere with a company’s articles, as the articles are considered a contract between the company’s members. Therefore, it is important to constantly revise and amend articles to fit with the direction and business of the company.

Track record Articles of Association

Our expertise is not just limited to drafting we can offer tax advice in relation to your shareholding and your shares. Drafting and advising on articles of association for companies, shareholders, investors, founders and minority shareholders is one of the core business at Gannons and we have dealt with a variety of situations across a wide range of sectors, some recent matters include:

  • Drafting the articles of association for an IT business. We advised on the various share rights and the consequences of the differing share rights.
  • Reviewed existing articles for a educational business seeking EIS investment. We were able to deal with the requirements for EIS tax relief as well as protection for the relevant investor investing under EIS.
  • Drafting relevant provisions in the Articles of Association where it was a 50:50 company. We drafted provisions alongside a shareholders agreement to ensure that their were relevant provisions should the company become deadlocked.
  • Drafting relevant provisions in the articles of association where there would be employee shareholders, so the company would be protected should the employee shareholders leave the business.

Articles of association are the company’s internal rules. The articles are the first point of call in the event of a dispute or disagreement between the directors and or the shareholders. Standard articles rarely provide adequate protection or flexibility. For that reason successful companies adapt standard articles and tailor them to requirements often alongside a shareholders’ agreement. No situation is ever identical and we are pleased to discuss what your position will be.