The articles of association form the backbone of the company serving many purposes. The articles govern the three components of business – income, voting power and capital and they also control the activities of directors and shareholders. Standard articles downloaded upon company incorporation rarely cover the detail if there is more than one shareholder or director and this causes problems. For that reason companies do implement tailored articles of association and we help them.
Please do call us to discuss any queries.
How to implement articles of association to fit your requirements
Identifying the risk areas the articles of association can solve
Your requirements will depend upon the purpose of the company, shareholder voting power and the management structure. We have picked out some situations where we have implemented bespoke articles of association to address specific concerns of the founders, investors or shareholders.
Offering shares under the Articles
If you use the model articles of association supplied upon incorporation, the existing shareholders of the company will be able to block any issue of shares where the shares have not been offered to all the existing shareholders pro-rata to their shareholdings. This right is known as the right of pre-emption and is automatic.
Dis-applying shareholder right in the articles
However, it is possible to dis-apply the right of shareholders to be offered shares if you either amend the model articles or hold shareholder approval.
Providing different rights to shareholders
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.
Creating different shareholder rights in the articles
If you want to differentiate between shareholders you will need to create separate share classes and set out the rights in the articles of association. Standard articles of association do not deal with different share classes. If you ignore the articles of association the shareholders will have claims against the directors and the company.
Protecting minority shareholders under the articles of association
Minority shareholders carry little influence individually. Minorities will be bound by the decisions of majorities, however unfair or unreasonable such decisions of the majority may be. However, with bespoke articles of association drafted to require consent from minorities to major decisions the minorities can be empowered to protect their investment.
Going to court is often cost prohibitive
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.
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 of association do not provide for faster routes of dismissal than those provided for under the model articles downloaded on incorporation.
The articles are a public document open for inspection by all at Companies House. If you want to keep details relating to shareholders rights private you will need to include provisions in a shareholders’ agreement. This is because the shareholders’ agreement is a private agreement not accessible by the public.
Amending the articles of association
Unless you have agreed otherwise, to change the articles at least 75% of shareholders with voting power must vote in favour of any change. This compares with 100% of shareholders needing to agree any change to the shareholders’ agreement. We can advise you on what has to be included in the articles and what can be reserved for a shareholders’ agreement.
Managing dilution via the articles of association
Dilution means that any new issue of shares will reduce your shareholding in the company. For example, if you hold 10 shares out of a 100, you own 10%, but if 20 new shares are issued you will own 10 out of 120 which is 8.33%. The question becomes, does the new share issue generate sufficient value to justify your decrease in shareholding? This is an area where disputes can easily erupt.
Dilution can be managed but only if you have reserved the powers to control dilution in either the articles of association or the shareholders’ agreement.
Powers of veto solve some problems
An effective management tool is to build into the articles of association powers of veto – this power enables shareholders to block decisions. It is common to include a power to block the dilution of shares unless shareholders agree.
Compulsory transfers under the articles of association
Without specific drafting in the articles of association there will be no control for shareholders on the transfer of shares. 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 and can deal with:
Rights to buy shares from departing shareholders
- The articles of association can be used to determine the value of shares being sold. This is often called “good and bad leaver”. There are no fixed rules on how value must be determined. The articles of association are used to plug the gaps which exist at law.
- It is possible to set out who has the right to buy shares. For example, the company can be given first choice to decide if it wants to buy back shares and cancel them. Failing that, groups of shareholders can be given the option. Or, all shareholders have the choice but pro-rata to existing shareholders.
- The right to sell shares to third parties can be managed via the articles of association to keep shares in the right hands.
Rights to bind shareholders into a trade sale using the articles of association
- The articles of association can be used to “drag” shareholders into a third party sale. These provisions are very standard and recommended.
- If a substantial shareholding is being sold, the articles of association can be used to protect minorities. The minorities can be given the right to sell on the same terms – known as “tag”.
Employees and directors who leave employment
- Without prior modification to your articles of association the employee will be able to retain his shares. The articles of association can be used to overcome this problem.
Special Purpose Vehicles (SPVs)
Special Purpose Vehicles are used to minimise risk of a new venture or to separate a new line of business from the existing business. Often SPVs are used to hold an asset such as a property portfolio. SPVs have no pre-existing liabilities so they are attractive to investors.
The articles of association for a SPV will need to take into account:
- Share structures to limit legal liability if the new venture of the SPV fails;
- Investment into SPV and dilution;
- Asset transfers into and out of the SPV;
- Selling the SPV.
We set up special purpose vehicles and help you exploit it during its’ lifetime. When the SPVs’ purpose has expired, we help you sell or disband the SPV.
Articles of association for joint ventures
Joint ventures often take form of special purpose vehicles to shelter the new collaboration from the existing trade. As the rights and responsibilities of collaborators vary between the parties, the articles of association need to deal with:
- Profit sharing and management of an SPV during its lifetime;
- Dissolving the SPV after the purpose of it has expired.
Setting up joint venture structures requires considering its lifespan from set up to exit. Our commercial solicitors prepare practical joint venture agreements.