The Statutory Contract in Section 33(1) Companies Act 2006

It has often been said s 33 (1) Companies Act 2006 creates a statutory contract, albeit one with very distinctive features. Explain the nature of this statutory contract and who may enforce the provisions of the Articles of Association as a result.

The introduction of the Companies Act 2006 amended the law regulating corporations which had been heavily criticized over the last century.

In United Kingdom, a company is created by registering it with a government agency called Companies House, which is an executive agency of the Department for Business, Innovation and Skills. It is a distinct part of the government department with its own budget. The Chief Executive of Companies House is the registrar of companies.

In order to register a new company the following items must be filed in an application; (a) a memorandum of association, which forms the company, (b) an application for registration, (c) the company’s constitution, contained in articles of association and initial shareholdings, (d) a statement of the company’s proposed officer and (f) a statement of compliance.[1]

The Companies Act (CA) 2006 makes a primary change to the company’s constitution. Henceforth the company will effectively have a single constitution. The articles of association will become the company’s constitution. Formerly there were two components to the constitution the memorandum of association and the articles of association.[2]

Section 33 of the CA 2006, states that “the provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions” whereas under the old s 14 of the CA 1985, the memorandum and articles of association, when registered hold both the company and its members accountable to the same extent as if they had respectively been signed and sealed by each member, and provided that they contained covenants on the part of each member to observe all the provisions of the memorandum and articles.”

Now The phrase “on the part of the company and each member”, as opposed to simply “on the part of each member” is included in s 33 (1) CA 2006. The wording of this section, except certain minor variations, may be traced back to the Companies Act 1844. This particular Act adopted the method of forming an unincorporated joint stock company which existed at that time. In effect, the phraseology of previous versions of s 33 ignoring the fact that the company was a separate legal entity appeared to suggest that articles bound only the members. The updated wording of the CA 2006 apparently addressed this oversight.[3]

Articles of association sets out the internal regulations of the company, covering matters such as calling of company meetings, appointment, removal powers of directors, keeping of accounts, payment of dividends and issuing new shares and pre-emption rights.

A memorandum of association as defined now in s 8 of the Act is a prescribed form and contains a statement that the subscribers wish to form a company and become members of that company when it is incorporated. If the company has share capital it must also state that the subscribers agree to take at least one share each. Although this is the document which formally seeks to form the company, it is no longer a constitutional document unlike the position under the CA 1985.

An application sets out the company’s proposed name, country of registration, liability of members (under CA 2006, companies continue to be limited by shares or by guarantee or can be unlimited), and whether the company to be private or public, and also must contain the intended address.[4]

As defined in s 17 of the Companies Act 2006 (CA) company’s constitution as including the articles of association along with any resolutions and agreements to which Chapter 3 applies.[5]

In general, those setting up a company are free to choose any name they wish. They are, however, constrained by certain rules.[6] Like ss 58-59 of the CA state that ltd or plc must follow the name. On the other hand Companies House keeps a record of all names and will not register a company with the same name as one already on the register. Restrictions on names include names which would be offensive, blasphemous or treasonous or likely to incite racial hatred. Also specific approval of the Secretary of State is needed for names that might suggest a connection with government or local authority (s 54). Names or words like police, queen, Great Britain also need approval of Secretary of State. During the life of the company the members may change the name by special resolution (a vote needing a 75% of majority).[7]

It should be noted that under the CA 1985 companies were required to determine the objects in the memorandum, which means that they had to specify exactly what they were empowered to do. Therefore, if a company stepped outside the objects specified , then the company had no legal capacity to do and such transactions would be deemed to be “ulta vires” (beyond authority) and, therefore, invalid. This was a problem from the moment that companies wanted to be able to scrutinize business opportunities that were profitable. So, in re-examining the area of law, new companies registered since 2006 Act will have unrestricted objects unless the company chooses to have an objects clause restricting what it can do companies from before CA 2006 with an object clause have the power to remove it.[8]

Unusual features of the contract

The contract formed by articles of association differs from a contract of sale of goods or a contact for the construction of building: it does not provide for each party to fulfil certain obligations after which the contract ends. The articles of association of a company are part of the company’s constitution, which sets the internal rules governing decision – making in the company and being the framework within which the company operates.

The contract formed by articles of association is of a type sometimes called “rational contract”, which is characterized by longevity and imperfection, that is, the contract that does not predict the outcome under any circumstance.[9] Bratton Seymour Service Co Ltd v Oxborough [1992] is an indicative case where the Court of Appeal noted that there is considerable difference between the articles of association and a normal contract. The courts have no jurisdiction to rectify the articles of association of a company even if they do not agree with what has been the intention of the contracting parties.[10]

It is obvious that s 33 (1) creates a statutory contract which binds the company and the members under the provisions of company’s constitution. The long term dynamic nature of the relationship between the company and its members and between the members themselves means that ultimately the articles of association may need amendment. CA 2006 s 21 provides that, subject to any provision for entrenchment, articles can be amended by the members by a 75 per cent of majority of the contracting parties against the wishes of the minority, subject to any provision for entrenchment.

In relation to articles of association, unlike a normal contract, the court will not exercise its power to rectify a document and, when interpreting articles, will not take into account surrounding circumstances known to those who registered or amended them. This was illustrated in Scott v Frank F Scott (London) Ltd [1940] where the court found the issue of construction in favour of the claimant and, additionally found that there was no margin for rectification of a company’s constitution.[11]

Enforcing the Contract (Enforcing the Articles)

The legal rights of a company belong to the company as a separate person and any wrong to the company the dominant pretender is the company not the member. The case of Foss v Harbottle (1843) reflects the general principle of company law according to which in order to rectify something wrong done to a company or to the company’s property, or to enforce rights of the company, the company itself is the proper claimant, and the court will not ordinarily entertain an action brought on behalf of the company by a shareholder.[12]

The rules in the above case emphasise the courts desire to prevent multiplicity of shareholders suits, to eliminate vexatious and wasteful actions by shareholders and to recognise separate corporate personality.[13]

Company enforce the articles against a Member

According to s 33 CA 2006 both the company and its members are bound to the same extent according to the provisions of a company’s constitution. This was not clear from the wording of the old s 14 CA 1985. However, judiciary systematically held that the company was a party to the contract. This was defined in Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915] where it was held that the memorandum and the articles of association constitute a contract between the company and the members. Thereafter, in Hickman, a provision requiring a member to refer any dispute with company to arbitration was held binding on the member.[14]

Member enforce the Articles against a Member

It is obvious that the contract binds the members and the company together, but it was misty whether it binds the member’s inter se, but does it meaning that each member has a binding enforceable contract with every other member and, therefore, a shareholder enforces the provisions of the articles against another shareholder. Thus, the simple question as to whom the proper claimant in such an action would be remains pending and, consequently has been the subject of judicial debate and confusion.

In Re Tavarone Mining Co, Pritchard’s Case (1873), Mellish LJ said: “...the articles of association are simply a contract as between the shareholders inter se in respect of their rights as shareholders. They are the deed of partnership by which the shareholders agree inter se.”[15]

Further, in Wood v Odessa Waterworks Co (1889), Stirling LJ said: “the articles of association constitute a contract not merely between the shareholders and the company, but between each individual shareholder and every other.”

However, the courts have been reluctant to provide members of companies with contractual remedies in disputes between members. In Welton v Saffrey [1897], Lord Herschell said: “… there is no contract in terms between the individual members of the company; but the articles do not any the less, in my opinion, regulate their rights inter se. Such rights can only be enforced by or against a member through the company, or through liquidator representing the company; but I think that no members has, as between himself and another member, any right beyond that which the contract with the company gives.” In addition, in Salmon v Quin and Axtens Ltd [1909], Farwell LJ, after citing with approval the dictum of Stirling LJ quoted earlier said: “…it may well be that the court would not enforce the covenant as between individual shareholders in most cases.”[16]

The only directly relevant case is Rayfield v Hands [1960], where Vaisey J interpreted the reference to the directors and so held that the article concerned membership and had contractual force.[17] Specifically he said: “there is a contract inter se directly enforceable by the members against each other, BUT this is not of general application” and stressed the quasi partnership nature of the company he was dealing with.[18] This situation is the most controversial, and it may be that there are further limits on direct enforceability between members.[19]

Therefore, s 33 (1) derived from its predecessors in order to correct the statutory contract, that is, a contract which binds the members and the company inter se but also binds each member inter se.

Member enforce the Article against the Company

Conflicting interpretations of the issue seem to be problematic according to the capacity of the shareholder to enforce what he perceives to be his rights under the articles of association against the company. But, membership rights which have been conferred on the member “qua member” can be enforced.

An illustrating case is Pender v Lushington (1877), where during a meeting of members the chairman refused to accept Pender’s votes. He asked the court to grant an injunction to stop the directors acting contrary to the resolution. He succeeded on the basis of the contract in the articles, which bound the company to the shareholders.[20]

Additionally, in Wood v Odessa Waterworks Co (1889), Stirling J held that the implication of the article of association was that a dividend must be paid in cash and could not be paid in kind. The company was accordingly restrained from acting upon the resolution.[21]

Moreover, Lord Wederburn in an article on Foss v Harbottle pointed out a list of the rights which the courts have, in the past, considered to be personal in nature. He included pre-emption rights, the right to have directors appointed in accordance with the articles, the right to be registered as a shareholder and the right to obtain a share certificate. From the above it can be argued that the matter is still less than clear as to what exactly separates a personal membership right from a general membership right.

Furthermore, where it is not a case of the shareholder wanting to enforce a particular right qua member, but rather a breach which constitutes a wrong to the company, then only the company can take an action.[22]

On the other hand, whether or not a company sues to enforce its legal rights must be decided by the persons who, under the company’s constitution, have authority to institute legal proceedings in the company’s name. These will normally be the directors.

The principle that a company is the only person able to claim redress for injury to itself is known as the proper claimant principle. It prevents a member of a company claiming redress on behalf of the company. The principle cannot be avoided by redress for a loss. There are exceptions whether the company is prevented by the wrongdoer from taking action itself. The proper claimant principle applies even if a majority of members support a claim by a member to enforce a right of the company, Mozley v Alston (1847) and if all members are claiming, Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd (1969).[23]

Can an Outsider enforce the Articles?

The articles are a statutory contract between company and members and are therefore, not deemed to constitute a contract between the company and an outsider. They only bind the members in their capacity as members.

In Eley v Positive Government Security Life Assurance Co Ltd (1876), the court held that he was an outsider and could not enforce the contract in his capacity as a solicitor. But, it was not clear from the decision whether the position would have been different had he sued as a member. The articles only gave him rights in his capacity as a member.[24]

In Browne v La Trinidad [1887], “... it would be remarkable that, upon the shares being allotted to him, a contract between him and a company, as to a matter not connected with holding of shares, should arise.”[25]

Further, in Hickman v Kent or Romney Marsh Sheep-Breeder’s Association [1915], Ashbury J said: “...alike to all shareholders and can only exist by virtue of some contract between such person and the company, and the subsequent allotment of shares to an outsider in whose favour such an article is inserted does not enable him to sue the company on such an article.”[26]

However, on occasion, the company’s constitution may form the basis of a separate agreement. This was the case, for instance, in Re New British Iron Company ex p Beckwith [1898], where directors were able to imply a contract on the same terms as the articles when suing for their remuneration. Nevertheless, if this is the case then the contract incorporating the terms of the company’s articles may well be on alterable terms since the articles are freely alterable by the company.[27]

Be that as it may, articles of association, traditionally caused confusion to both academics and students alike given its conflicting legal effects. S 33 of the Companies Act 2006, which replaced s 14 of the Companies Act, significantly has updated the wording of this traditional awkward section and, consequently resolved some elements especially that of the articles binding both equally the company and its members. Evidently, there are a lot of gaps and it seems that the only pertinent conclusion to be reached is that s 33 (1) is a complicated contract, unlikely to be settled by precedent, and even with the coming of the modern and uploaded Companies Act 2006, the ongoing debate, most likely, will intensify.

Page 1 of 7

[1] Mayson, French & Ryan, 2013, Company Law, 30^th edition, Oxford United Press, at pg. 42

[2] Bourne,N, 2011, Bourne on Company Law, 5^th edition, Routledge, at pg. 76

[3] Wilde, C, & Weinstein, S, 2009, Smith & Keenan’s Company Law, 14^th edition, Pearson Education Limited, at pg. 82

[4] Sime, S, 2010, Company Law in Practice, 8^th edition, Oxford University Press, at pg. 22-23

[5] Ibid 3 at pg 81

[6] Ibid 1 at pg. 77

[7] Lecture Handouts

[8] Ibid 7

[9] Ibid 1 at pg. 79

[10] Ibid 2 at pg. 116

[11] Ibid 2 at pg. 116

[12] Ibid 4 at pg. 253

[13] Ibid 7

[14] Ibid 2 at pg. 113

[15] Ibid 1 at pg. 79

[16] Ibid 1 at pg. 89

[17] Ibid 2 at pg. 90

[18] [1960] Ch 1

[19] Ibid 3 at pg. 33

[20] Ibid 4 at pg. 84

[21] Ibid 2 at pg. 207

[22] Ibid 7

[23] Ibid 1 at pg. 560

[24] Ibid 1 at pg. 113-114

[25] Ibid 2 at pg. 81

[26] Ibid 2 at pg. 82

[27] Ibid 1 at pg. 115