THE FUNDAMENTALS OF ARTICLES OF ASSOCIATION UNDER INDIAN COMPANY LAW

A company’s Articles of Association define those rules, regulations, and bye-laws which help in the conduct of business, and management of the company’s internal affairs. Section 2(5) of the Companies Act of 2013 defines the term “article.” This refers to articles of association of a company that was initially established or amended from time to time in accordance with any prior company legislation or this Act. All of the rules in Table A of Schedule I of the Act that relates to a corporation are also included in the articles. In addition, this article of association of a corporation must not override the memorandum of association, which is the primary instrument conferring legal rights upon the corporation.  Furthermore, a clause that falls outside the scope of the memorandum of association shall be deemed extra-vires, as interpreted in Shyam Chand v. Calcutta Stock Exchange[1]. It is imperative to exercise the utmost caution when drafting the articles of association. In addition, certain provisions of the Company Act also apply to the company “despite anything to the contrary in the articles.” In other words, the articles must include provisions in respect of all matters which are required to be included herein to ensure that the company’s operations are not hindered in the future.

CLAUSE OF ENTRENCHMENT.

An entrenchment provision may be contained in the articles of association. The concept of provision of entrenchment is laid down under section 5(3) of the Companies Act 2013. The precise definition of “entrenchment” is to make a habit or belief so firmly that change is unlikely or difficult. Thus, this clause makes some amendments in the articles of association difficult. The articles of association of the company can contain entrenchment provisions if the company so desires. It can either be made at the time of incorporation or by amending the articles of association after incorporation. Provisions for entrenchment can only be included in the case of a private company, with an amendment in the company’s articles of association with a consensus which must be reached by all its, a special resolution is needed to be passed in the case of a public company as per section 5(4) of the Company act 2013.

AMENDMENTS/CHANGES IN THE ARTICLE OF ASSOCIATION

Section 14 of the Companies Act 2013 gives companies the power to change their articles by passing a special resolution regarding the outlined restrictions in the memorandum of association. The firm must function effectively using this authority.

Articles can be altered in any of the following manners

  • By amending new articles
  • With new clauses, they may be added or inserted.
  • If via omitting a clause/s;
  • This can be accomplished by amending the clause/s.
  • By substitution of a specific clause/s.

 Such an alteration in accordance with article 14 the can lead to change in the nature of functioning of the company mainly in 2 ways

  • CONVERSION FROM A PRIVATE COMPANY INTO A PUBLIC COMPANY

A corporation may transform from private to public status by eliminating or deleting the three clauses defined in Section 2(68), by which the requirements of a private company are established by them. Replacing the resolution and amended articles in accordance with the converting of public to a private business, must be submitted to the Registrar within the time frame specified.

  • CONVERSION FROM A PUBLIC COMPANY TURNS INTO A PRIVATE COMPANY

It is insufficient to simply adopt a special resolution to convert a public corporation to a private firm. In order to succeed in transferring its status from public to private, the corporation must seek consent and approval from the Court. A copy of the special resolution must be lodged within 30 days of it being passed and must be signed by the company registrar. A corporation must file a copy of the amended, new articles of organisation within 15 days after receiving the clearance order from the Tribunal.

RESTRICTIONS ON THE POWER FOR ALTERATION OF AOA
  • The memorandum will prevail in the case of a dispute.
  • Because it replaces both the memorandum and the articles of the company, the change cannot violate the terms of the Companies Act or any other company legislation.
  • Cannot break the Tribunal’s rules, changes or proposals.
  • Modifications cannot be unlawful and must not violate public policy. In addition, it must be for the company’s genuine advantage and interest. The changes must benefit the firm as a whole and not be intended to defraud the minority.
  • A public company can be changed into a private firm if the Tribunal approves.
  • A corporation cannot amend its articles or deactivate board members in the absence of a corporation’s permission since the change of board is prohibited under company law.
  • A corporation may not utilise the change to conceal or correct a violation of the contract with a third party, or to avoid the contractual obligation.
  • A corporation cannot amend its articles to remove a member of the board of directors since this is against company law and so cannot occur.
ALTERATION OPPOSED TO THE MEMORANDUM OF ASSOCIATION

The amendment to the Articles of association can have an impact on the memorandum of association. In the case of Hutton vs. Scarborough Cliff Hotel Co[2] , a resolution authorizing the issuance of new shares with a preferred dividend was passed at the General Assembly, but the memorandum did not include such authority. The issuance of new shares with a preferred dividend was deemed an amendment to the Articles of Incorporation outlined in the Memorandum of Understanding, and this amendment was declared invalid. The Memorandum of Understanding is silent as it neither permits nor prohibits the issuance of preferred stock. The court stated that the power to amend the Articles of Incorporation, either explicitly or implicitly, is subject only to those expressly prohibited by the Memorandum of Understanding. The court in the case of Andrews vs. Gas Meter Co. Ltd[3]held the issue of shares valid. According to the 5th clause of a company’s memorandum the nominal capital of the company was €60,000, and it can be divided into 600 shares of €100 each. There was no provision related to preference shares either in memorandum or articles of associations. Shares bearing preferential dividends are issued after a special resolution is passed. The court ruled that if the memorandum forbids such a practice, then this issue should be invalid. Since the memorandum didn’t contain such a clause, the matter stood.

BREACH OF CONTRACT BY ALTERATION

Changing articles of association can be considered a breach of contract with an outside party. In Chithambaram Chettiar vs. Krishna Aiyangar,[4] the company secretary accepted the position based on a monthly compensation of Rs. 50. The company articles of association contained this provision. Due to the change, the monthly remuneration will be Rs. 25 per month. The court ruled that in case a contract heavily relies on the article of association, then it will be operative if an article is amended, however, if the company has entered into an independent contract, then it has no choice but to assign damages for breach by changing the articles.

LIABILITY INCREASES FOR THE MEMBERS

It is not possible to convert a limited liability member into a member with unlimited liability until he/she has given his/her consent in writing. Changes to liability or the ability to purchase more shares are permitted only with the consent of the respective member.

 LEGAL EFFECTS ON ENFORCEMENT OF ALTERATION OF AOA

These are the legal implication of the articles of association:

  • Company members are bound by its rules and regulations

The article forms a contract that ties both the members and the corporation. Each member is obligated to the firm and must abide by the articles as well as the memorandum. Members of the company are equally obligated by the original articles as well as those that are changed from time to time, as stated in the case of Malleson v. National Insurance Co[5].

  • Legal actions can be brought against the company by members

Because the articles bind the firm and the members, a member can sue if the corporation violates the articles. For example, if a firm improperly pays a dividend, an individual member may sue the company for an injunction. Furthermore, the corporation is obligated to the individual members in terms of their rights. Usually, only the majority of its members can bring an action for a violation of the articles. Individual members or a minority of members may not sue unless it is to enforce personal rights or to prevent the corporation from engaging in any unlawful or fraudulent activity.

  • Members are obligated to each other

The articles bind the members collectively, and each member is bound by the other members. However, this does not mean that the articles result in the formation of an express contract between the company’s members. As a result, the member of the business will not have the right to sue other members to enforce the articles.

  • A company’s relationship with outsiders is bound

An outsider is anyone who is not a member of the company, meaning that all outsiders are bound by the company’s agreements. There are no contractual rights against the company provided by the articles between outsiders and the company. There are no contractual obligations even if outsiders were mentioned in those documents as partners in the business.

Author(s) Name: Anjali Singh (Vivekanand Institute of Professional Studies)

References:

[1] Shyam Chand v. Calcutta Stock Exchange, AIR 1949 Cal 337

[2] Hutton vs Scarborough Cliff Hotel Co. (1865) 2 Dr. & Sm. 514

[3] Andrews vs Gas Meter Co Ltd (1884) LR 25 Ch D 320.

[4] Chithambaram Chettiar vs Krishna Aiyangar  ILR 33 Mad 36.

[5] Malleson v National Insurance and Guarantee Corporation [1894] 1 Ch. 200.

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