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Law for Business

Knowhow - guidance - precedents

22 MAY 2015

Articles of association – more than meets the eye

Articles of association – more than meets the eye
The obligation under the Companies Act 2006 to file articles of association with Companies House is part of the company law regime's efforts to ensure that those who deal with a company have a certain amount of information about its internal arrangements.

In reality, however, a company's articles may tell only part of the story. In many cases, they are supplemented by a shareholder's agreement, which is by nature a private document. In the case of some small companies, too, the shareholders may have a close personal relationship such that a court might be prepared to enforce an informal understanding amongst them as to their conduct of the company's affairs - for example, as to their role in its management - pursuant to its wide discretion to grant relief in connection with an unfair prejudice petition.

What is more, even the articles themselves may not be quite as they appear. Whilst the courts will not rectify them for mistake, they will, on occasion, be prepared to imply terms into them. The law on implied terms is fairly clear, i that the courts will read words into articles only if it is necessary to do so in order to give effect to their meaning, but this is one of those areas in which it can be difficult to apply the law to a particular set of facts. The difficulty lies, of course, in determining what, exactly, articles mean, and the recent decision of the Court of Appeal in Sugarman v CJS Investments [2014] EWCA Civ 1239 provides useful guidance on this question.


The law on implied terms was set out by the Privy Council in Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10:

'The court has no power to improve upon the instrument which it is called upon to construe, whether it be a contact, a statute or articles of association. It cannot introduce terms to make it fairer or more reasonable. It is concerned only to discover what the instrument means. However, that meaning is not necessarily or always what the authors or parties to the document would have intended. It is the meaning which the instrument would convey to a reasonable person having all the background knowledge which would reasonable be available to the audience to whom the instrument is addressed...'

'... in every case in which it is said that some provision ought to be implied in an instrument, the question for the court is whether such a provision would spell out in express words what the instrument, read against the relevant background, would reasonably be understood to mean.'

As to how the law has been applied in practice, it is fair to say that although the courts have an instinctive reluctance to interfere with the plain wording of a company's articles, they have nevertheless shown themselves to be willing to read words into them in appropriate cases.

  • The underlying strictness of the courts' approach can be seen in Bratton Seymour Service Co Ltd v Oxborough [1992] BCC 471, in which the question for the Court of Appeal was whether to imply into a property management company's articles a term requiring shareholders to contribute towards the cost of maintaining the property's amenity areas. Although the articles contained no indication that shareholders were required to make any such contribution, the company argued that it was necessary to imply the term in order to give the articles 'business efficacy' in the light of its promoter's plans for the management of the property. The judges unanimously refused this argument, on the ground that it was not appropriate to imply a term into a set of articles on the basis of extrinsic circumstances. As Steyn LJ put it:
'It is possible to imply a term purely from the language of the document itself: a purely constructional implication is not precluded. But it is quite another matter to seek to imply a term into articles of association from extrinsic circumstances.

Here, the company puts forward an implication to be derived not from the language of the articles of association but purely from extrinsic circumstances. That, in my judgment, is a type of implication which, as a matter of law, can never succeed in the case of articles of association.'

  • On the other hand, Belize Telecom itself is an example of a case in which the court was prepared to imply a term into a company's articles. The articles in question gave the holder of a 'special share' the right to appoint and remove two directors as long as it also held 37.5% or more of a company's issued share capital, but were silent as to the position of any directors who had been appointed pursuant to that right in the event that the level of the special shareholder's shareholding subsequently fell below the 37.5% threshold. Faced with precisely that scenario, the Privy Council held that a term should be implied into the articles to the effect that the directors ceased to hold office. As Lord Hoffman put it in delivering the decision of the Board: 'the implication is required to avoid defeating what appears to have been the overriding purpose of the machinery of appointment and removal of directors, namely to ensure that the board reflects the appropriate shareholder interests in accordance with the scheme laid out in the articles.' The key to the decision lies in the last few words of that excerpt; whereas in Bratton Seymour the term in question would have had to have been implied on the basis of extrinsic circumstances, here the term was implied primarily on the basis of the contents of the articles themselves.
  • The Court of Appeal's decision in Cream Holdings Ltd v Davenport [2011] EWCA Civ 1287 was along similar lines to that of the Privy Council in Belize Telecom. The articles in question provided a mechanism for the appointment of an accountant to value the shares of a departing shareholder in connection with a pre-emption provision, and the court implied into them a term requiring the company and the shareholder to co-operate in the process of valuing the shares by agreeing to the reasonable terms of the proposed accountant. Patten LJ, who delivered the only substantive judgment, commented that the implication of the term was 'an obvious and necessary means of giving effect to the contract'.
  • The scope of the courts' power to imply a term is wider than it may appear at first glance. In Equitable Life Assurance Society v Hyman [2002] 1 AC 408, a life assurance society's articles gave its directors a wide discretion in relation to the payment of bonuses to policyholders, but the question arose as to whether a term should be implied into them to the effect that the discretion would not be exercised so as to undermine guaranteed annuity rates contained in the company's policies. In holding that such a term should, indeed, be implied, Lord Steyn (who delivered the main judgment of the court on this point) took into account not just the wording of the article in question, but also 'its particular commercial setting'. In particular, he noted that the policyholders would not have expected the directors to undermine the guaranteed annuity rates, and felt obliged to give effect to their 'reasonable expectations'. Although Lord Steyn was at paints to stress that the power to imply terms should be used sparingly, the case confirms that a term may be implied not only on the basis of the wording or scheme of the articles themselves, but also on the basis of the wider commercial environment in which the articles operate.
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Sugarman v CJS Investments LLP [2014] EWCA Civ 1239

As noted above, the Privy Council explained in Belize Telecom that the court's function when it comes to construing articles is to identify what they mean. The court may well approach that task by asking itself whether the language of the articles, as it stands, makes sense from a business perspective, and this question - and the difficulties which may be involved in answering it - was at the heart of the Court of Appeal's decision in Sugarman.

The essential facts of that case were as follows:

  • the articles before the court were those of a property management company, Lawrence House Management Company (City Road) Ltd
  • the property consisted of 104 flats, and the lease of each flat carried with it one share in the company
  • the pattern of ownership of the flats was varied, in that, for example, a single party held 66 leases (and so held 66 shares), whilst at least two other parties held just one lease each (and so held 1 share each)
  • article 13 of the company's articles, which was headed 'Votes of members', provided that 'every Member present in person or by Proxy shall have one vote'
  • in connection with general meetings concerning the appointment of directors, the question arose as to whether the effect of article 13 was to give each shareholder (a) one vote; or (b) one vote for each of his shares.
The Court of Appeal held unanimously that the effect of the article was to give each shareholder a single vote, regardless of how many shares he held. Floyd LJ, who delivered one of the two reasoned judgments, began by considering whether, purely as a matter of interpretation, article 13 could be said to apply only in respect of votes on a show of hands, in which case votes on a poll would be governed by the default provision of section 284(3) the Companies Act 2006, under which shareholders voting on a poll have one vote for every share they hold. Not surprisingly, he concluded that the article could not be interpreted in that way, and went on to consider whether he could nevertheless imply such a qualification into it, on the basis that to do otherwise would lead to 'commercial absurdity'. Briggs LJ's judgment focused solely on the commercial absurdity point.

As far as the commercial absurdity test was concerned, then, Floyd LJ noted that the effect of the article was to give each shareholder a degree of involvement in the company's affairs, and that the owner of more than one flat might not have the same interest in the company's activities as the owner of just one flat, and took the view that it was not absurd to treat those two categories of owners differently. The most interesting observations on the test, though, came from Briggs LJ. First, his comments on the meaning of 'commercial absurdity' are instructive:

'There can unfortunately be a fine dividing line between that which appears commercially unattractive and even unreasonable and that which appears nonsensical or absurd. It causes continuing difficulty in the application of English law to problems of construction, not least because it is not unusual for apparently reasonable judicial minds to disagree on the question whether a particular contractual or other documentary provision has crossed it ...'

Secondly, he made it clear that the court will not be easily persuaded that the commercial absurdity test has been met. He noted that it would, indeed, be strange if the owner of, say, 102 out of 104 flats could be out-voted by the two owners of the other two flats, but commented that 'it is dangerous to test commercial absurdity by reference to extreme examples'. On the assumption that the promoters of the company would not have had in mind a scenario in which large numbers of flats were owned by a single party, he felt that a voting arrangement which gave each shareholder just one vote, regardless of how many shares he actually held, 'falls short of absurdity, even if it may still appear unreasonable, un-commercial or even undemocratic, to many'. He pointed out, for example, that such an arrangement might be designed to deter parties from acquiring too many flats.


There is no doubt that the courts exercised considerable restraint when it comes to implying terms into companies' articles, and that is as it should be. Companies are obliged to make their articles public in order to ensure that those who deal with them have a certain amount of information about their internal affairs, and that objective would be frustrated if third parties could not rely on the courts generally to allow articles to stand as they are written.

It is surely right, too, that the courts will exercise their power to imply a term only in order to give effect to the meaning of the articles, and not in order to 'improve' them in accordance with their own views. However, the way in which the courts go about identifying the meaning of the articles is potentially problematic from the perspective of a third party, in that it makes it difficult for him to take a view as to whether a particular provision may be susceptible to modification by a judge. For one thing, the courts will not confine themselves to an examination of the wording of the articles, but will undertake the more complicated task of placing them in their commercial context. For another, they may well apply the commercial absurdity test, as, as Briggs LJ noted in Sugarman, there is a good deal of scope for even the most learned legal minds to take different views as to whether the effect of a provision is such as to render it commercially absurd. What, then, are the practical implications of the law in this area?

As far as third parties are concerned, it adds to the reasons why it can be dangerous to assume that the plain wording of a company's articles reflect the complete picture as regards the organisation of its internal affairs. Not only may the articles be supplemented by a formal shareholders' agreement or even an informal understanding amongst the shareholders, but in exceptional cases they may, in effect, be amended by a judge.

In theory, the notion that a court will be prepared to imply a term in order to give effect to the true meaning of its articles should be of some comfort to a company. In practice, however, the uncertainties involved in the process by which the courts reach their decision as to whether to imply a term mean that a company will not know in any given case whether, and if so in what way, a court might intervene. In this connection, the observation of the Privy Council in Belize Telecom that the meaning of a document 'is not necessarily or always what the authors or parties to the document would have intended' is particularly worthy of note. In fact, the lesson which companies should draw from the case law on implied terms is that they should do all they can to minimise the chances that the courts might intervene, and the way to achieve that aim is perfectly simple: to devote as much thought and care to the contents of their articles as they do to any other important commercial document.
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