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Law for Business

Knowhow - guidance - precedents

19 APR 2013

Did you know ...

that there is a common law restriction on the power of shareholders to alter the articles?

  

Under section 21 of the Companies Act 2006, shareholders have the power to alter the articles of association by means of a special resolution.

Although the section itself does not specify any restrictions on this power, or even hint that any might exist, it is well known that there are a number of restrictions elsewhere in the Act.  Section 22, for example, provides for the entrenchment of provisions in the articles, and section 25 prevents a shareholder from being bound against his will by an alteration to the articles which would impose upon him an obligation to pay money to the company.  Section 630, meanwhile, restricts shareholders' freedom to make alterations which would vary class rights.

It is less well known, perhaps, that there is a common law restriction which may, in some cases, prevent shareholders from taking advantage of section 21.

The common law restriction

The statutory power to alter the articles is one of the mechanisms employed by the company law regime to ensure that shareholders retain ultimate control of the company's affairs.  In particular, the fact that shareholders can alter the articles to take management power away from the board tends to ensure that the board complies with the owners' wishes.

Looked at from another angle, section 21 also affects the relationship between the shareholders themselves, since it allows a majority of 75% to bind the minority, potentially introducing changes to the articles with which the minority strongly disagrees.  Bearing in mind this aspect of the statutory power, the Court of Appeal in Allen v Gold Reefs of West Africa, Ltd (1900) held that the power must be exercised "bonâ fide for the benefit of the company as a whole".

This is a subjective test, in the sense that the court will simply ask whether, when voting on a resolution to alter the articles, the shareholders were acting in what they honestly believed were the company's interests.  If the shareholders are genuinely trying to do what they feel is right for the company, they have nothing to fear.  If, however, they are acting maliciously or oppressively, or if the alteration "is such that no reasonable men could consider it for the benefit of the company" (Shuttleworth v Cox Brothers and Company (Maidenhead), Ltd (1927)), their attempt to alter the articles may fall foul of the test.

Practical implications

Take the case of a company with five shareholders, each of whom has a seat on the board.  If four of the five support a resolution to alter the articles so as to provide that board meetings must be attended in person, in what circumstances might the fifth, who lives abroad, be able to argue that the alteration fails the test?  If the majority genuinely feel that the board will function better if the directors are required to discuss matters face to face rather than over the telephone, he will not have a case.  If, however, they are altering the articles because they have taken a dislike to him and wish to diminish his role within the company, he may well be able to argue that they are exercising their power under section 21 maliciously, rather than for the benefit of the company.

Comment

Alterations to the articles are very often uncontroversial.  In cases of dispute, though, the shareholders who are seeking to introduce the amendments need to be aware that the effect of the common law restriction on the statutory power is that their motives might come under the microscope.

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