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Law for Business

Knowhow - guidance - precedents

07 JAN 2013

Ten things every director needs to know - Part 3

This is the third in a series of articles in which we explore the role of a director from various angles, some of them slightly unconventional.  Each article identifies a fact of which directors need to be aware - whether concerning their duties, their relationship with other key players or their responsibilities under the Companies Act 2006 - and uses it as a starting-point to illuminate a particular aspect of their role.

The articles are written with new directors in mind, and take a practical approach to the issues raised.  However, they also look at the underlying law, on the basis that a director who understands the foundations of his role will be in a better position to comply with his obligations, and so we hope that the series will also be of interest to those with more experience of running a company.

Topics which we will cover in future issues include:

  • the impact of measures designed to protect creditors;
  • a director's responsibilities concerning the company's accounts;
  • whether it is acceptable to be a 'sleeping director';
  • criminal offences under the Companies Act 2006; and
  • the board's role in relation to allotting shares.

This third article in the series, however, discusses the importance of the company's articles of association.

3.   You cannot afford to ignore the company's articles of association.

We noted in the first article in this series that ultimately it is the shareholders who control the company.  One of the means by which they convey their wishes to the directors is through the company's articles of association, and directors have a specific duty under section 171 of the Companies Act 2006 (the "Act") to act in accordance with the articles.  It is vital, therefore, that a director is aware of - and understands - the contents of his company's articles of association.

The articles are often described as the company's internal rulebook, and on the whole this is an accurate description, for although the Act contains numerous provisions concerning the company's internal rules and procedures, many of the most important decisions as to how the company is run are left to the shareholders to decide in the articles.

In some cases, the Act establishes a default procedure which the shareholders can override or supplement.  For example, section 550 provides for directors of private companies with only one class of shares to be able to allot further shares without the authority of the shareholders, but goes on to state that this power is subject to any restrictions contained in the articles.  Similarly, whilst section 168 provides shareholders with a statutory procedure for removing directors from office, it expressly permits alternative removal procedures.

In other cases, the Act is largely or entirely silent on a matter.  It might be thought that, just as it sets out detailed rules governing shareholder decisions, presumably it also establishes the procedures by which the board takes decisions.  In fact, the Act has virtually nothing to say on this question.  Whether the directors should be able to pass written resolutions, for example, is left to the discretion of the shareholders, as (normally) are the issues of the quorum for board meetings and the ability of directors with conflicting interests to vote.  On the question of the mechanism for appointing a director, too, the Act is silent, and indeed even the answer to the crucial question as to how, fundamentally, power is to be divided between the board and the shareholders is to be found not in the Act, but in the articles.

The contents of the articles can differ considerably from company to company, but a new director might wish, as a starting-point, to familiarise himself with some of the key topics which are dealt with in most articles.  These include the following:

  • the division of powers between the shareholders and the board - the articles generally confer upon directors the power to manage the company's business (see, for example, article 3 of the model articles for private companies)
  • the division of powers amongst the directors - the articles often allow the directors to delegate their powers to a managing director (see, for example, article 5 of the model articles for private companies)
  • the process by which directors take decisions - the model articles for private companies establish a detailed framework for decision-making by directors, not simply providing for decisions to be taken at a board meeting or by unanimous agreement (generally in the form of a written resolution), but also dealing with matters such as quorum, the chairman and directors' conflicts of interest (see articles 7 to 16)
  • mechanisms for the appointment and removal of directors
  • where a company has more than one class of shares, the rights attached to the different classes
  • the procedure for paying dividends - although the Act contains rules restricting the circumstances in which a company is free to pay a dividend, the internal procedure for the declaration of dividends is a matter for the articles (article 30 of the model articles for private companies, for example, provides that a final dividend may only be declared by an ordinary resolution of the shareholders, following a recommendation by the directors)
  • general meetings - shareholder decision-making is addressed at considerable length in the Act, but the articles often contain supplementary provisions relating to general meetings, dealing with matters such as attendance and proxy notices
  • the company's ability to indemnify its directors or purchase insurance for them (see, for example, articles 52 and 53 of the model articles for private companies).

It will be apparent from this list that the articles can venture into territory which is readily comprehensible only to someone with a good working knowledge of company law.  How, then, should a new director with no company law experience set about the task of getting to grips with them?

The first step is to read the articles.  Some of the detail may well be difficult to absorb, but the essential features of many of the provisions - those on board decisions, for example - will be apparent to most people, regardless of whether they have a legal background or experience of running a company.  As far as the more technical aspects of the articles are concerned, and indeed the practical implications of even those provisions which appear to be relatively clear, the company secretary, if there is one, will normally be an excellent source of information, and other board members may be able to provide valuable guidance.  If there are any remaining areas of concern, the solution, of course, is to seek external legal advice.

The key point is that the articles are important.  A responsible and diligent director will appreciate that they are not merely a technical legal document which he can choose to ignore.  One way or another, he will ensure that, as part of his efforts to comply with the wishes of the company's owners, he knows what they say and understands their implications.

Nigel Banerjee can be contacted at nigel.banerjee@kcl.ac.uk.

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