The Companies Act 1985: interpritation

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Title: The Companies Act 1985 s. 14(1) states: Subject to the provisions of this Act, the memorandum and articles, when registered, bind the company and its members to the same extent as if they respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles. In Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915] 1Ch 881 at 897 Astbury J said of this provision: "The wording of [this subsection] is difficult to construe or understand." Consider the differences in the interpretation of this provision. What are the main alterations to this provision which have been made by s.33(1) Companies Act 2006? ANSWER Introduction All practitioners and students of company law will be familiar with section 14 of the Companies Act 1985 and its somewhat convoluted implications. The section provides that, on registration the memorandum and articles of a company together bind the company and all of its members to a contract incorporating their terms just as if the documents had been signed by each member and included undertakings on the part of each member to respect and adhere to the provisions of the memorandum and articles. Section 14 has long been known as imposing a corporate or statutory contract on the company and its members. In recent times steps have been taken to replace the Companies Act 1985. The Companies Act 2006 received the Royal Assent on 8 November 2006. Margaret Hodge, Minister for Industry and the Regions, has welcomed the new Act as predicted to “bring major benefits to business by modernising and simplifying company law” and set out an implementation timetable which pledges to commence all parts of the Act by October 2008.[1] That said, it is anticipated that most parts of the Act will actually be brought into force by October 2007.[2] Consisting of 1300 sections the 2006 Companies Act is the largest piece of legislation ever brought onto the statute book. Among its many changes is a re-writing of the section 14 corporate contract. The new version, which is contained in section 33(1) of the 2006 Act, has been simplified and re-worded. The contrast between the two provisions is analysed in the following commentary after an examination of the old law and the jurisprudence relating to it. Section 14 of the Companies Act 1985 Section 14 of the Companies Act, the text of which is set out in the title above, has effect, as stated, that the memorandum and articles of association constitute a contract between the company and each member and between the members themselves. However, it is long established principle that the memorandum and articles do not have the capacity to constitute a contract with outsiders unless an express agreement exists to the contrary or a provision of the constitutional documents is found to constitute an implied term of a contract between a third party and the company.. The legal superstructure surrounding the section 14 contract is therefore sophisticated and complex. Moreover given that the contract seeks to govern the often fraught relationships between a company and its shareholders and between the shareholders themselves it is hardly surprising to note that litigation on the issue is fairly commonplace.. These factors have combined over the years to produce a dense and sometimes uncertain body of law. It is therefore unsurprising that in Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915][3] Astbury J reportedly stated that the wording of section 14 is “difficult to construe or understand”. In the following sections of this paper the individual characteristics and effects of the section 14 corporate contract are analysed and explained using case law illustrations. The form and nature of the statutory contract At the outset it is pertinent to consider the nature of the statutory contract established by the memorandum and articles. Cogent authority for the contractual effect of the articles can be distilled from the declaration of Lord Selbourne LC in the House of Lords in the case Oakbank Oil Co v Crum (1882)[4]. The Lord Chancellor stated: “Each party must be taken to have made himself acquainted with the terms of the written contract contained in the articles of association… He must also in law be taken to have understood the terms of the contract according to their proper meaning… and that being so he must take the consequences whatever they may be, of the contract which he had made.”[5] The contract created by section 14 is, it is submitted, a special statutory contract with its own distinctive characteristics. The binding force behind the contract flows directly from statute, rather than from any bargain struck between the parties and as such it is directly subject to and referable to other provisions of the Companies Act.. For example, section 9 of the 1985 Act provides that the terms of the statutory contract, the articles of association, can be varied by a three-quarters majority vote of the members voting in general meeting (a special resolution). This is clearly in contrast to the ordinary rules of contract, where unanimity between the parties (or consensus in idem) is required for a variation of contractual terms. This rule has clearly been embedded for pragmatic reasons of effective management and control. Mindful of the fact that a company may have many members the statutory contract acknowledges the risk of possible stagnation and therefore provides this crucial exception to the “normal” and golden rule of contractual conduct. It is useful to note that there are other contractual principles which are inapplicable in the case of the statutory contract as a consequence of its unique nature. For example, unlike the case with a normal contract, as illustrated by the case Scott v Frank F Scott (London) Ltd (1940)[6] the court has no jurisdiction to rectify a set of articles once registered even if it can be proved that they do not, as they stand, represent what was the true original intention of the promoters who incorporated the company. Nor can the court endeavour to imply terms for the purpose of supplementing the articles under the business efficacy rule as the case Bratton Seymour Service Co Ltd v Oxborough (1992)[7] testifies. The first legal consequence of the section 14 contract is that the memorandum and articles are held to comprise a binding contract between the company and each individual member. The corollary of this is that each member will be held to be bound to the company by the provisions set down in the company’s articles in his capacity as member. Furthermore, although section 14 does not explicitly lay down the rule that the articles bind the company to the membership, the company is indeed treated as bound to each member in his capacity as member to honour all the provisions made out in the articles. The case of Hickman v Kent or Romney Marsh Sheepbreeders’ Association (1915)[8] is instructive. Hickman was engaged in a dispute with the Association in question. However, the Association’s articles provided that disputes between the company and the membership must be referred to an arbitration process. Hickman sought to assert to the court that the articles did not constitute a contract between the members and the company, and thus that he was not bound by the arbitration clause. The matter was considered by Astbury J, who analysed the case law, but it was thereafter held that the articles were binding and that the Association was entitled to a stay in the action. The articles were indeed found to constitute a contract between the company and the members so as to ensure that arbitration was employed to resolve disputes. Supporting authority can be found, inter alia, in the case of Pender v Slatington (1877)[9]. Here at a shareholders’ meeting the chairman declined to accept a member’s votes. The articles provided that one vote would be allocated to every ten shares owned by shareholders. The decision of the chairman caused the defeat of a resolution proposed by the member in question, and as a consequence he applied to the court for the grant of an injunction preventing the directors acting in contravention of the denied resolution. The plaintiff succeeded in his claim: the court once again confirming that the articles were a contract binding on the company just as it was binding on the members of the company. In Wood v Odessa Waterworks Co (1889)[10] the articles provided that a dividend should be paid to the members annually. One year the company issued a debenture to members instead and a member complained to the court. It was held that the articles should have been followed. Stirling J stated quite categorically that: “the articles of association constitute a contract not merely between the shareholders and the company, but between each individual shareholder and every other.” That said, in Salmon v Quin & Axtens (1909)[11] Farwell LJ approved Stirling J’s remark, but then stated that the court would not enforce the covenant as between individual members in most cases. Moreover, in the case Welton v Saffery (1897)[12] Lord Herschell denied that there was any contract between the individual members of a company and ruled that any rights given to them inter se could only be enforced by or against a member through the conduit of the company itself: “It is quite true that the articles constitute a contract between each member and the company, and that there is no contract in terms between the individual members of the company; but the articles do not any the less…regulate their rights inter se. Such rights can only be enforced by or against a member through the company or through the liquidator representing the company..” In light of this ostensibly contradictory statement it seems that Astbury J’s comments in the earlier Hickman v Kent or Romney Marsh Sheepbreeders’ Association case that are highlighted in the title to this paper were indeed well founded. Further confusion was added by Scott LJ in London Sack & Bag Co Ltd v Dixon & Lugton (1943)[13]. He stated: “It may well be, even as between ordinary members of a company who are also in the nominal way shareholders, that section 14 adjusts their legal relations inter se in the same way as a contract in a single document would if signed by all.” It is submitted that the weight of case law does confirm that the memorandum and articles will be enforced as a contract between the members themselves. There is surely considerable practical utility and commonsense in permitting members to bring actions against each other if one party fails to adhere to a provision in the memorandum or articles without the complexity time and expense of involving the company. Why should it be necessary to involve the company in any such action? Additionally it should be noted that there is always a real risk that the members against whom it is intended to enforce the articles either have control of or are able to exert influence on the board of directors who will be charged with the decision as to whether to authorise the use of the company name in order to enforce the articles. It seems to defy any intelligent analysis to insist on the company’s participation in actions directly concerning and between individual members. In Rayfield v Hands (1960)[14] Vaisey J commented that he found the statement of Lord Herschell in Welton v Saffery “somewhat cryptic” and it is suggested that this is judicial code for “plainly wrong”. In Rayfield a company’s articles provided that members wishing to transfer their shares should inform the directors of the company, who would be obliged to purchase the shares at a fair price. The plaintiff member held a number of shares and requested that the defendant directors should buy them but this request was declined. An action was brought to sue on the contract established by the articles of association and this was done without joining the company. The court had no difficulty in finding that the directors were bound to buy the shares. The articles were found, on the strength of section 14, to have created a binding contract between the directors, in their capacity as members, and the plaintiff, in his capacity as a member. The memorandum and articles do not provide rights or impose obligations on non-members. It is a corollary of the above rule that no legal rights purportedly given by the memorandum or articles to a member in any capacity other than that of member (for instance either as a company solicitor or a director) will be enforceable against the company.. So called ‘outsider rights’ will not be enforced. The memorandum and articles do not constitute a contract with outsiders and must be confined in their effect to the members in regards to their rights and obligations in that capacity. In the case Eley v Positive Government Security Assurance Co (1876)[15] the articles of association expressly stated that the plaintiff would be employed as the company’s solicitor. After acquiring shares in the company the plaintiff worked for the company for a period of time, but later the company dismissed him. The plaintiff sued for breach of the contract that was constituted by the articles. Perhaps the plaintiff’s credentials as a solicitor were not as strong as they could have been because, predictably, it was held that the action must fail because there was no binding contract in the articles between the company and the member in his capacity as a solicitor, which was held to be no more than an outside interest in terms of the statutory contract. The foregoing cases map out much of the legal effect of the section 14 contract. It is clear that while there has been confusion as to the meaning of section 14 in the past, and in particular at the time at which Astbury J made his featured comment in Hickman, much of this ambiguity has now been resolved. The new statutory contract: Section 33(1) Companies Act 2006 As stated section 14 is now in the process of being replaced by section 33(1) of the Companies Act 2006. The new provision states as follows: 33 Effect of company's constitution (1) 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. This can be set against the text of the old provision, which provides: 14. Subject to the provisions of this Act, the memorandum and articles, when registered, bind the company and its members to the same extent as if they respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles.” The two provisions seem to be very similar in substance, although the new provision set out in section 33(1) of the 2006 Act has been simplified and drawn in more streamlined terms. This chimes with the fact that a new simplified and streamlined model set of articles has also been made available under the new Act. It is pertinent to note that under the 2006 Act the status of the company memorandum has changed to become merely a formal document recording the position at the point of registration, and that just the articles of association will be treated as the continuing constitutional document of the company. This does not represent a major change in practice given that it has always been the company’s articles of association that have provided the vast majority of any terms that have fallen subject to litigation. In summary it is submitted that the new provision does not alter the previous law in significant terms or challenge the principles of case law that have been established alongside the application of earlier versions of section 33(1). The language of the provision has been clarified and updated and it is now specifically referable to the articles only, but that aside, previous precedents on the section 14 contract will continue to be of bearing. Concluding Comments on the Corporate Contract As stated in the title to this paper, in Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915][16] Astbury J complained that the wording of section 14 was “difficult to construe or understand”. It took almost 100 years before Parliament responded to his concern, but the section 14 provision has now finally been re-written in the form of section 33(1) of the Companies Act 2006. Many of the concerns and ambiguities noted by Astbury J in 1915 have been resolved in the intervening period. As the simplified provision contained in section 33(1) of the 2006 Act beds down it is predicted that far fewer judicial concerns will be apparent in subsequent years because most of the questions that could be asked of it have already been answered by the courts. THE END DOCUMENT WORD COUNT : 2931 (excluding footnotes) BIBLIOGRAPHY Companies Act 2006: http://www.opsi.gov.uk/ACTS/acts2006/ukpga_20060046_en.pdf. Dine J, Company Law, 5th ed, (2005) Palgrave Macmillan DTI, Companies Act 2006: A summary of what it means for private companies, February 2007: http://www.dti.gov.uk/files/file37956.pdf. DTI Government News Network: http://www.gnn.gov.uk/environment/detail.asp?ReleaseID=240760&NewsAreaID=2 French D, Blackstone's Statutes on Company Law 2006-2007, (2006) Oxford University Press Grier N, Company Law, (2005) W.Green Griffin, Company Law Fundamental Principles, 4th ed., (2005) Longman Hicks A & Goo S.H., Cases & Materials on Company Law, 5th ed, (2004) Oxford University Press House of Commons Hansard Cases as footnoted. 1

Footnotes

[1] Hansard 28 January 2007, Column 90WS. [2] See: http://www.bytestart.co.uk/content/19/19_1/companies-act-guide.shtml. [3] [1915] 1Ch 881 at 897. [4] (1882) 8 App Cas 65. [5] Ibid, at p70. [6] (1940) Ch 794. [7] [1992] BCLC 693. [8] [1915] 1 Ch 881. [9] (1877) 6 Ch D 70. [10] (1889) 42 Ch D 636. [11] [1909] 1 Ch 311.. [12] (1897) AC 299. [13] [1943] 2 All ER 763. [14] [1960] Ch 1. [15] (1876) 1 Ex D 88. [16] [1915] 1Ch 881 at 897.
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