CPA Section 3: Promoters, Company Promotion and Pre-Incorporation Contracts

Company Law Block Revision Mock Exams

Promotion is conducted by persons who come up with the idea to form a company. They are legally referred to as promoters.

A promoter is a person who was a party to the preparation of the Company Prospectus or on the particulars thereof but doesn’t include any person so engaged in his professional capacity e.g. Advocate, CPS, unless they are named as directors of the company being formed.

In the words of Cockburn C.J in Twycross v Grant (1877) 2C.P.D. 469:

“A promoter, I apprehend, is one who undertakes to form a company with reference to a particular project and set it going and who takes the necessary steps to accomplish that purpose.                ”

This explanation fails to capture the role that a person must play to qualify as a promoter. In the words of Lindley J in Emma Silver Mining Co. V Lewis 4 C. P. D. 396 (I879):

“As used in connection with companies, the term promoter involves the idea of exertion for the purpose of getting up and starting a company (floating it).”

This explanation also fails to fully identify the role of a promoter.

Promotional acts usually include:

  1. Preparation of the Memorandum and Articles of the proposed company
  2. The appointment of the first directors
  3. Preparation of the prospectus
  4. Negotiating the preliminary contracts
  5. Paying the preliminary expenses etc.

 

A PROMOTER DEMYSTIFIED

It has been observed that a promoter is a person who comes up with the idea of enterprise and participates in transforming the idea into a company. He is said to be the person who prepares the documents, registers the company and meets its preliminary expenses.

A promoter is any person who has taken some part in bringing a company into existence or in procuring persons to join it as soon as it is technically formed.

The role of a promoter may be active or passive e.g. the advocate engaged to form a company becomes a promoter thereof if he agrees to become a director or provides a director.  The question as to who a promoter is one of fact and varies from case to case. In the words of Bowen L.J. In Whaleybridge Calico printing Co Ltd V Green,

“The term promoter is a term not of law but of business it usefully sums up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence. Although company law recognizes the role played by a promoter the term still remains ill-defined and so is the promoter’s relationships with the company in formation. He is therefore described as an illegitimate child of the law; actively known but formally ignored.”

 

THE LEGAL POSITION OF A PROMOTER

 A promoter is not an agent of the company in formation as it does not legally exist. This is because at common law, a person cannot be an agent for a non-existing principal as it was held in Kelner V Baxter.

A promoter is also not a trustee of the company in formation as the beneficiary does not exist. This was so held in Omnium Electric Palaces Ltd V Baines.

Promoters thus stand in a fiduciary position with regard to the company in formation. In the words of Lord Cairns in Erlanger v New Sombrero Phosphates Co. (1878) 3 A.C. 1218 (The Sombrero case) are instructive,

“They stand in my opinion, undoubtedly in a fiduciary position [as] they have in their hands the creation and molding of the company. This is an equitable relationship based on trust confidence and good faith; it imposes upon the promoters certain equitable or fiduciary obligations”

In this case, the promoters of a company sold a lease to the company at twice the price paid for it without disclosing this fact to the company. It was held that the promoters breached their duties and that they should have disclosed this fact to the company’s board of directors.

 

DUTIES AND OBLIGATIONS OF PROMOTERS

Promoter’s duties fall into two broad categories; fiduciary and common law

Fiduciary Duties

  1. Duty to act bonafide: Promoters are bound to act in good faith in what they consider to be the best interest of the company and all actions must be guided by the principles of utmost good faith and fairness.
  2. Proper accounting: Promoters are bound to explain the application of monies or assets which come into their hands from the date they become promoters. The account must be complete and honest.
  3. Disclosure: As fiduciaries, promoters are bound to disclose personal interest in transactions to avoid conflict of interest. Any secret profit made must be disclosed failing which the promoter is liable to account for the same and the contract may be rescinded by the company. Such disclosure may be made to an independent board of directors or to all members in the prospectus.

In the Sombrero Case, persons who were in the process of forming a company bought a lease in the West Indies for £55,000 so as to mine phosphate deposits. They sold the lease to the company for £110,000 a fact that they did not disclose. The facts came to light 8 months later and all the directors were removed from office. The company sought to rescind the contract for the non-disclosure and it was held that it was entitled to do so. Whereas disclosure to the general body of shareholders is sufficient, disclosure to a few persons who constitute the initial membership of the company is insufficient.

It was so held in Gluckstein V Baines (1900) where the plaintiff and four others bought certain premises for £140,000 and sold it to a company they were forming for £180,000. The company had no independent board of directors. Although the prospectus disclosed the £40,000 profit, it did not disclose a further £20,000 the promoters had made on the premises. In liquidation, the liquidator sought to recover £6,341 from Gluckstein as his share of the secret profit. It was held that he was liable to account for the non-disclosure. In the words of Lord Macnaghten:

“Disclosure is not the most appropriate word to use when a person who plays many parts announces to himself in one character what he has done or is doing in another…to the intended shareholders there was no disclosure at all an elaborate system of deception was practiced on them.”

 

Common law or General Duties

  1. Determine and settle the company name.
  2. To request or cause the registration of a company.
  3. To prepare or cause the preparation of the constitutive documents.
  4. To meet the preliminary expenses.
  5. To secure the services of directors.
  6. To prepare the prospectus if necessary.
  7. To ensure that the company has an independent board of directors
  8. To acquire assets for use by the company.
  9. To enter into business contracts on behalf of the company.

 

REMUNERATION OF PROMOTERS

A promoter is neither entitled to remuneration for incorporating the company nor is he entitled to recover the expenses incurred. This is because there is no contractual relationship between the promoter and the company. Such a contract cannot exist as the company has no legal existence or capacity to contract – Kelner v Baxter

The company could not after its incorporation enter into a contract to pay him for his services because no consideration to support the contract would be furnished by him. The services rendered would be past consideration.

However in practice promoters recover their expenses in accordance with the Articles. For example, a clause providing that Company Directors may pay all the expenses incurred in promoting and registering it.

Promoters may be rewarded in other ways as follows:

  1. Upon disclosure, a promoter is free to sell overvalued assets to the company in formation in return for a profit.
  2. By disclosing, a promoter is free to sell overvalued assets to the company in return for fully paid shares.
  3. A promoter may act as an agent to enable the company acquire an undertaking from a third party in return for a commission which ought to be disclosed.
  4. Promoters may be afforded the opportunity to take up extra shares at par value after the market value has risen.
  5. Traditionally, promoters have been rewarded by being offered either deferred, founders or management shares.
  6. Promoters may also be appointed as the initial directors of the company

PRE-INCORPORATION CONTRACTS/PRELIMINARY CONTRACTS

These are contracts entered into by persons purporting to do so on behalf of the company before its incorporation. They are also referred to as Preliminary Contracts.

Under Section 18 (4)of the Companies Act, a company comes into existence on the date of incorporation. Before then it is not a legal person and has no capacity to contact or have agents.

At common law, a pre incorporation contract is generally unenforceable by or against the company.

Section 44 of the Companies Act provides that a contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as a contract made with the person purporting to act for the company or as agent for it, and the person is personally liable on the contract accordingly.

 

RULES GOVERNING PRE-INCORPORATION CONTRACTS

  1. Before incorporation, a company has no legal existence it can neither contract nor have agents as held in Kelner v. Baxter (1886)
  2. At common law, a person who purports to contract as an agent where he has no principal existing at that particular time is personally liable on the contract. This was so held in Kelner v. Baxter (1886) where 3 persons who were forming a company ordered a large quantity of wine from plaintiff and signed the contract as follows:

“On behalf of Gravesend Royal Alexander Hotel Ltd”

The wine was supplied and consumed by the hotel business which subsequently collapsed. The plaintiff sued the promoters in question and the issue was who the contracting parties were. It was held that even though the defendants had contracted as agents, they had no principal and were thus personally liable on the contract. The Court was of the considered view that it was necessary to hold the defendants liable to give effect of the contract by stating:

“Where a contract is signed by one who professes to be signing as an agent, but who has no principal existing at the time and the contract would be altogether inoperative unless binding upon the one who signed it, he is bound thereby and a stranger cannot, by a subsequent notification, relieve him from such responsibility”

  1. At common law a contract purportedly entered into by a nonexistent person is void. This is because for a contract to come into existence there must be at least two parties. In Newborn v. Sensolid (G.B Ltd) (1954) a contract was entered into between Leopold Newborn London Ltd and the Defendant for purchase of goods by the latter. The defendant subsequently refused to take delivery of the goods and an action was commenced by Leopold Newborn Ltd. It was discovered that at the time the contract was entered into, the company had not been incorporated. Leopold Newborn thereupon sought personally to enforce the contract. It was held that the signature on the document was the company’s signature and as the company was not in existence when the contract was signed, there never was a contract and Mr. Newborn could not come forward and say that it was his contract. The fact was that he made a contract for a company which did not exist. In the words of Lord Goddard:

“This purports to be contract by the company; it doesn’t purport to be a contract by Mr. Newborn. He does not purport to be selling his goods. The only person who had any contract here was the company and Mr. Newborne’s signature merely confirmed the company’s signature.”

  1. At common law, a pre-incorporation contract cannot be ratified by the company after incorporation as the company did not exist when the contract was entered into. It was so held in Price V Kelsal (1959). In Natal Land Co. Ltd V Pauline Colliery Syndicatewhere the respondent company applied for specific performance of a contract entered into before its incorporation, it was held that the contract was unenforceable as it was incapable of being ratified by the company.
  2. At common law, the mere adoption or confirmation by directors of a contract entered into before incorporation creates no relationship whatsoever between the company and the party. It was so held in North Sydney Investments and Another V Higgins and Another.
  3. At common law, a pre-incorporation contract is enforceable by or against the company if after incorporation the company has entered into a new contract similar to the previous agreement. It was so held in Howard V Patent Ivory Manufacturing Co Ltd. The new contract by the company may be express or implied by the conduct of the company after incorporation. In Mawagola Farmers & Growers Ltd. V Kanyanja and Others (1971) the appellant company had 500 shares of 20 UGShs each. Before incorporation, its promoters held many meetings in many parts of Uganda soliciting subscribers for the shares. Some of the respondents bought shares from the promoters while others bought them from the company after incorporation. No shares were allotted to them. The returns of the company showed that all the shares had been allotted, the company shares had been consolidated and the company’s capital had been increased. The respondents applied to the High Court for rectification of the register of members to include their names as members and the High Court ordered the rectification on the ground that the company had entered into new contract after incorporation. The company appealed. The Court of Appeal upheld the decision on the ground that there was evidence a new contract by the company.

REMEDIES AGAINST PROMOTERS FOR BREACH OF DUTY

The company or a third party may pursue any of the following remedies against the promoters where appropriate for breach

The company or third party who has dealt with a promoter in breach of his fiduciary obligations may rescind the contract in question. The essence of the remedy is to restore the parties to the position they were before the contract. Its grant or refusal is dictated by the principles of equity.

The remedy is unavailable where:

  • The party entitled to it has slept on its rights for too long.
  • The party entitled to it has expressly or impliedly affirmed or accepted the contract.
  • Third party rights have arisen on the contract.
  • Restitutio in integrum is not possible.

In the Sombrero case, it was held that the company was entitled to rescind the contract for non-disclosure by the promoters.

  1. Account / recovery of profit.

The company is entitled to recover any secret profit made by a promoter in his promotional activities without disclosure. The same is recoverable under an action for money had and received as held in Gluckstein V Barnes (1900) where Gluckstein was ordered to account for £6,341 which was a secret profit he had made as a promoter.

The company has an action in damages against a promoter for breach of duty which is sustainable notwithstanding the absence of fraud. This action is an alternative to an account. In Re Leeds and Hanley Theater of Varieties Ltd, where a promoter had made a secret profit of £12,000 and the company sued, the Court of appeal awarded the same as damages.

Under section 44 (1) of the Act, persons who purport to enter into contracts on behalf of the company before the company is formed are personally liable on the same.

Additionally, a third party who has suffered loss or damage by reason of subscribing for shares or debentures of a company on the faith of a prospectus containing any untrue statement is entitled to compensation for loss or damage by among others, every person who was a promoter of the company.

  1. Investigations

Under Part XXX of the Act an investigation may be made into the affairs or the membership of the company.

Section 788(2)(c) is clear that investigations shall be conducted where the persons responsible for the company’s formation (promoters) or the management of its affairs are or have been guilty of fraud, misfeasance or other misconduct towards it or towards its members. This means that the promoters will be personally liable for breach of their duty.

THE COMPANY’S CONSTITUTION

Part III of the Companies Act 2015 deals with the Company’s Constitution i.e. the Memorandum and Articles of Association.

THE MEMORANDUM OF ASSOCIATION

Under the 2015 Act the Memorandumserves a limited but nonetheless important purpose.

It evidences the intention of the subscribers to the Memorandum to form a company and become members of that company on formation. In the case of a company limited by shares the Memorandum will also provide evidence of the members’ agreement to take at least one share each in the company.

Section 12 (1) of the Act provides that aMemorandum of association is a Memorandum stating that the subscribers:

  • Wish to form a company under this Act; and
  • Agree to become members of the company and,
  • In the case of a company that is to have a share capital, to take at least one share each.

A company may not be registered unless its Memorandum of association is:

  • In the form prescribed by the regulations,
  • Authenticated by each subscriber, and
  • Lodged with the Registrar for registration during company formation

The Memorandum is therefore very different from that created under the previous Companies Act which had clauses such as Name Clause, Capital Clause, Liability Clause, Situation Clause, Objects Clause etc. In addition, it will not be possible to amend or update the Memorandum of a company formed under the 2015 Act.

In terms of transition, Section 26 of the 2015 Act provides that provisions contained in previous versions of Memorandum of Association but are not provisions of the kind referred to in Section 12, (the MOA clauses) become provisions of the company’s Articles on that commencement.

It’s important to also note that key information regarding the internal allocation of powers between the directors and members of the company will be set out in the Articles of Association.

 

THE DOCTRINE OF ULTRA VIRES AND THE COMPANY’S CAPACITY

Ultra vires literally means beyond the powers. It is the rule of capacity formulated in Common Law and adopted in varying degree by statute. Its effect was to limit the contractual capacity of a company so as to restrict the risk to the shareholder’s capital.

This is a legal rule articulated by the House of Lords in the case of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche to the effect that where a contract made by a company is beyond the objects of the company as written in the object’s clause of the Company’s Memorandum of Association it is beyond the powers of the company to make the contract. Lord Cairns states in obiter dictum that such a contract cannot be ratified even by the unanimous consent of all the shareholders of the company. If deemed ultra vires, then the directors would be found personally liable.

This common law rule has however been done away with by S.28 and S.33 of the 2015 Act.

Section 28 provides that unless the Articles of a company specifically restrict the objects of the company, its objects are unrestricted.

Section 33 states that the validity of an act or omission of a company may not be called into question on the ground of lack of capacity because of a provision in the Constitution of the company.

This effectively means that the Company has the capacity to undertake any transaction, which must be legal, without any limitation instigated by the Constitution.

Section 34 further provides that the power of the directors to bind the company, or authorize others to do so, is free of any limitation contained in the company’s Constitution. Additionally:

  • The 3rd party must be dealing with the company in good faith
  • Is assumed to have been dealing in good faith unless proven otherwise
  • The 3rd party need not enquire as to any limitationon the powers of the directors to bind thecompany or to authorize others to do so

NB:

  1. Where the directors have however exceeded their powers, they will be personally liable.
  2. 34 does not prevent legal action being instituted under any other laws challenging the validity of the contract entered into by the Company. Such contracts are voidable at the option of the company
  3. The director in question or a connected party in such a contract will be liable to:
  • Account for any gains made directly or indirectly under the contract
  • Indemnify the company for any loss or damage resulting from the transaction
  1. The contract ceases being voidable if:
  • Restitution ad integrum is not possible.
  • The company is fully indemnified
  • A bona fide 3rd party’s rights would be affected
  • The transaction is affirmed by the company

 

THE ARTICLES OF ASSOCIATION

Under the 2015 Act, the Articles of Association are the key constitution of the company.They are registered with the Registrar upon incorporation of the company.

Under Section 21, where Articles of Association are not registered, the Model Articles of Association (previously Table A) will apply by default. The Regulations to the 2015 Companies Act will provide for Model AOA for public and private companies.

Section 26 of the Act provides that provisions which previously would be found in the Memorandum of association but which should now be considered as part of the Articles of Association will be duly considered as such.

Section 28 provides that unless the Articles of a company specifically restrict the objects of the company, its objects are unrestricted. This is an important section because it greatly diminishes the application of the doctrine of ultra vires in company law.

Legal Effect of Registering the Articles

Section 30 provides that a company’s constitution binds the company and its members to the same extent as if the company and its members had covenanted or agreed with each other to observe the constitution. As a result, money payable by a member to the company under its Constitution is recoverable in a court of competent jurisdiction as a debt due from the member to the company

The existence of this contract was first acknowledged by Lord Herschell in Welton v. Seffery (1891) where he observed:

“It is quite true that the Articles constitute a contract between each member and the company.”

It is contended that the contract created by the Articles has certain special characteristics. These characteristics were highlighted by Ashbury J in Hickman v.  Kent (1915). Article 49, of the affected Company’s Articles, provided that any dispute between a member and the company should be referred to arbitration.  A dispute arose between Hickman and the company, in which he was a member, and its secretary.  Hickman sued the company.  The company applied for a stay of the proceedings for the dispute to be referred to arbitration in accordance with article 49.  The court granted a stay on the ground that Articles constituted a contract between the company and its members and therefore both were bound to observe its provisions.  In making this decision Ashbury J laid down the following features of the contract: –

  1. No Article can constitute a contract between a company and a third person. The contract created by the Articles is between the company and its members only.
  2. No right merely purporting to be given by an Article to a person e.g. director or promoter can be enforced against a company unless that person is a member and brings the action in his own capacity as a member. The rights conferred by this contract can and only be enforced by members in their capacity as members.
  • The contract created by the Articles must be consistent with the Memorandum and the provisions of the Companies Act.
  1. The terms of the contract keep on changing from time to time whenever the company alters its Articles in exercise of the power conferred upon it in Sec. 22.
  2. The contract confers rights and imposes obligations on the company and its members.

In Eley v. Positive Government Life Assurance Co., Article 118, of the defendant company’s Articles, provided that Eley be appointed the company solicitor for life to transact all the companies’ legal business at a fee.  After incorporation, Eley was appointed the company’s solicitor and transacted its legal business for some time.  He then bought shares and became a member.  Shortly thereafter the company ceased to employ him preferring other solicitors to transact its legal business.  Eley sued to enforce the Contract in Article 118. It was held that the Articles were unenforceable since Eley was an outsider. Though he was a member, he was suing to enforce a right accruing to him in a capacity other than that of a member.

In Rayfield v. Hands, Article 11 of the affected company’s Articles, provided that any member intending to transfer shares had to inform the directors who were to take up the shares equally between them at a fair value.  Rayfield who held 725 shares informed the directors of his intention to transfer his shares but the directors declined to take up the shares.  The directors were also members of the company.  Rayfield sued the directors to enforce Article 11.  It was held that the Article was enforceable as it referred to directors in their capacity as members.

Amendment of the Articles of Association

Section 22 provides that a company may amend its Articles only by special resolution – qualified majority of 75%

In Andrews v. Gas Meter Co. Ltd (1906), the original Articles of the company stated that the company had no power to issue preference shares.  The company had by a special resolution altered the Articles to give itself the power to issue preference shares to increase its capital.  The plaintiff sued on the question whether a company could alter its Articles to give itself a power it did not have under the original Articles.  It was held that a company could alter its Articles to confer upon itself such a power since the power to alter Articles was statutory.

  1. Statutory Restrictions On The Alteration Of The Articles

Generally, a member is bound by the AOA as well as any subsequent amendments thereafter.

However, Section 23 provides that a member of a company is not bound by an amendment to the Articles of a company after the date on which he became a member, if the amendment:

  1. requires the person to take or subscribe for more shares than the number held by the person at the date on which the amendment is made: or
  2. in any way increases the person’s liability as at that date to contribute to the company’s share capital or otherwise to pay money to the company.

Section 23 does not apply if the member agrees in writing to be bound by the amendment.

The amended Articles must be lodged with the Registrar for registration within14 days after the special resolution containing the amendment is passed, failing which the company, and company officers, commit an offence and on conviction are each liable to a fine not exceeding KES 200,000.

Other Restrictions include:

  1. The alteration must be authorized by a special resolution of members in a general meeting.
  2. The alteration must not be inconsistent with the provisions of the Companies Act or any other written law.
  3. It must not increase the liability of members or require them to take up more shares without written consent.
  4. It must not be inconsistent with the rights of dissenting members affected by a variation of class rights to apply to the Court for the variation to be cancelled.
  5. It must not be contrary to a Court order (if any) made pursuant to the Act for the purposes of minority protection.

Resolutions Requiring Registration

The following resolutions and agreements will be deemed to affect the company’s Constitution and should be registered with the registrar within 14 days of being passed:

  1. A special resolution;
  2. A resolution or agreement agreed to by all the members of a company that if not so agreed to would not have been effective for its purpose unless passed as a special resolution
  3. A resolution or agreement agreed to by all the members of a class of shareholders that if not so agreed to would not have been effective for its purpose unless passed by a particular majority or otherwise in a particular manner;
  4. A resolution or agreement that effectively binds all members of a class of shareholders though not agreed to by all those members
  5. A resolution to give, vary, revoke or renew authority for the purposes of section 451 – authorization for off-market purchase of shares;
  6. A resolution conferring, varying, revoking or renewing authority following market purchase of a company’s own shares;
  7. A resolution for voluntary liquidation;
  8. A resolution passed regarding transfer of securities.

 

  1. Common Law/Judicial Restriction on the alteration of the Articles

The alteration must be made in good faith and for the benefit of the company as a whole. It was held inAllen v. Gold Reefs of West Africa (1900) 1 Ch. 626. In the words of Lindley J:

“[This power] must  be  exercised  subject  to  the  general  principles  of  law  and  equity  which  are  applicable  to  all  powers conferred on majorities and enabling them to bind minorities. It must be exercised not only in the manner required by law but also bona fide for the benefit of the company as a whole.”

Further reference may be made to the case of Shuttleworth v. Cox Brothers Ltd (1927) 2 KB 29where the Articles of the Company provided that the Plaintiff and 4 others should be the first directors of the company. Further each one of them should hold office for life unless he should be disqualified on any one of some six specified grounds, bankruptcy, insanity etc. The Plaintiff failed to account to the company for certain money he had received on its behalf. Under a general meeting of the company a special resolution was passed that the articles be altered by adding a seventh ground for disqualification of a director which was a request in writing by his co-directors that he should resign. Such request was duly given to the Plaintiff and there was no evidence of bad faith on the part of shareholders in altering the articles. The Plaintiff sued the company for breach of an alleged contract contained in their original articles that he should be a permanent director and for a declaration that he was still a director. The court held that the contract if any between the Plaintiff and the company contained in the original articles in their original form was subject to the statutory power of alteration and if the alteration was bona fide for the benefit of the company, it was valid and there was no breach of contract. Lord Justice Bankes observed as follows:

“In this case, the contract derives its force and effect from the Articles themselves which may be altered. It is not an absolute contract but only a conditional contract.”

The question here is who determines what is for the benefit of the company? Is it the shareholders or the Courts? Scrutton L.J. had the following to say:

“… to adopt such a view that a court should decide will be to make the court the manager of the affairs of innumerable companies instead of shareholders themselves. It is not the business of the court to manage the affairs of the company. That is for the shareholders and the directors.”

The Courts are however clear than when determining the validity of an alteration, regard must also be had or given to existing and future members of the company.

In Sidebottom v. Kershaw Leese & Co. Ltd the Plaintiff was a minority shareholder in a small farming company.  He was interested in a business which was in direct competition with that of the company. Members in the general meeting resolved to add to the Articles that a shareholder had to transfer his shares to nominees of directors if a written request was served upon him by the board.  A request was served upon the Plaintiff who instituted proceedings challenging the validity of the said Article.  It was held that the alteration was valid as it was beneficial to the company to get rid of competition from its membership.

However in Brown v. British Abrasive Wheel Co. Ltd a public company required further capital urgently or risked being wound up.  The majority holding 98% of the shares were willing to provide the capital provided that they were allowed to buy the shares of the minority.  The minority refused to sell the shares.  The majority in general meeting resolved to add to the Articles a provision to the effect that a member was bound to transfer his shares if a written request was served upon him by holders of not less than 90% of the shares.  The Plaintiff challenged the validity of the proposed alteration.  The Courts granted an injunction restraining alteration as it was not made in good faith and for the sake of the company as a whole but exclusively for the benefit of the majority.

 

Alteration of Articles and the Effect on Directorships

The legal consequence of an alteration of the Articles on a contract of directorship depends on how the director was appointed to office.A director may be appointed to office:

  • In accordance to the Articles;
  • Under a contract of service independent of the Articles; and
  • Under a contract of service dependent on the Articles.
  1. Directorship under the Articles

A director appointed to office in accordance with the Articles remains in office so long as the Articles remain unchanged.

If they are altered by the company in such a way that he loses office, the director has no actionable claim against the company as was the case in Shuttleworth v. Cox Brothers Ltd (1927) 2 KB 29where the Articles provided that the plaintiff and other persons be appointed directors and hold office for life unless removed on any of certain six grounds as enumerated by the Articles. The plaintiff had on many occasions failed to account of monies received on behalf of the company. The members resolved to add to the Articles a seventh ground for disqualification of directorships i.e. a director had to resign if a written request was served upon him by the other directors. A request was served upon the plaintiff who sued for a declaration that he was still a director. It was held that he had ceased to be a director of the company since his directorship was based on the Articles.

  1. Directorship under contract of service independent of the Articles

A director appointed to office under such a contract remains in office as long as the terms of the contract dictate and can only be removed in accordance with the terms of the contract.

Any purported removal on the basis of the Articles amounts to a breach of contract which the director has a remedy in damages as was the case in Southern Foundries v. Shirlaw (1940) A.C. 701 where the plaintiff was appointed MD of a company in 1833 under a 10 year written contract service. After a reorganization of the company, a new set of Articles was adopted. One of the Articles empowered the company to remove any director from office by notice. The plaintiff was removed from the office of director whereupon he ceased being the MD. The sued in damages for wrongful dismissal and was awarded £12,000.

A similar holding was held in Shindler V Northern Raincoat Co Ltd where the plaintiff has been appointed MD under a contract of service for 10 years but the company purported to remove him from office under the Articles. He was awarded £7500 in damages for breach of contract.

  1. Directorship under a contract of service dependent on the Articles

This is a contract of service which embodies the relevant provision of the Articles.

A director appointed to office under such a contract may be removed under the Articles as constituted or as altered from time to time.

This was the case in Read v. Astoria Garage (1952) 1 All.E.R 922 where the plaintiff was appointed and served as MD for 17 years. The Articles provided that an MD ceased to hold office if the general meeting so resolved or if he ceased to be a director for any reason among others. The board of directors terminated his term of office by notice to that effect that decision which the general meeting had passed had been ratified. It was held that he was not entitled to damages as the company had reserved to itself the power to remove the MD from office.

Can a company be restrained from altering the Articles?

This question arises where the proposed alteration leads to breach of contract or interferes with the rights of members.

In Punt V Symons it was held that an injunction will not be generally issued to restrain a company from altering its Articles.

In the words of Lord Porter in Southern Foundries Ltd V Shirlow:

“A company cannot be precluded from altering its Articles thereby giving itself the power to act upon the altered Articles, but so to act may nevertheless be a breach of contract if it is contrary to a stipulation in a contract validity concluded before the alteration”

However, an injunction may be granted to restrain a company from altering its Articles if it is the most appropriate remedy in the circumstances as held in British Mural Syndicate V Alpperton Rubber Co Ltd 1950 2 Ch. 186 where, by an agreement binding on the Defendant company it was provided that so long as the operative syndicate should hold over 5000 shares in the Defendant’s company, the Plaintiff’s syndicate should have the right of nominating two directors on the Board ofthe Defendant Company. A clause to the same effect was contained in Article 88 of the Defendant Company’s Articles of Association. Another Article provided that the number of directors should not be less than 3 nor more than 7. The Plaintiff syndicate had recently nominated 2 persons as directors. The Defendant Company objected to these two persons as directors and refused to accept the nomination and a meeting of shareholders was called for the purpose of passing a special resolution under Section 13 of the Companies Act cancelling the article. The court held that the defendant company had no power to alter its Articles of Association for the purpose of committing a breach of contract and that an injunction ought to be granted to restrain the holding of the meeting for that purpose.

 

THE DOCTRINE OF CONSTRUCTIVE NOTICE

This doctrine is to the effect that persons who deal with the company are deemed to know the contents of its public documents i.e. the Memorandum, the Articles, Special Resolutions among others. It was so held in Ernest V Nicholls.

This is because such documents are registerable with the Registrar and are open to public scrutiny by those who care to inspect them.

Persons who deal with companies are presumed to know the extent of their contractual capacity i.e. whether a transaction is intra or ultravires the company.

For purposes of the ultra vires doctrine a person transacting business with a company will be taken to be aware of the company’s objects, if restricted. Consequently, if he concludes a contract with the company and it turns out that the contract was for a purpose which is neither expressly nor impliedly within the company’s objects and hence ultra vires, he is regarded as having entered into an ultra vires contract knowingly even though he was not actually aware of its being ultra vires. He cannot successfully sue the company for breach of contract as was illustrated in Ashbury Railway Carriage v. Riche where the company’s objects authorized it to make and sell railway carriages and wagons and all kinds of rail fittings but the company purported to enter into a contract for the construction of a railway in Belgium.

Third parties are therefore required to inquire into the affairs of the company by reading its public documents.

However the doctrine of constructive notice operates negatively, meaning that a party can only rely on a provision of the Articles if it has actual knowledge of its existence. It was so held in Rama Corporation V Proved Tins and General Investments Ltd where a director of the plaintiff company contracted with a single director of the defendant company who had no authority of the board to contract on behalf of the company. However, the Company’s Articles empowered the Board to delegate powers to committees of one or more directors. The director of the plaintiff company was unaware of this Article. The defendant company repudiated the contract and was sued. It was held that the company was not liable as the director had no authority to contract on its behalf. The plaintiff could not rely on the Article permitting delegations as it was unaware of its existence. In the words of Justice Slade:

“There is no positive doctrine of constructive notice. It is a purely negative one”

The doctrine of Constructive Notice protects the company from third parties who do not make adequate or appropriate inquiry.

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