Home / Practical issues with the model articles of association
3rd October 2023
A company’s articles of association (Articles) govern how its shareholders and directors must act and provide a set of rules to which they must adhere.
Each company that is set up must have Articles upon incorporation. A company can opt to either have a tailored set of Articles (upon incorporation or at any time following incorporation) or use the Model Articles (based on The Companies (Model Articles) Regulations 2008). These are a standard set of Articles, which provide basic rules for a company’s officers and shareholders to adhere to.
Many business owners incorporate their company themselves online via Companies House and tick the box to adopt the Model Articles, which can seem like the quickest, simplest, and most cost-effective option especially at the start of a new business venture. There are, however, many instances where a company may wish to take a specific action, or the shareholders and directors of a company may wish to regulate their relationship and the operations of a company in a way, which is not permitted or catered for by the Model Articles. Some limitations with the Model Articles include:
Model Articles only provide for one class of shares which have equal rights as to dividends, voting and return of capital upon the company being wound up.
The shareholders may wish to have different rights on their shares. It may be the case for example, that a new investor may want to take a less involved role in terms of decision making and/or shareholders may want to declare differential dividends on their shares. Shareholders in the company may want to have different rights in order to protect the power balance in the company.
Rights of first refusal in favour of the existing shareholders (called “pre-emption rights”) are often contained in a company’s Articles when it is looking to either issue new shares to a new or existing shareholder or if an existing shareholder is looking to transfer their shares (in part or full) to someone else (either to another existing shareholder or an entirely new shareholder).
The Model Articles operate such that the pre-emption rights in the Companies Act 2006 (i.e. “statutory pre-emption rights”) apply upon the issue of new shares in a company, and do not include pre-emption rights upon the transfer of shares from an existing shareholder to someone else. This can present an issue for existing shareholders’ as it could cause unwanted dilution of the company’s existing share capital if the statutory pre-emption rights do not operate in a manner that they would ideally wish (and could cater for in bespoke contractual pre-emption rights in the Articles). Equally, an existing shareholder may transfer their shares to anyone they wish without offering them to the existing shareholders first to give them a right of first refusal.
It’s worth noting under the Model Articles, the directors may refuse to register the transfer of a share (meaning that the directors can prevent the legal ownership of a share transferring).
In light of a recent High Court judgement, the issue around whether a sole director can operate a company incorporated under the Model Articles has been cast in doubt. It is now generally considered that a company with the Model Articles must have more than one director unless it was incorporated with, and has only ever had, one director.
When a board meeting of the directors takes place, each director must declare their interests in the matters proposed at the meeting. The Model Articles, generally speaking (and subject to some limited exceptions), do not allow for a director who has an interest in the matters proposed to vote or take part in a meeting. This can frustrate the business of the company proceeding and a company’s bespoke Articles will often have provisions that allow a director to vote at and take part in the meeting even though they have interests in the matters to be dealt with, provided that they have first declared their interest to the other directors at the meeting.
The Model Articles do not provide for a director to appoint alternate directors (i.e. a person to act on an absent director’s behalf at a board meeting). The Articles can be amended to provide for this, as it can give directors greater flexibility, particularly when trying to manage the affairs of the company during times when they are unavailable and can’t attend meetings in person or remotely.
The Model Articles require that all shares issued by a company are paid for in full when they are issued and do not make any provision for shares to be issued partly paid. If you intend to issue shares in a company that are not paid for in full at the time of issue then the Model Articles will not be suitable for you and you will require a bespoke set of Articles that allow for this and will also likely wish to include lien and forfeiture provisions in the Articles to enable the company to require the shares are paid for in full in the future and to cancel the shares if they are not paid for in full when required.
It may therefore be a false economy to adopt Model Articles on incorporation of a company – they may not be fit for purpose and may require replacement or amendment at a later date. If there is any disagreement amongst shareholders as to whether or not or how the Articles should be replaced or amended this can give rise to costly disputes or disruption to the business.
Ensuring that the relationship between shareholders and management of the company is properly regulated from the start through adopting a bespoke set of Articles and a shareholders’ agreement can avoid problems later down the line.
We therefore recommend that company owners should consider adopting bespoke Articles and also whether a shareholders’ agreement is suitable for them at the outset of their business venture.
A shareholders’ agreement typically deals with other matters as between shareholders not dealt with in the Articles such as positive and restrictive covenants, confidentiality obligations, dividend policies and so on, including matters the shareholders wish to keep private (as, unlike the Articles, a shareholders’ agreement is not a publicly available document).
Our corporate team has a wide range of expertise and experience when dealing with the drafting of, and advice relating to, Articles and shareholders agreements and would be happy to discuss with you.