Introduction
Article of Association (hereinafter referred to as "Articles") is one the essential documents which the company has when goes for incorporation along with the Memorandum of Association (hereinafter referred to as "Memorandum"). Memorandum is the primary document that lays down the primary objective behind the incorporation of the company and the power it possesses. The memorandum lays down the definite area and objective within which the company has to operate, and it cannot venture beyond the memorandum. On the other hand, Articles are subservient to the memorandum, and it only lays down the by-laws, rules, and regulations that govern the internal affairs of the company and the conduct of business. It regulates the internal management of the company and defines the power of its officers. Articles are contracts between the company and the members and between the members inter se.
Section 2(2) of the Companies Act, 2013 (hereinafter referred to as "Companies Act") provides the definition of the article and provides that article means Article of Association of the company as originally framed or as altered from time to time under any current company law or any previous company law. It includes both the originally framed articles at the time of incorporation, and it also include the altered article as the article of association. In this blog, we will discuss as to what are the content of Articles, various doctrines, alterations and their effects, and various aspects with the help of relevant legal provisions and case laws.
Content of Article of Association
As already stated, the articles are the rules or by-laws that govern the internal affairs and management of the company. Section 5 of the Companies Act provides the content to be there in the Articles and it provides the articles to contain regulations management of company and also contain such matter as may be prescribed. It does not impose any bar on the company to include the articles which it considers are in the benefit of the company and necessary for the management of the company.
The Articles of the company usually contain rules and regulations relating to the following matters:
(i) The exclusion, wholly or in part, of the model articles as contained in respective Tables.
(ii) Share capital - shares and their value and their division into equity and preference shares, if any.
(iii) Rights of each class of shareholders and procedure for variation of their rights.
(iv) Procedure relating to the allotment of shares, making of calls and forfeiture of shares.
(v) Increase, alteration and reduction of share capital.
(vi) Rules relating to transfer or transmission of shares and the procedure to be followed for the same.
(vii) Lien of the company on shares allotted to the members for the amount unpaid in respect of such shares and the procedure in respect thereof.
(viii) Appointment, remuneration, powers, duties etc. of the directors and officers of the company.
(ix) Constitution and composition of Audit Committee, Remuneration Committee, CSR Committee.
(x) Procedure for conversion of shares into stock and vice versa.
(xi) Notice of the meetings, voting rights of members, proxy, quorum, poll, etc.
(xii) Audit of accounts, transfer of amount to reserves, declaration of dividend, etc.
(xiii) Borrowing powers of the company and the mode of exercise of those powers.
(xiv) Issue of share certificates including procedure for issue of duplicate shares.
(xv) Winding up of the company.
There are various matters mentioned in the Article for the smooth functioning of the company and it must be made carefully and must include all rules necessary for the internal management of the company. Companies are free to incorporate any article that they consider necessary for their management, but it must not be against the Companies Act or the memorandum.
Provisions for Entrenchment
Provision related to entrenchment is introduced in the Companies Act for the very first time under Section 5(3). It means that the Articles may provide, that certain specified provisions of the Articles will not be alterable merely by passing a special resolution; they will require a more elaborate prescribed procedure to be followed. The provisions for entrenchment referred to above shall only be made either on formation of a company, or by an amendment in the articles agreed to by all the members of the company in the case of a private company and by a special resolution in the case of a public company. Where the articles contain provisions for entrenchment, whether made on formation or by amendment, the company shall give notice to the Registrar of such provisions in Form No. INC-32 along with the fee as provided in the Companies (Registration offices and fees) Rules, 2014 for the new company at the stage of incorporation and in the case of existing companies, the same shall be filed in Form No.MGT.14 within thirty days from the date of entrenchment of the articles, as the case may be, along with the fee as provided in the Companies (Registration offices and fees) Rules, 2014.
Alteration of the Article of Association
Articles of the company can be amended from time to time to meet the necessary conditions that may occur during the time. The procedure of amending Articles is simpler than amending the memorandum. The article of the company can be altered by passing the special resolution. The alteration that has the effect of converting a private company to a public company and vice-versa is also allowed and may be done by following the same procedure of passing the special resolution in the case private company and by the special resolution plus the approval of the tribunal in the case of converting the public company.
For converting a private company to a public company, the articles of the company are altered in a manner that they no longer include the restrictions and limitation that are required to be included in the article of a private company. Section 2 (68) of the Companies Act, provides the definition of a private company and it provides that the company having a minimum paid-up share capital and which by its article restricts:
i) the right to transfer its share.
ii) limits the number of members that the company can have, except in case of one-person company.
iii) prohibits any invitation to the public to subscribe the securities of the company.
Now in the case of a public company similar procedure is followed, which is just the opposite of the procedure in case of conversion of a private company. As we put certain restrictions on private companies under the Articles to be called a private company, for a public company those restrictions are removed. For the conversion of a public company to a private company the alteration are done in a manner that have a effect of removing those three restrictive classes. In case of a conversion of a public company, the approval of the tribunal is also must along with passing of special resolution and merely passing the resolution would not suffice.
Limitation on power to alter the Article
The companies under section 14 of the Companies Act have the right to alter the Articles by passing a special resolution. If the alteration is with respect to the conversion of a public company to a private company, then additional requirement of approval of tribunal is there. Although, the company has the right to alter its articles, but this right is not absolute and subject to certain restrictions and limitation. Those restrictions are:
i) The alteration in the Article must not be conflict with the memorandum and must not go beyond the memorandum. Both can be used to interpret each other when there is any ambiguity but in case of any conflict between the memorandum and articles, then articles prevail over articles.
ii) The alteration in the Articles must not be inconsistent with the Companies Act or any other laws.
iii) If any alteration made by the tribunal under section 242 of the Companies Act, then the company cannot alter the articles in manner which is inconsistent with the alteration made by the tribunal except with the approval of tribunal.
iv) The altered articles must not include anything that is illegal or opposed to public policy or unlawful.
v) The alteration made must be bona fide and for the benefit of the company as a whole. The alteration must not be such that it only benefits the majority shareholder and commits fraud on the minority shareholder. In other words, an alteration to the articles must not discriminate between the majority shareholders and the minority shareholders to give the former an advantage over the latter. In All India Railway Men’s Benefit Fund v Jamadar Baheshwarnath Bali, the court said that the company cannot alter the article in such a manner that it is used to oppress or defraud a minority of shareholders or so as to violate any statutory provision or principle of law and that the power like the other powers, must be exercised fairly and according to law.
vi) Alteration of articles which has an effect of conversion of public company to private company, in such case approval of tribunal is must.
vii) A company cannot justify a breach of contract with third parties or avoid a contractual liability by altering articles. In Mathrubhumi Printing & Publishing Co. Ltd. v Vardhaman Publishers Ltd., it was said that by effecting alteration in its articles, a company cannot defeat or escape from its contractual obligation to any person. The company will always be liable for damages in case the alteration results in a breach of the contract the company had entered into with any person.
viii) Amendment of articles to empower the Board of Directors to expel a member is opposed to the fundamental principles of company jurisprudence and is ultra vires of the company.
Binding effect of Alteration
The effect of amendments made to the Article are same as that of the original article. Section 10 of the Companies Act provides that the article shall bind the company and member to the same extent as if they had been signed by the company and each member. It means that the article which was originally there or amended from time to time, both are valid in law and bind the members. Articles or memorandum once registered bind the company to the members and members to the company and the other members also, but neither the company nor the members are bound to outsiders.
Doctrine of Constructive Notice
Constructive notice is a term used usually to refer to such notices which are not actually given to the concerned members, but the circumstance is such that the person is deemed to have notice of the same. Under section 399 of the Companies Act, provides that the memorandum and the article become public documents, when registered with the registrar and can be inspected by anyone on payment of certain fees. Section 17 read along with Rule 34 of the Company (Incorporation) Rules, 2014 provides that a company shall on payment of the prescribed fee send a copy of each of the following documents to a member within seven days of the request being made by him
1. the memorandum;
2. the articles, if any;
3. every agreement and every resolution referred to in sub-section (1) of section 117, if and so far as they have not been embodied in the memorandum and articles.
Therefore, any person who is to enter into the contract with the company has the required means of ascertaining and in such cases, it is presumed that the person dealing with the company has read these documents and understood it in its true sense. This is called the "doctrine of constructive notice". Even if the person does not have the actual notice, he is presumed to have an implied or constructive notice of the memorandum or articles.
Doctrine of Indoor management
The doctrine of Constructive notice was quite inconvenient, particularly in a case where for example the directors or any officer of the company has authority under the articles to exercise power only subject to certain prior approvals or sanction of the shareholder. Now, the investors or any other third party dealing with the company is not expected to inspect whether the prior approval was taken or not. Once the directors has the authority and powers under the Article, this is now their responsibility to take prior approvals or sanctions, and the third party not expected to know these intricacies. They assume that the person representing the company and dealing with them has taken all the necessary approvals. This is known as the "doctrine of Indoor management". This doctrine was first laid down in Royal British Bank v Turquand.
In this case, the directors of a company were authorised by the articles to borrow on bonds such sums of money as should from time to time, by a resolution of the company in general meeting, be authorised to be borrowed. The directors gave a bond to T without the authority of any such resolution. The question arose as to whether the company was liable on the bond. It was held that the company was liable on the bond, as T was entitled to assume that the resolution of the company in general meeting had been passed.
The basic difference between both the doctrines is, in the former doctrine, the person dealing with the company is assumed to have read the memorandum and articles of the company even if he might not have actually read them. Now, in the latter doctrine, it is assumed on the part of the officer of the company with which any outsider is entering into contract that such officer has observed the required sanctions or approval and is abiding by the articles of the company. The person dealing with the company not bound to inquire into the irregularity in the internal management of the company.
Conclusion
The Articles of Association are a key component of a company's internal management structure. They set out the rules and guidelines that govern how the company operates, including the roles of directors, the rights of shareholders, and the processes for making important decisions. The Articles work alongside the Companies Act, 2013, to ensure that the company operates legally and efficiently.
Understanding and adhering to the Articles is essential for anyone involved in the management or ownership of a company. The courts have emphasized that the company’s actions must align with both the Articles and the law. As companies grow and change, the Articles may need to be updated to remain relevant and effective, helping to ensure that the company continues to function smoothly and in compliance with legal requirements.
It is also to be kept in mind, that the articles are subservient to the companies act and the Memorandum and it must not be in conflict with the Memorandum or Companies Act. In case of any conflict memorandum or company law will prevail over the articles.