Introduction

The Companies Act, 2013 defines ‘articles’ as the “articles of association of a company originally framed, or as altered from time to time in pursuance of any previous company laws or of the present.” The Articles of Association of a company are that which prescribe the rules, regulations and the bye-laws for the internal management of the company, the conduct of its business, and is a document of paramount significance in the life of a company. The Articles of a company have often been compared to a rule book of the company’s working, that regulates the management and powers of the company and its officers. It prescribes several details of the company’s inner workings such as the manner of making calls, director’s/employees qualifications,  powers and duties of auditors, forfeiture of shares etc.

In fact, the articles of association also establish a contract between the members and between the members and the company. This contract is established, governs the ordinary rights and obligations that are incidental to having membership in the company.

It must be noted, however, that the articles of association, are subordinate to the memorandum of association of a company, which is the dominant, fundamental constitutional document of the company. Further, as laid down in Shyam Chand v. Calcutta Stock Exchange, any and all articles that go beyond the memorandum of association will be deemed ultra vires. Therefore, there should not be any provisions in the articles that go beyond the memorandum. In the event of a conflict between the memorandum and the articles, the provisions in the memorandum will prevail. In case of any ambiguity or uncertainty regarding details in the memorandum, it should be read along with the articles.

Distinction Between Memorandum and Articles of Association

The pivotal differences between memorandum and articles of association are as follows:

Nature and Content of Articles of Association

As per the Companies Act, 2013, the articles of association of different companies are supposed to be framed in the prescribed form, since the model form of articles is different for companies limited by shares, companies limited by guarantee having share capital, companies limited by guarantee not having share capital, an unlimited company having share capital and an unlimited company not having share capital.

The signing of the Articles of Association

The Companies (Incorporation) Rules, 2014 prescribes that both the Memorandum and the Articles of a company are to be signed in a specific manner.

• Memorandum and Articles of a company, are both required to be signed by all subscribers, who are further required to add their names, addresses and occupation, in the presence of at least one witness, who must attest the signatures with his own signature and details.
• Where a subscriber is illiterate, he must affix a thumb impression in place of his signature, and appoint a person to authenticate the impression with his signature and details. This appointed person should also read out the content of the documents to the illiterate subscriber for his understanding.
• Where a subscriber is a body corporate, the memorandum and articles must be signed by any director of the body corporate who is duly authorised to sign on behalf of the body corporate, by a passing a resolution of the board of directors of the body corporate.
• Where the subscriber is a Limited Liability Partnership, the partner of the LLP who is duly authorised to sign on the behalf of the LLP by a resolution of all the partners shall sign.

Provisions for Entrenchment

The concept of Entrenchment was introduced in the Companies Act, 2013 in Section 5(3) which implies that certain provisions within the Articles of Association will not be alterable by merely passing a special resolution, and will require a much more lengthy and elaborate process. The literal definition of the word “entrench” means to establish an attitude, habit, or belief so firmly that bringing about a change is unlikely. Thus, an entrenchment clause included in the Articles is one which makes certain changes or amendments either impossible or difficult.

Provisions for entrenchment can only be introduced in the articles of a company during its incorporation, or an amendment to the articles brought about by a special resolution in case of a public company, and an agreement between all the members in case of a private company.

Alteration of Articles of Association

Section 14 of the Companies Act, 2013, permits a company to alter its articles, subject to the conditions contained in the memorandum of association, by passing a special resolution. This power is extremely important for the functioning of the company. The company may alter its articles to the effect that would turn:

A public company into a private company

For a company wanting to convert itself from public to a private company simply passing a special resolution is not enough. The company will have to acquire the consent and approval of the Tribunal. Further, a copy of the special resolution must be filed with the Registrar of Companies within 30 days of passing it. Further, a company must then file a copy of the altered, new articles of association, as well as the approval order of the Tribunal with the Registrar of Companies within 15 days of the order being received.

A private company into a public company

For a company wanting to convert from its private status to public, it may do so by removing/omitting the three clauses as per section 2(68) which defines the requisites of a private company. Similar to the conversion of the public to a private company, a copy of the resolution and the altered articles are to be filed with the Registrar within the stipulated period of time.

Limitations on power to alter articles

• The alteration must not contravene provisions of the memorandum, since the memorandum supersedes the articles, and the memorandum will prevail in the event of a conflict.
• The alteration cannot contravene the provisions of the Companies Act, or any other company law since it supersedes both the memorandum and the articles of the company.
• Cannot contravene the rules, alterations or suggestions of the Tribunal.
• The alteration cannot be illegal or in contravention with public policy. Further, it must be for the bona fide benefit and interest of the company. The alterations cannot be an effort to constitute a fraud on the minority and must be for the benefit of the company as a whole.
• Any alteration made to convert a public company into a private company, cannot be made until the requisite approval is obtained from the Tribunal.
• A company may not use the alteration to cover up or rectify a breach of contract with third parties or use it to escape contractual liability.
• A company cannot alter its articles for the purpose of expelling a member of the board of directors is against company jurisprudence and hence cannot occur.

Binding effect of Memorandum and Articles of Association

After the Articles and the Memorandum of a company are registered, they bind the company and its members to the same extent as if they had been signed by each of the members of the company. However, while the company’s articles have a binding effect, it does not have as much force as a statute does. The effect of binding may work as follows:

Binding the company to its members

The company is naturally completely bound to its members to adhere to the articles. Where the company commits or is in a place to commit a breach of the articles, such as making ultra vires or otherwise illegal transaction, members can restrain the company from doing so, by way of an injunction. Members are also empowered to sue the company for the purpose of enforcement of their own personal rights provided under the Articles, for instance, the right to receive their share of declared divided.

It should be noted, however, that only a shareholder/member, and only in his capacity as a member, can enforce the provisions contained in the Articles. For instance, in the case of Wood v. Odessa Waterworks Co., the articles of Waterworks Co. provided that the directors can declare a dividend to be paid to the members, with the sanction of the company at a general meeting. However, instead of paying the dividend to the shareholders in cash a resolution was passed to give them debenture bonds. It was finally held by the court, that the word “payment” referred to payment in cash, and the directors were thus restrained from acting on the resolution so passed.

Members bound to the company

Each member of the company is bound to the company and must observe and adhere to the provisions of the memorandum and the articles. All the money that may be payable by any member to the company shall be considered as a debt due. Members are bound by the articles just as though each and every one of them has signed and contracted to conform to their provisions. In Borland’s Trustees v. Steel Bros. & Co. Ltd., the articles the company provided that in the event of bankruptcy of any member, his shares would be sold at a price affixed by the directors. Thus, when Borland went bankrupt, his trustee expressed his wish to sell these shares at their original value and contended that he could do so since he was not bound by the articles. It was held, however, that he was bound to abide by the company’s articles since the shares were bought as per the provisions of the articles.

Binding between members

The articles create a contract between and amongst each member of the company. However, such rights can only be enforced by or even against a member of the company. Courts have been known to make exceptions, and extend the articles to constitute a contract even between individual members. In the case of Rayfield v Hands Rayfield was a shareholder in a particular company., who was required to inform directors if he intended to transfer his shares, and subsequently, the directors were required to buy those shares at a fair value. Thus, Rayfield remained in adherence to the articles and informed the directors. The directors, however, contended that they were not bound to pay for his shares and the articles could not impose this obligation on them. The courts, however, dismissed the directors’ argument and compelled them to buy Rayfield’s shares at a fair value. The court further held that it was not mandatory for Rayfield to join the company to be allowed to bring a suit against the company’s directors.

No binding in relation to outsiders

Contrary to the above conditions, neither the memorandum nor the articles constitute a contract between the company and any third party. The company and its members are not bound to the outsiders with respect to the provisions of the memorandum and the articles. For instance, in the case of Browne v La Trinidad, the articles of the company included a clause that implied that Browne should be a director that should not be removed or removable. He was, however, removed regardless and thus brought an action to restrain the company from removing him. Held that since there was no contract between Browne and the company, being an outsider he cannot enforce articles against the company even if they talk about him or give him any rights. Therefore, an outsider may not take undue advantage of the articles to make any claims against the company.

The doctrine of Constructive Notice

When the Memorandum and Articles of Association of any company, are registered with the Registrar of Companies they become “public documents” as per section 399 of the Act. This implies that any member of the general public may view and inspect these documents at a prescribed fee. A member of the public may make a request to a specific company, and the company, in turn, must, within seven days send that person a copy of the memorandum, the articles and all agreements and resolutions that are mentioned in section 117(1) of the Act.

If the company or its officers or both, fail to provide the copies of the requisite documents, every defaulting officer will be liable to a fine of Rs. 1000, for every day, until the default continues, or Rs. 1,00,000 whichever is less.

Therefore, it is the duty of every person that deals with the company to inspect these public documents and ensure in his own capacity that the workings of the company are in conformity with the documents. Irrespective of whether a person has actually read the documents or not, it is assumed that he familiar with the contents of these documents, and that he has understood them in their proper meaning. The memorandum and articles of association are thus deemed as notices to the public, hence a ‘constructive notice’.

Illustration: If the articles of Company A, provided that any bill of exchange must be signed by a minimum of two directors, and the payee receives a bill of exchange signed only by one, he will not have the right to claim the amount.

The doctrine of Indoor Management

The concept of the Doctrine of Indoor Management can be most elaborately explained by examining the facts of the case of Royal British Bank v. Turquand, which in fact, first laid down the doctrine. It is due to this that the doctrine of indoor management is also known as the “Turquand Rule”.

The directors of a particular company were authorised in its articles to engage in the borrowing of bonds from time to time, by way of a resolution passed by the company in a general meeting. However, the directors gave a bond to someone without such a resolution being passed, and therefore the question that arose was whether the company was still liable with respect to the bond. The company was held liable, and the Chief Justice, Sir John Jervis explained that the understanding behind this decision was that the person receiving the bond was entitled to assume that the resolution had been passed, and had accepted the bond in good faith.

However, the judgement, in this case, was not fully accepted into in law until it was accepted and endorsed by the House of Lords in the case of Mahony v East Holyford Mining Co.

Therefore the primary role of the doctrine of indoor management is completely opposed to that of constructive notice. Quite simply, while constructive notice seeks to protect the company from an outsider, indoor management seeks to protect outsiders from the company. The doctrine of constructive notice is restricted to the external and outside position of the company and, hence, follows that there is no notice regarding how the internal mechanism of the company is operated by its officers, directors and employees. If the contract has been consistent with the documents on public record, the person so contracting shall not be prejudiced by any and all irregularities that may beset the inside, or “indoor” operation of the company.

This doctrine has since then been adopted into Indian Law as well in cases such as Official Liquidator, Manabe & Co. Pvt. Ltd. v. Commissioner of Police and more recently, in M. Rajendra Naidu v. Sterling Holiday Resorts (India) Ltd. wherein the judgment was that the organizations lending to the company should acquaint themselves well with the memorandum and the articles, however, they cannot be expected to be aware of every nook and corner of every resolution, and to be aware of all the actions of a company’s directors. Simply put, people dealing with the company are not bound to inquire into every single internal proceeding that takes place within the company.

Exceptions to the Doctrine of Indoor Management

1. Where the outsider had knowledge of the irregularity— Although people are not expected to know about internal irregularities within a company, a person who did, in fact, have knowledge, or even implied notice of the lack of authority, and went ahead with the transaction regardless, shall not have the protection of this doctrine. Illustration: In Howard v. Patent Ivory Co. (38 Ch. D 156), the articles of a company only allowed the directors to borrow a maximum amount of one thousand pounds, however, they could exceed this amount by obtaining the consent of the company in a general meeting. However, in this case, without obtaining this requisite consent, the directors borrowed a sum of 3,500 Pounds from one of the directors in exchange for debentures. The company then refused to pay the amount. It was eventually held that the debentures were only good to the extent of one thousand pounds since the director had full knowledge and notice of the irregularity since he was a director himself involved in the internal working of the company.
2. Lack of knowledge of the articles— Naturally, this doctrine cannot and will not protect someone who has not acquainted himself with the articles or the memorandum of the company for example in the case of Rama Corporation v. Proved Tin & General Investment Co. wherein the officers of Rama Corporation had not read the articles of the investment company that they were undertaking a transaction with.
3. Negligence— This doctrine does not offer protection to those who have dealt with a company negligently. For example, if an officer of a company very evidently takes an action which is not within his powers, the person contracting should undertake due diligence to ensure that the officer is duly authorized to take that action. If not, this doctrine cannot help the person so contracting, such as in the case of Al Underwood v. Bank of Liverpool.
4. Forgery— Any transaction which involves forgery or is illegal or void ab initio, implies the lack of free will while entering into the transaction, and hence does not invoke the doctrine of indoor management. For example, in the case of Ruben v. Great Fingal Consolidated, the secretary of a company illegally forged the signatres of two directors on a share certificate so as to issue shares without the appropriate authority. Since the directors had no knowledge of this forgery, they could not be held liable. The share certificate was held to be in nullity and hence, the doctrine of indoor management could not be applied. The wrongful an unauthorized use of the company’s seal is also included within this exception.

Further, this doctrine cannot include situations where there was third agency involved or existent. For example, in the case of Varkey Souriar v. Keraleeya Banking Co. Ltd. this doctrine could not be applied where there was any scope of power exercised by an agent of the company. The doctrine cannot be implied even in cases of Oppression.

 Conclusion

Therefore, it is to be understood that in the sphere of corporate governance, the articles of a  company is a crucial document which, along with the memorandum from the company’s core constitution and rule book, and hence defines the responsibilities of its directors,  kinds of business es to be undertaken by the company, and the various means by which the shareholders may exert their control over the directors, and the company itself. While the memorandum lays down the objectives of the company, the articles lay down the rules by which these objectives are to be achieved.  In cases of conflict, the Memorandum supersedes the Articles and the Companies Act further, supersedes both Memorandum and Articles.

These articles may be altered as per Section 14 of the Companies Act, 2013. The entrenchment provisions in the Articles of a company protect the interests of all the minority shareholders by ensuring that amendment in the article can only occur after obtaining the requisite prior approval of the shareholders. The Articles of a company bind the company to its members and bind the members to the company and further also bind the members to each other, they constitute a contract amongst themselves and therefore, its members with respect to their rights and liabilities as members of the company.

FAQs

Q1. Are articles of association the same as the constitution?

No, the Memorandum of association is the constitution of the company. The articles of association, are subordinate to the memorandum of association of a company, which is the dominant, fundamental constitutional document of the company

Memorandum of Association is a document that contains all the fundamental information which are required for the incorporation of the company. Articles of Association is a document containing all the rules and regulations that governs the company.

Q2. Who can enforce articles of association?

Since the Articles of a company bind the company to its members, and bind the members to the company and further also bind the members to each other, they constitute a contract amongst themselves and therefore, its members with respect to their rights and liabilities as members of the company. A member may thus, sue the company, just as the company may sue its members to enforce and also restrain any breach of the articles of the company.

Q3. How does one obtain a company’s articles?

One can get access to any company’s memorandum and articles from any of the following:

1. Ministry of Corporate Affairs website (Company public documents section)
2. Company public documents may be obtained from several from private players such as InstaFinancials.

Q4. Do articles of association need to be signed?

Rule 13 or the Companies (Incorporation) Rules, 2014 prescribes that both the Memorandum and the Articles of a company are to be signed in a specific manner. Memorandum and Articles of a company, are both required to be signed by all subscribers, who are further required to add their names, addresses and occupation, in the presence of at least one witness, who must attest the signatures with his own signature and details.

Q5. Can articles of association be altered?

Yes, a company is empowered to incorporate under new, different articles of association, or even to amend/alter its articles of association at any point, simply by a special resolution of its shareholders in a general meeting, provided that they fulfil the requisite conditions of the Companies Act, 2013.

Q6. Is the Memorandum of Association easier to alter or the Articles?

The Memorandum can only be altered under specific circumstances and only as per the provisions of the Companies Act, 2013. Permission of the Central Government is also required in certain cases. Articles can be altered a lot more easily, simply by passing a special resolution of the shareholders.

Source:- blog.ipleaders