Articles of Association v. Shareholders Agreement in England and Wales: Which one works best for you and your company?

The decision of whether to solely rely on a company’s Articles of Association or implement a bespoke Shareholders’ Agreement depends on the specific needs and priorities of the individual shareholders and the company alike. Whilst both documents serve to govern the internal workings and relationships within a company, they differ in their purpose, scope, legal standing and accessibility. In the following article, we discuss the specific roles of each constitutional document, the differences between them and how they can work in tandem (or which takes precedence where a conflict arises).

What are articles of association and its purpose?

The articles of association (“Articles”) are known for being the company’s constitution and is a foundational legal document required to be filed at Companies House upon incorporation of a company, making it publicly accessible to all. The Articles  outline the fundamental rules which govern the company’s structure, management and rights and obligations of its shareholders (i.e., members). Once registered at Companies House, the Articles are binding on the company and each of the shareholders and can be enforced by either i) a member against the company, ii) by the company against a member and/or iii) by a member against another member. When shares in the company are subsequently purchased, new shareholders are also automatically bound by the current Articles of the company.

What can I expect to see within Articles?

The purpose of the Articles is to govern the internal workings and management of the company, so it would be unsurprising to see specific rights of the members, procedures for transferring and issuing shares, setting out how decisions are made and the structure of the company. More importantly, it covers responsibilities and powers of the directors, how they are appointed and removed, the procedures for board meetings and the delegation of authority.

Some typical headings you would expect to see are:

• Directors powers
• Decision making of directors
• Share capital (and rights attached)
• Shares and distributions (i.e., how dividends are paid)
• Conflicts of interest
• Liability
• Shareholders’ decision making
• Directors’ indemnity insurance

It is important to note that not every set of Articles are the same and can be drafted bespoke to accommodate the requirements of the company and its members, unless using the statutory default model articles in accordance with the Companies Act 2006. Say for instance, if you are a majority shareholder of your company and wish to have rights to force your minority shareholders to join in on a sale of the company to a third party buyer, we would expect to see drag along rights incorporated within the company’s Articles. On the other hand, if the company wants to give minority shareholders the right to participate in a third party sale of shares with you (as majority shareholder) and on the same price, terms and conditions, then we would expect to see tag along rights included.

What is a Shareholders’ Agreement and its purpose?

A Shareholders’ Agreement is a private contract between some or all shareholders of a company, and similar to Articles, sets out how the company will be run, the rights and responsibilities of the shareholders and various protections. Typically used between shareholders of private companies, it is used to ensure any potentially contentious issues are addressed in advance and avoid any disputes in future. It goes without saying that being a private document is a key advantage, especially where parties wish to keep terms confidential as it is not normally open to public inspection.

What can I expect to see within Shareholders’ Agreements?

Some usual provisions you would expect to see within Shareholders’ Agreements include those relating to ownership, issue and transfer of shares, management and control of the company, how profits are distributed and mechanisms to resolving future disputes. The agreement may also address governance matters of the company and allow for decision-making authority, especially where a founder or investor is involved. However, the specifics will be determined by the commercial needs of the company and parties involved and is typically subject to negotiation.

Some typical headings you would expect to see are:

• Restrictions on the parties
• Dividend policy
• Shareholder and Company obligations
• Matters requiring Shareholder Consent (or Investor Consent, in instances where a third party investor is involved)
• Deed of Adherence

There is a conflict between my company’s Articles of Association and Shareholders’ Agreement – which one do I use?

Shareholders’ Agreements are typically drafted bespoke to accommodate the commercial agreement between the shareholders of the company,  but should also be drafted in conjunction with the Articles to avoid any conflict between the two documents. Where a conflict arises however, the Articles shall take precedence, unless the Shareholders’ Agreement explicitly contain a supremacy clause stating that it prevails where conflicts arise between the two. Where certain matters are silent in the Shareholders’ Agreement however, the Articles will then prevail.

Summary of Articles of Association – various Pros and Cons

Although a legal requirement, some advantages are:

• automatic adherence of incoming shareholders;
• wider remedies, such as damages, injunction, contractual sanctions etc.; and
• minority protections already in place (i.e., you can only amend Articles by passing a Special Resolution (i.e., shareholders approval of not less than 75% of those present/voting)).

Some disadvantages:

• requirements to comply with statutes and regulatory requirements
• Cannot fetter (i.e., restrict) the company’s powers – instead you can get around this by having weighted voting rights instead
• Publicly available document
• Potential complexities in incorporating bespoke Articles

Summary of Shareholders Agreement – various Pros and Cons

Some advantages of having a Shareholders’ Agreement in place are:

• Confidentiality – there is no requirement to publicise the document and is private between shareholders and the company
• Certainty of terms being entered into
• Minority protections – certain things requiring unanimity and veto rights can be incorporated into the agreement
• Additional bespoke matters can also be incorporated such as decision making, appointment of directors, and a detailed breakdown on share transfers, as well as matters requiring consents by specific individuals or shareholder groups

Some disadvantages:

• Requires unanimity to amend it
• Deed of adherence is required for new incoming shareholders
• If you do have unanimity, there may be an additional problem of deadlock, which you will also need to deal with in the agreement
• Company can be a party, but careful drafting is required so that it doesn’t fetter (or restrict) the company’s powers going forward.

What might work for someone else, may not work for you so it is vitally important you obtain the correct legal and financial advice before making any decision. At Clarkslegal, our specialists are well versed in advising owners of SMEs and owner-managed businesses on their business. If you’re looking to implement bespoke Shareholders’ Agreement or Articles of Association, feel free to reach out to our  corporate team. and we would be happy to have an initial chat to understand your requirements further.