Drafting of Article of Association

Section 26 to 32 of the Companies Act, 1956 specifically deals with the issue of Articles of Association. Section 26 of the Companies Act, 1956 is as follows:

“Section 26. There may be in the case of public company limited by shares and there shall in the case of an unlimited company or a company limited by guarantee or a private company limited by shares, be registered with the memorandum, articles of association signed by the subscribers of the memorandum, prescribing regulations for the Company.”

Thus, while it is a requirement for the Private Limited Companies to have an Articles of Association, it is an option when it comes to Public Limited Companies.  The detailed provisions of the Companies Act, 1956 regulates the Public Limited Companies while liberty is given to the Private Limited Companies to have their own regulations on many issues or aspects. Normally, a care is taken while preparing articles of association of a Public Limited Company in view of their exposure, stakes and professional guidance.

The schedules to the Companies Act, 1956 provides model Articles of Association which can be adopted by different kind of companies.  I do strongly feel that preparation of Articles of Association is a difficult exercise unless the model articles are adopted or only very few changes are made to the model articles to the extent provided under the Companies Act, 1956.

I want to express my view on preparation of Articles of Association of Private Limited Companies as Public Limited Companies normally are very careful and takes a good professional advice on everything from the beginning.

It is the settled company law principle that Articles can not override the provisions of the Act. Again, certain privileges under the Companies Act, 1956 are available only when those are backed by the Articles of Association. Though, we use the word ‘preparation’, I feel that the professionals advising the Company or involved in incorporation of a Company normally may only do few additions or alternations to the model Articles of Association provided in the Act itself. But, when the promoters want to have their own say on the Company’s regulation, two preliminary things should be in mind while preparing Articles ofAssociation of a Private Limited Company and those are:

1. It is not correct to delete the regulations contained in the model articles of association without considering its impact and in view of the fact that many provisions of the Act can be availed only when those are backed by the Articles of Association.
2. While incorporating a regulation which is not there in the model articles provided, one should be very careful about the provisions of the Companies Act, 1956 and no provision should go against the provisions of the Act.

I have seen interesting regulations in the Articles of Association of a Private Limited Company which can not sustain at all in view of the express bar under the Act. Private Limited Companies or the closely held companies may, at times, enter into interesting arrangements in the course of their business and they take the provisions of the Company Law so easily.  In practice, even the professionals advising the companies, will go by the wish of the managerial personnel of the Company or the Company and they may not insist on the Companies to be in strict compliance of the provisions of the Act or the Company Law.

It is settled legal principle that any act which is against the Memorandum and Articles, and which is against the provisions of the Act are void and those are normally referred to as “ultra vires”.

Though, there is a principle of “doctrine of constructive notice”, we can not expect the third parties to probe into the Company with which they are entering a business transaction and it is not possible practically in many cases. Only Public Financial Institutions or the Financial Institutions may be in a position to probe company’s internalregulations and other things when the Company approaches them for a loan. Barring that, in many cases, a third party may not be able to look at the company’s internalregulations and other internal issues and also we are aware of “doctrine of indoor management” etc, though it operates in a different situation.

Company Law is very complicated and interesting. Any laxity on the part of the promoters or the professionals advising the Company, can lead to lot of complications or difficulties.

Assuming a case that the promoters or the majority in a Company has no intention at all to impeach the rights of the other or cause any loss or damage; even in those cases, the procedural irregularity may cause so many problems to the Company when a dispute arises.

The complications can be like:

1. Can we say that an act which is against the provisions of the Act or the regulations is legal?
2. Can we get all the business deals of a Company set-aside on the ground that there exist a simple procedural irregularity or the business deals are entered into ignoring the regulations of the Company?
3. Where is the effective mechanism to find-out as to whether the Company functions in accordance with the provisions of the Act or not?
4. How to get a company corrected when it is proceeding with an untenable regulation in its Articles?

I have just listed few complications that we can see with the laxity on the part of the promoters while getting the regulations prepared or ensuring that the Company functions in accordance with the provisions of the Act. I can definitely say that the non-compliance of the provisions of the Act, would lead to numerous complications.

A creditor or a shareholder can not sustain a winding-up petition against a Private Limited Company showing that the company contains a regulation and functions based on the regulation which is clearly against the expressprovisions of the Act. It is difficult really. Section 397/398 of the Companies Act, 1956 are not meant for ensuring that the Company functions in accordance with the regulations thought the Company Law Board is conferred with extraordinary powers while entertaining an application under section 397/398 of the Act. There will be lot of problems when some one approach the Civil Court seeking a declaration that a regulation contained in the Articles ofa Company is void or the transaction entered into in violation of the regulations in the Articles are void.

In view of numerous complications with incorrect drafting of Articles of Association, I would like to mention few points which can be considered while preparing an Articles of Association of a Company or getting a Private Limited Company incorporated.

1. It is to be remembered that though we use the word “preparation of articles” while getting a company incorporated, it is actually an adoption even when the promoters insist for few changes in the model articles provided in the Act.
2. It is advisable to convince the promoters not to insist for additions, changes, alternations or deletions in the model articles provided in the Act.
3. Promoters are to be convinced that the Articles can be altered easily.
4. It is to be remembered that the additions, changes or alternations in the model articles provided requires careful scrutiny of the provisions of the Act.
5. Unless it is necessary to have a new regulation in the Articles of Association or a new regulation is must for promoting the Company, it is better not to resort to additions, alternations, changes etc. in the model Articles provided in the Act.

Note:

1. I have focused only on the preparation of Articles of a Private Limited Company.
2. I have not detailed all provisions dealing with the Articles of Association under the Act.
3. I have not discussed many company law concepts surrounding the issue.
4. I am aware of the vastness of the subject.