Demystifying legal jargon – constitutional documents

Legal jargon surrounding companies and their constitution can be confusing and sometimes frustrating to understand. As lawyers, we use ‘legalese’ to speak about certain documents and it is easy for us to forget that our clients may never have come across these types of documents before.

To assist, we set out below a few of the key documents and the terms contained within them. These are documents which the majority of individuals with any kind of involvement with a company will come across at some point.

Memorandum of association (Memorandum) and articles of association (Articles)

Also known as Mem and Arts

Nowadays, the Memorandum is simply a requirement for incorporating a company and confirms that the initial shareholder (the “subscriber”) wishes to form a company and consents to be a shareholder. Prior to 1 October 2009, the Memorandum was a significant constitutional document which included, for example, the objects of the company and the authorised share capital of the company (over which it is not possible to issue further shares without a specific process being followed). For companies incorporated prior to 1 October 2009, it remains important to be aware of the contents of the Memorandum.

The Articles govern the internal affairs of a company and act as a contract between each of the company’s shareholders and the company. The Companies Act 2006 (the “Act”) require all companies to have Articles which must be contained within a single document and are divided into successively numbered paragraphs. The purpose of this document is to give the shareholders and directors of the company a document which clearly sets out how the company’s affairs are to be regulated (principally basic management and administrative structure).

Articles generally govern a variety of areas; common provisions include:

  • the appointment and removal of directors,
  • different classes of shares and the rights attaching to those shares,
  • the processes involved with issuing and transferring shares,
  • the procedures for calling, holding and voting at general meetings and board meetings,
  • drag along rights (i.e. when the majority shareholders can force minority shareholders to sell their shares on the same terms as them), and
  • tag along rights (i.e. when minority shareholders have the right to have their shares bought on the same terms as the majority shareholders).

Certain provisions can be ‘entrenched’ in the Articles. This means that certain provisions cannot be amended at all or only be amended or removed if certain conditions are met or if set procedures are followed. Entrenched provisions can only be made when the company is formed, or at a later date, if all the shareholders agree.

This reflects how important Articles are in terms of the company’s governance and also affords protection to the shareholders, directors and to the company itself.

Articles can be as bespoke as a company wants them to be (within reason) and so can be amended to reflect exactly how it is intended for the company to be run. This being said, it is important to remember that some provisions of the Act cannot be excluded by the Articles. This is why it is good practice to seek legal advice when adopting new Articles to ensure they are compliant with the Act and any other relevant legislation as well as ensuring they achieve what they are intended to.

Shareholders’ agreements

Also known as a SHA

A shareholders’ agreement is, as the name indicates, an agreement between the shareholders of a company (and sometime the company itself). It can be between all or, in some cases, only some of the shareholders (for example, shareholders holding a certain class of share).

Its purpose is to protect the shareholders’ investment in the company (whether a minority or majority shareholder) and govern how the company is run. The main difference between Articles and a shareholders’ agreement is the fact that it is a private document – i.e. unlike Articles, it does not need to be registered at Companies House.

Shareholders’ agreements are not regulated by the Act and there is therefore no legally set procedure to alter their provisions. Instead, the shareholders’ agreement will usually provide that all shareholders who are a party to the document must give their consent to amend it.

There is often overlap between the Articles and a shareholders’ agreement, however, clauses which are usually set out in a shareholder’s agreement, include:

  • the company’s dividend policy,
  • decisions which require certain consents to be given (which are usually referred to as Reserved Matters) designed to provide an element of protection for minority shareholders,
  • information about how the company is to be run (for example, frequency of board meetings),
  • restrictive covenants (i.e. what a shareholder is prevented from doing after ceasing to be a shareholder of the company),
  • the process to be followed to issue and transfer shares, and
  • rights and obligations that are specific to certain directors (for example, the personal right to remain appointed as a director).

When going into business with other people, for example family and friends, there is usually complete trust and an assumption that no legal paperwork needs to be put in place to provide protection to anybody. In the best-case scenario, the company and relationships with your business partners will be a success and you’ll never need to look at your shareholders’ agreement, however, in the worst case scenario, a shareholders’ agreement could protect your position and avoid a costly legal dispute. You should therefore always consider seek legal advice with drafting a shareholders’ agreement to ensure that your interests are sufficiently protected.

Discover how Moore Barlow can help define your responsibilities and protecting your rights with a shareholders’ agreement. Explore our service here.

Investment agreements

Shareholders’ agreements and investment agreements contain similar provisions and are made between the shareholders of a company. Sometimes the two can be combined into one document known as a ‘subscription and shareholders’ agreement’.

The main difference is that investment agreements tend to be used when an investment is being made into a company and therefore the purpose of an investment agreement is to deal with the subscription for shares in return for the investor’s cash or provision of debt funding by an investor and to give protection to investors and reassurance in relation to their investment.

Provisions which are usually contained in an investment agreement include:

  • warranties – the shareholders or company (and sometimes directors of the company) will usually make statements (‘warranties’) about various aspects of the company, confirming them to be true and accurate at the time the investment agreement is entered into,
  • completion conditions, for example, the investors may stipulate that certain conditions must be satisfied before the investment monies can be released to the company,
  • tables setting out the company’s share capital before and after the investment,
  • how the investment will be structured – i.e. by debt or equity, and
  • when decisions by the directors will need consent of the investors or investor directors, as investors will usually want a contractual right to prevent the existing shareholders making key decisions about the company without their consent.

How Moore Barlow can help

As noted above, there are several points which you will need to consider before preparing and entering into any of the above-mentioned documents.

A lot of the situations which the documentation seeks to cover may seem unlikely to occur (for example the process of removing a director or a deadlock of the board resulting in decisions not being able to be made) as it is likely that at the outset the relationship between all parties will be amicable. However, it is important to ensure your company’s documents are suitably drafted so that you can avoid disputes and complications down the line.

If you would like any advice in relation to drafting new or updating existing constitutional documents, please do contact us.