The pitfalls of incorporating with model articles

All limited companies must have articles of association. They are a publicly available document setting out the rules that officers and shareholders must follow when running companies. Model articles are the standard default articles prescribed by the Companies Act 2006 (the “Act”) and replaced Table A from 1 October 2009.

It is increasingly common for newly incorporated companies and start-ups to incorporate quickly and online with model articles, to save the burden of adopting tailored articles of association. Additionally, if a company does adopt bespoke articles which don’t exclude or modify the relevant model articles then the relevant Model Articles will (as far as applicable) form part of the company’s articles of association.

Many directors are not aware of the provisions of the model articles. In this article, we list some issues with model articles on a company’s flexibility to run and why in the long run tailored bespoke articles might be better from the outset.

1) Directors conflicts

Model article 14 specifies that if a proposed decision of the directors is concerned with an actual or proposed transaction or arrangement with the company in which a director is interested, that director is not to be counted as participating in the decision-making process for quorum or voting purposes. In small private companies where directors are also shareholders there is arguably always a conflict between the two roles. This can result in directors not being able to vote on simple matters and therefore requiring shareholder approval to proceed.

In a small company this can create an unnecessary strain, the process can be time consuming and may require additional legal drafting. A bespoke set of articles can be drafted to give directors the ability to vote if they declare any conflicts at the outset, making the process much more streamlined.

2) Different classes of share

Newly incorporated companies are often incorporated with only one class of share. This often suits small manager-owner companies. Ordinary shares carry the right to a dividend and to vote. However, the creation of separate classes can allow different rights to attach to the various class of shares, for example one class can confer a right to a dividend but another can not. If investors are seeking to come into the company from the outset they may require different classes of shares. A set of bespoke articles can be designed to suit all parties’ needs.

3) Pre-emption rights on allotment and transfer of shares

Pre-emption rights are the “right of first refusal”. It follows that on an allotment or transfer of any shares the current shareholders are offered the chance to acquire the same amount of shares, so as not to dilute their own shareholding.

The Act has a specified process for pre-emption rights on allotment. A bespoke set of articles may seek to remove the statutory pre emption right on allotment to give the directors more freedom to allot shares and so as not to seek shareholder approval for the removal of pre-emption provisions. On the contrary, bespoke articles could specify a certain process to follow. Model articles are silent to pre-emption rights on a transfer and therefore if directors would like a degree of protection on who should receive shares first if one original shareholder decides to leave, bespoke articles would be sensible.

4) Alternate directors

The model articles nor the Act makes provision for the appointment of alternate directors. Although not as common in small private companies, the ability to appoint an alternate director might be useful if the director in question knows he will be away or not capable of contact during a particular period.

5) Directors meeting

Model article 11(2) states that a quorum for any directors meeting is 2 directors. If a newly incorporated start up is incorporated with model articles and has two directors then should there be a disagreement and one director does not show up – a quorum will not be present and nothing can be decided.

To avoid this frustration bespoke articles can be adopted which specify the quorum is only 1 director. Alternatively, if a start-up or small business incorporates with a high number of directors and the quorum is only two, decisions of the directors could be decided without some even being present.

6) Allotment of shares

Model article 21 requires all shares that are allotted following the initial formation of the company to be issued fully paid up. This means that new shareholder following incorporation must pay for their shares in full when they are allotted to them.

A bespoke set of articles could remove this article to allow directors to issue shares which are nil, partly or fully paid. A nil paid share is simply where the subscription price of a share is left outstanding when issued. Nil paid shares are sometimes considered to have certain tax benefits.

7) Proxies

The model articles contain no express requirement as to the time of delivery of a proxy notice however previously table A provided that such appointment should be received not less than 48 hours before the time appointed for the meeting. By drafting be spoke articles the shareholder of the company can have certainty as to a required delivery times of any proxy notice.

How Moore Barlow can help you

If you are concerned that your articles of association are not fit for the current purpose of your company or you are considering incorporating a new company and need extra help with the constructional documents please contact our corporate team.