KNOW YOUR LAW #8 – THE CONTRACT FOR REGULATION OF ENTITIES

PROVISION COVERED	Section 5
CONCEPT COVERED	Articles of Association

THE CONSTITUTIONAL DOCUMENT:

Section 5 of the Companies Act, 2013 deals with the necessity of Articles of Association (hereinafter referred to as “AOA” / “Articles”). Together with the memorandum of association, the AOA are collectively recognized as the constitutional documents for a company which administers a company and directs its activities in compliance with the law. These documents establish the fundamental corners of a company without which a company’s existence cannot be substantiated.

ENFORCEMENT PURVIEW - PURPOSE:

The purpose of the Articles is spilt out through the employment of phrase “regulations for management of the company” in Section 5(1) of the Companies Act, 2013. While the MOA sets out the purpose of existence of a company, the Articles on the other hand recognizes the existence of a company through the MOA and thereafter to supplement the enforcement of the objects of a company, the AOA accept the MOA and lists out the regulations for administering the affairs of the company which in so far shall help in fulfilling the main objects.

In the case of Ashbury Railway Carriage v. Riche (1875), it was observed that “The Articles play a part subsidiary to the memorandum of Association. They recognize the memorandum as the charter of incorporation of the company and by recognizing so, the articles proceed to define the rules, duties, rights and powers of the governing body as between themselves and the company at large.”Companies are required to be governed through a catena of rules with due regard to their respective objectives based on the nature of their establishment. The Companies Act, 2013 is an established codified law applicable on a common footing to all the economic structures known as companies. It is practically not possible for the law to include specific set of directions to each company and thus the law has embodied itself in the form of AOA with an option to all the companies to modify the same as they deem fit in line with achieving their main objects. The AOA embeds different provisions with respect to regulation of a Company which inter alia include management of share capital, conduct of the board members, holding board and general meetings, indemnification etc. just to name a few.  

CONTRACT:

The AOA is not just a document. It is a binding domestic contract between the members of a company and the company upon how the administration of the company shall be carried out which is legally enforceable. The bench of the Madras High Court of Justices Satyanarayana Rao and C Reddi in S.T. Narayana Chettiar and Ors. v. The Kaleeswarar Mills Ltd. (1950) (AIR 1952 Mad 515) contemplated that “The articles constitute a contract binding on the company and the members in all matters.” The construction of the Articles can be envisaged in both positive and negative sense. On a positive perspective, the AOA promote the management of affairs in a more structured manner while on a negative basis, the AOA restricts the exercise of powers by the governing body and the company itself. Such contract is executed between the members of the company on a common consensus who have material monetary interest in a company. The Bombay High Court in Gordhandas Pursottam Sonawala v. Natvarlal Chandulal & Co. (1950) (AIR 1952 Bom 349) outlined that “It is again true that the articles of association of a company constitute a domestic contract between the members in their capacity as members, by reason of the operation of the Indian Companies Act.”

NON SUBSTITUTIABLE IN ENTIRETY:

Once the AOA of a company is embraced and executed between the members, it cannot be replaced in entirety subsequent to the establishment of the company. Nevertheless only the regulations contained in the articles can be modified or altered concerning different needs. The Department of Company Affairs (as then) through letter dated 20^th October 1963 clarified that once the articles of a company is adopted, it cannot be replaced later due to any reasons. However, the provisions in articles may be altered following due procedure of law.

However, due to the transmission of the law from the regime of Companies Act, 1956 to the Companies Act, 2013, companies registered under the Companies Act, 1956 are empowered to adopt the articles in such formats specified in Schedule I to the Companies Act, 2013 by the virtue of operations of Section 5(7), 5(9) read with Section 5(7) and Schedule I to the Companies Act, 2013 collectively, which however shall have effect of only amending the articles under the present law rather than the replacement of the contract itself.

TRANSMUTATION OF THE POSITION OF LAW:

The position of the Company law on the nature of the Articles have not undergone significant change ever since the adoption of the first company law in the Indian context had taken place. At present, Section 2(5) of the Companies Act, 2013 defines AOA as “The articles of association of a company as originally framed or as altered from time to time or applied in pursuance of any previous company law or of this Act.” This however does not enlist the character or the nature of the Articles. The nature and the purpose of the same is understood through the language casted in Section 5(1) of the Companies Act, 2013.

The Companies Act, 2013 through Section 2(5) articulates that the intention of law with respect to the nature and purpose of AOA has not undergone a change through the employment of words as originally framed or altered from time to time. Following listed are the instances where the foundational stones were laid to the meaning of AOA:

·        The Indian Companies Act, 1882:

The Indian Companies Act, 1882 as enacted by the British was completely based on the English law. Section 37 of the 1882 Act defined the Articles as:

S. 37. Regulations to be prescribed by articles of association

“The memorandum of association may, in the case of a Company limited by shares, and shall, in the case of a Company limited by guarantee or unlimited, be accompanied, when registered, by articles of association signed by the subscribers to the memorandum of association, prescribing such regulations for the Company as the subscribers to the memorandum of association deem expedient.”

Section 37 of the Indian Companies Act, 1882 which defined the AOA placed emphasis on the MOA when registered shall through the AOA prescribe the regulations for the Companies. This corresponded to Section 10 of the English (Consolidation) Act, 1908 so as to mean that the International law as well fairly recognized the Articles for governance of the companies vide rules and regulations embedded within.

·       The Indian Companies Act, 1913:

S. 17. Articles of Association

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

Section 17 of the Indian Companies Act, 1913 as well fairly had embedded the principle that the articles supplement the enforcement of MOA and prescribe the rules for administering the company.

·        The Companies Act, 1956:

S. 2(2). Definitions

"Articles" means the articles of association of a company as originally framed or as altered from time to time in pursuance of any previous companies law or of this Act, including, so far as they apply to the company, the regulations contained, as the case may be, in Table B in the Schedule annexed to Act No. 19 of 1857 or in Table A in the First Schedule annexed to the Indian Companies Act, 1882 (6 of 1882), or in Table A in the First Schedule annexed to the Indian Companies Act, 1913 (7 of 1913), or in Table A in Schedule I annexed to this Act.”

The purpose of AOA as originated from the seeds of Section 37 of the Act of 1882 as adopted in Section 17 of the 1913 Act which finds import under Sections 2(2) and 2(5) of the Companies Act, 1956 and 2013 respectively.

STRUCTURE OF THE ARTICLES:

Section 5(6) of the Companies Act, 2013 read with Schedule I to the Companies Act, 2013 outlines the prescribed five forms of the MOA which shall be applicable to different classes of companies which are summarized as below:

FORM	APPLICABILITY
Table F	Applicable in case of companies limited by shares
Table G	Applicable to companies limited by guarantee and having share capital
Table H	Applicable to companies limited by guarantee and not having share capital
Table I	Applicable to unlimited companies having share capital
Table J	Applicable to unlimited companies not having share capital

However, it is not a hard and fast rule of the law that the Companies shall only adopt the model articles prescribed under Schedule I and there is flexibility available to companies to alter and include further provisions in its Articles. Section 5(2) of the Companies Act, 2013 empowers companies to alter and include additional matters in the AOA as it deems fit from time to time. Since AOA is a contract between the members and the Company, any alteration in the AOA shall secure the approval of the members in general meeting of the Company.

ENTRENCHMENT PROVISIONS:

Sections 5(3), 5(4) and 5(5) of the Companies Act, 2013 deal with newly embedded concept of “entrenchment” clause in the Articles which earlier under the Companies Act, 1956 did not find a mention. The concept of entrenchment in the context of the Companies Act, 2013 emerged to safeguard the interest of the companies and the minority shareholders. The presence of an entrenchment clause or a provision in the Articles protect the sanctity of the originally enacted AOA on the common consensus of all the members.

As already stated earlier, AOA is recognized as a constitutional document for companies which can be amended from time to time with the consent of the special majority of members in a general meeting through a special resolution. At this juncture, the minority shareholders who voice up against the motion if genuine are deprived and their concern in the company even though being an investor is unheard. Therefore, the concept of entrenchment concept emerged under the law which got embedded under Section 5(3). Entrenchment means and implies that in case certain aspects in the AOA are to be amended, then the same can be amended only if certain perquisite conditions such as:

·        Securing the assent of all the shareholders or

·      Securing the assent of members wherein votes casted in favor shall be 4/5 times more than the votes casted against

for amending such clause in the AOA is obtained. Section 114 of the Companies Act, 2013 outlines that in case of special resolution proposed to be passed at the general meeting the votes casted in favor shall be more than votes casted against. The entrenchment clause in an AOA casts a much stringent situation which only if fulfilled, shall pave way for amending the specific clauses in AOA which are important to the company. Section 5(4) of the Companies Act, 2013 contemplates that the provisions of entrenchment shall be a part of the AOA at the time of incorporation or the same can also be inserted into the AOA through amendment:

·       When all the members of private company give their assent thereto

·      When votes casted by the members for the amendment is three times the votes casted against in case of public limited companies.

The concept of entrenchment which has an extended scope emanated in the Indian Context through the doctrine of Basic Structure in the cases of Kesavananda Bharati v. State of Kerala (1973), Golak Nath v. State of Punjab (1967) wherein the Supreme Court expounded the power of parliament to amend the provisions of constitution through the majority autonomy. The concept of entrenchment can be attributed and equated to the “Eternity Clause” which exists in the Australian Constitution under Article 128 which declare that the Commonwealth Constitution is entrenched as it may only be amended by referendum, the amendment must gain the support of a majority of Australian voters nationwide plus a majority of voters in a majority of states.

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