Company law: amending the articles of association and minority rights

When drafting company articles, the objective is to provide clear and concise guidance on how a company conducts its business together with procedures for common shareholder events. Provisions in the articles may provide control over its shareholdings so they may not pass to third parties, for example on the death of a shareholder or members attempting to sell their shares to individuals, the directors may not wish to be involved with the company.

Generally, court actions in terms of shareholder actions follow three themes where litigation is common:

(1)          Amending the company articles of association by the majority.

(2)          Pre-emption and fair price rights.

(3)          Ascertaining the ‘fair price’ of shareholdings.

Overview ‒ amending the articles of association

In practice as private companies grow and mature, they may require new investors or undertake joint ventures and ultimately implement their exit strategy and sell the company. To implement any major change in the company it is probable the articles of association will require amendment by the majority which the minority may perceive as detrimental.

Amendment of the articles

A company may amend its article by passing a special resolution. The articles cannot contain provisions which fetter this requirement by lessening the requirement to an ordinary resolution or, more importantly, attempting any entrenchment. The company and the directors must be free to amend the articles.

Special resolutions

To amend the articles of association a special resolution which is a statutory requirement under the Companies Act 2006, s 283, is required which means it is passed by not less than 75% of the voting rights of the eligible members.

It is not unconceivable for a minority shareholder (who wishes to keep their shareholding) to suggest to a majority shareholder (who wishes to sell their shareholding) that passing a special resolution to amend the articles of association, inserting a new provision and instigating a full sale to a third party is not acting in good faith for the benefit of the whole company.

Case example ‒ Alan Engineering Limited

Alan Engineering Limited has two shareholders: Mr Alan who holds 80% of the equity shares and Mr Albright, his uncle who made a small investment ten years ago for his shareholding of 20%. The company is now successful with 32 employees and a turnover approaching £2 million; however the company has large debts and Mr Alan is in poor health. Mr Alan has been approached by a competitor and an offer has been made to purchase all the company’s’ shares.

Mr Albright, who is not involved with the running of the company and is not a director, refuses to sell his holding, which prevents the sale of the company. Mr Alan passes a special resolution and amends the articles to include a ‘drag along’ clause that compels Mr Albright to sell his shares.

Mr Albright may feel aggrieved and may possibly consider legal action to contend the change of the articles is for the benefit of Mr Alan, whose purpose is to execute his exit strategy and sell the business.

Based on the evidence, the court could only conclude that the changes to the articles are for the benefit of the company. Mr Alan is in poor health, the company has debt and has no successor – it is perfectly feasible to suggest that if the sale is not executed the company may fall into liquidation.

The prima facie case that Mr Alan has amended the articles to benefit himself is coincidental to the change being bona fide for the benefit of the company – securing the long-term future of the company by paying off debt and getting an injection of capital from a prospective buyer thereby will secure the employment of 32 people.

Case law on amending the articles of association

It is established case law that any amendment by the majority of members must be in the best interest of the company and not persecute the minority. The courts will not overturn amendments to the articles by the majority even on the basis the amendment is a deliberate act that benefits the majority’s position (see case example); they will only interfere with the amendment on the basis it was not bona fide for the benefit of the company (Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656).

In Greenhaigh v Arderne Cinemas Ltd [1946] 1 All ER 512, [1951] Ch 286, Evershed MR said: ‘It is not necessary to require that persons voting for a special resolution should, so to speak, dissociate themselves altogether from their own prospects’. Each case is assessed on its own merit and the case law provides unambiguous guidance – the majority may amend the articles and improve their own position without interference from the courts.

The ‘bona fide for the benefit of the company as a whole’ was applied in Dafen Tinplate Co Ltd v Llanelly Steel Co (1907) Ltd [1920] 2 Ch 124. Dafen, the defendants, amended their articles of association passed in accordance with a special resolution to require a member to transfer their shareholding to a nominated third party at a fair price. Peterson J stated ‘the question was not whether the shareholders bona fide or honestly believed that the alteration was for the benefit of the company. It was whether, in fact the alteration is genuinely for the benefit of the company’.

Rights & Issues Investment Trust Ltd v Stylo Shoes Ltd [1965] Ch 250 is another case where the company amended the articles to allow for a share issue and alteration of voting rights, the court was asked to consider if the majority acting against the minority was oppressive. The plaintiff accepted the company acted bona fide for the benefit of the company as a whole. Pennycuick J said: ‘The question is whether this particular resolution represents an oppressive act on someone, and in particular, I suppose, the plaintiffs and any shareholders who did not vote in favour of the resolution’. The interlocutory injunction sought was duly rejected on the basis the company had followed the Companies Act 2006 and requirements of the articles of association.

In Citco Banking Corporation NV v Pusser’s Ltd [2007] UKPC 13, the articles were amended by special resolution to allot 200,000 Class B shares with enhanced voting rights. In addition, the Chairman Charles Tobias who held Class A shares voted to convert his holdings to Class B shares. Lord Hoffmann made clear the court’s agreement with the ‘general principle that shareholders are free to exercise their votes in their own interests’.

Richard C. Bishop is the author of Articles of Association: Guidance and Precedents and Articles of Association for Charities and Not for Profit Organisations: Guidance and Precedents.

Richard C. Bishop

Written by Richard C. Bishop

Richard is lecturer in finance at Leeds Beckett University teaching in the Centre for Tourism and Hospitality Management. Prior to working at Leeds Beckett, Richard taught marketing and business strategy at Wolverhampton University, specializing in delivering CIM modules and lead the financial service degree program at Coventry University College.

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