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Why have tailored articles of association and even a shareholders agreement

09 June 2016

If you are setting up a company with your business partner, you may be tempted to rely solely on the statutory default articles of association for private companies limited by shares (the Model Articles) to govern the internal procedures of the company, and the corporate relationship between you. These notes show why you really should consider having articles that are tailored to your circumstances, and even a shareholders’ agreement, between you and your partner - even if you wouldn’t dream of falling out with him or her.

Introduction

Suppose you are operating a business through a company of which you are the sole owner and manager. But now you want to introduce a partner so that you own and hold 60% of the shares in the company and your partner 40%, and he is the other director of the company. Perhaps he is already working in the business as an employee.

Model (default) Articles could result in early deadlock

Under the Model Articles, the quorum for board meetings is two. One of you, for example your partner, could block any board decision by just not turning up to the meetings.
To prevent this happening, tailored articles could provide that you form the quorum and have control over board decisions. As majority shareholder you could even give yourself the right in tailored articles (or in a shareholders’ agreement) to appoint or remove directors by notice to the company.

Another feature of the Model Articles is that any director who has a personal interest in a matter to be considered at a board meeting cannot form the quorum and cannot vote on that resolution (unless the matter comes within some narrow exceptions).

Tailored articles could provide that any conflicted director can be included in board meetings for quorum and voting purposes as long as he has fully disclosed his interest.
Under the default position, there would also be potential deadlock at shareholders’ meetings since the Companies Act 2006 provides that the quorum at those meetings is two, unless the articles provide otherwise.

Tailored articles could prevent your partner from blocking shareholder decisions as well.

How to get rid of a shareholder

In general you cannot force another shareholder to give up their shares, but tailored articles (or a shareholders’ agreement) could enable you to do so in certain circumstances.
One example is that if a shareholder is also an employee or director and ceases to be one of those, articles (or a shareholders’ agreement) could provide that that shareholder must offer his or her shares for sale to you, as the other shareholder, or to the company. The provisions might make a distinction in the price of the shares being offered, between whether the departing shareholder is a “good leaver” or “bad leaver”.

Another example is that if you wish to sell your shares and your buyer wants 100% of the company, you can have “drag-along rights” under which you would have the right to require your partner to sell to the buyer, generally on the same terms as you are receiving...

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