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Most important document in constitution of a company is Memorandum
The most important document in the constitution of a company is the Memorandum of Association of the company. The Articles of Association is the second most important document that needs to be registered by any company for its incorporation, registration and subsequent operation. It is a public document laying down the rules for the internal management of the company and it does not have the force of ‘law’. The provisions of the article amount to public notice, known as constructive notice. This is the doctrine of constructive notice.
The effect of the doctrine of constructive notice is harsh on the outsider who does business with a company. An outsider who does business with a company is always presumed to have a constructive notice of the documents of the company. An outsider cannot claim relief on the ground that he was unaware of the powers of the company in case of ultra vires of the company. As criticisms of the doctrine of constructive notice, the new theory called the doctrine of indoor management has been evolved by the courts. The doctrine of constructive notice seeks to protect the company against the outsider; the other doctrine operates to protect outsiders against the company. The rule of indoor management is based upon obvious reasons of convenience in business relations. Firstly, the memorandum and articles of association are public documents and therefore open to public. But, the details of internal procedures are not thus open to public inspection. Hence, an outsider may be expected to know the constitution and other essential details of the company; but not those actions which may or may take place within the closed doors.
Section 26 of the Companies Act, 1956 requires certain types of companies namely unlimited companies, companies limited by guarantee, and private companies limited by shares to mandatorily register their articles of association. This is necessary for these companies because section 27 provides certain mandatory provisions which must be included in the articles of such companies. These companies need to frame their own articles which must not only be consistent with their memorandum of association but also be in conformity with the provisions of the Act. Alternatively the companies may choose to adopt the model articles that are contained in the various tables in Schedule I of the Act. The schedule, which contains various model forms of memoranda and articles, contain provisions which are legal beyond all doubt and hence would not stand to be questioned in a court of law. This requirement as far as articles is concerned stands in direct contradistinction to the public limited companies which are free to either have or not have such articles. However this does not imply that public companies are capable of operating without articles. It merely gives them the freedom to choose whether or not to have their own set of articles. As we shall see from the proceeding discussion no company can survive without a given set of articles, hence the importance of the document as far as any company is concerned.
Chapter I- Articles of Association
‘Articles of Association’ is used to refer to a document which contains the rules, regulations and bye-laws that govern the management of the internal affairs of a company and the conduct of its business. It is something akin to a partnership deed in a partnership. The Act does not provide for an express definition of the term but merely states that it is used to mean the articles of association as originally framed or as altered from time to time in pursuance of any previous companies’ laws or of the present Act. The Articles stipulate the manner in which the relationship between the company and its members and between the members’ themselves are regulated. The subscribers to the memorandum of association are also the signatories to the articles and are given a free hand to decide and determine its contents. This is to ensure that maximum flexibility is granted to the companies in determining how to operate in the best possible manner and to keep statutory intervention to the minimum. Therefore it can be said that articles are integral to the survival of a company because without such governing rules and regulations it would becomes impossible to hold in harmony the diversity of relations under which they have to function.
The importance of articles of association can only be properly construed when its relation with the memorandum of association is established. Both the articles and memorandum are closely connected although the former is considered subordinate to the latter. This is because while the memorandum states the purposes of the establishment of the company, the articles provide the manner in which such purposes are to be achieved. The articles determine how the powers conferred on the company by the memorandum of association shall be exercised. Both the documents are considered contemporaneous in the sense that in cases of uncertainties both documents must be read together. In fact articles can, in several instances, be used to explain the ambiguities in the memorandum but not so as to extend the objects.
The alteration of articles of association particularly constitutes an important aspect of the functioning of any company. Section 2(2) of the Act itself states that a reference to articles includes the articles altered from time to time in pursuance of any previous companies’ laws or the present Act. Alteration becomes a necessary part of the functioning of a company because the need and circumstances of a company are bound to change considerably in the course of time. The objects with which it was formed may be found too limited. Similarly the internal distribution of powers and functions between its shareholders and directors may not be suitable in changed circumstances. In such cases it becomes desirable to extend the object of the company so as to increase or diminish the powers of the directors, to alter the voting rights attached to shares, or the create different classes of shares altogether. It is situations like these that necessitate a company to alter the contents of its articles and memorandum of association so as to enable it to carry itself forward. The need for alteration can be multifarious but the essence remains the same.
While the need to alter memorandum may be far and wide, alteration of the articles is something which every company would need from time to time since it is the everyday matters that the articles deal with. Again considering the nature of the subject matter dealt with by the memorandum, granting wide powers of alteration is not prudent. However if a similar stance is taken as far as articles are concerned it becomes impossible to effect desired changes and therefore the corporate enterprise would be frustrated. Keeping this in mind the counterbalance between memorandum and articles becomes even more so important. While the powers of alteration vis-à-vis memorandum need to be restricted considering the nature and importance of the document, a much wider and flexible connotation becomes necessary as far as the articles are concerned.
While ease and flexibility of alteration is prudent, excess powers can have several significant consequences. The nature of relationship between memorandum and articles and their binding legal effects complicates matters further in such a case. Wide power to alter the articles without adequate safeguards is likely to harm the interests of certain sections of the society including the shareholders, third parties and the public in general. It is, thus, necessary to impose certain restriction on these powers. In order to maintain this balance between the need to allow the company to operate independently and the need to protect certain classes from its abuses, certain fundamental limitations have been introduced by the courts and by the legislators.
Chapter II: Limits and Scope of Alteration
The power of alteration granted by the Companies Act is primary governed by the statutory limitations contained within the Act itself. The judicial limitations on power of alteration continue to apply but they are largely without any statutory recognition and therefore are merely general rules and not in the nature of absolute rules. The present chapter will analyze the limits and scope of the power of alteration in terms of both statutory and judicial limitations as far as the Indian law is concerned.
The altered articles will bind the members in the same way as the original articles, but this does not mean that the alterations have a retrospective effect. The power of alteration by a special resolution has been granted under the Companies Act by section 31. However, this power of alteration is almost absolute, subject to the following restrictions. Firstly, that the alteration must not be in contravention of the provisions of the Act, i.e. it should not attempt to do something which the Act forbids. Similarly the alteration can also not be in contravention of the provisions of any other statute in operation. For example the Act specifies that no company can finance purchase of its own shares and if the articles of the company are altered so as to have such power to purchase its own shares, then such power will be void. Secondly, the power of alteration of articles is subject to the conditions contained in the memorandum of association. So in the event of conflict between the memorandum and articles, it is the memorandum that will prevail. Another important condition for validity of an alteration is that such altered articles must not include anything which is either illegal or opposed to public policy or unlawful. In such cases the alteration will be declared void. It may be kept in mind that the articles may impose on the company conditions that are stricter than those provided under the law and such provisions cannot be held to be invalid. For instance the articles may provide that a resolution should be passed by a special majority when the Act requires it to be passed by an ordinary majority. However, no provision in the articles can dilute the conditions of the memorandum or of the Act.
A limitation on adoption of new set of regulations has also been placed by a Circular, stating that a company can never replace its articles, its only the regulations that can be changed. A mistake, in the articles can only be rectified by altering the articles by special resolution, it cannot be done by application to Court. An important limitation on the power of alteration is provided in the proviso to section 31. The proviso to sub section 1 says that an alteration which has the effect of converting a public company into a private company would not have any effect unless it is approved by the Central government. In such a case, the company has to, within three months from the date of the passing of the special resolution, make an application to the Regional Director concerned for his approval of alteration. The Company Law Committee recommendations were key to the addition of this particular provision, which justifies the requirement as being necessary for protection of the interest of the shareholders, the parties dealing with the company as well as the general public. Yet another important restriction is imposed by section 38 of the Act. According to that section there cannot be an alteration of the articles so as to compel an existing member to take or subscribe for more shares or in any way increase his liability to contribute to the share capital, unless he gives his consent in writing. However, written consent of a member is not necessary where the company is a club or any other association and the alteration requires a member to pay recurring or periodical subscriptions or charges at a higher rate.
There are two other statutory limitations which are worth noting at this point of time. For one, the alteration must not be inconsistent with the order of the Tribunal under section 397 or 398 of the Act. The Tribunal is empowered under section 404 to order any alteration to the articles in order to remedy ‘oppression’ or ‘mismanagement’ in the company. Any alteration in contravention of the said order would, therefore, be invalid. Finally vide circular no. 32/75, dated 1st November, 1975 any amendment of articles to empower the Boards of Directors to expel a member is opposed to the fundamental principles of company jurisprudence and it ultra vires of the company. The limitations imposed by the statute are absolute restrictions and need to be mandatorily complied with. On the other hand the judicial limitations are prima facie general restrictions. Mathrubhumi Printing & Publishing Co. Ltd. v. Vardhaman Publishers Ltd. is one of the leading Indian authorities on this particular aspect and discusses in great details the power of alteration and the limits and scope of its exercise. In that case, Radhakrishna Menon J. referred to the leading English cases such as the Allen’s case¸ the British Murac Syndicate case as well as the Southern Foundries case to establish that the judicial limitations established in these cases also applies in the Indian context. The case established the rule that the alteration must necessarily be bona fide for the benefit of the company as a whole but it would not be bad merely because it inflicts hardship on an individual shareholder. Further it was also held that the power conferred on the company under section 31 to alter the articles by special resolution is not be abused by the majority of shareholders so as to oppress the minority. It was also pointed out that the alteration of articles retrospectively cannot affect, to the prejudice of the consenting owner of the shares, the right already existing under a contract or take away the right accrued. It was also pointed out that a company cannot justify a breach of contract with third parties or avoid a contractual liability by altering its articles. The company will always be liable for damages in case the alteration results in a breach of contract the company had entered into with any person. Quite clearly the judgment in this case has confirmed the application of the judicial limitations as far as the power of alteration under the Companies Act is concerned.
The articles of association are a very important document for the management of the company and thus its alteration requires an elaborate and complicated procedure. The doctrine of constructive notice has come into a lot of criticism, instead the doctrine of indoor management is the new trend. The power of alteration of the articles of association is undoubtedly one of the most essential powers that are granted to a company to ensure its efficient and smooth operation. The power is purely a statutory power which cannot be overridden by any means, even through a contract or agreement. However, unfettered power of alteration has its own set of disadvantages and it is never feasible under any legal system to grant such power without any form of restraint. To address this aspect, several limitations, both statutory and judicial, have been developed under different legal systems. In this paper we discussed certain important limitations evolved firstly by the English courts and thereafter applied by the Indian Courts also.