When setting up a company, you need articles of association and a shareholders’ agreement tailored to your specific needs. These documents have some similarities, but it is crucial to put both in place.
By having them drafted by experienced corporate solicitors, you can have greater confidence that the provisions will give your business a clear foundation and reduce the risk of misunderstandings and disputes in the future.
Below, we take a look at the difference between articles of association and shareholders’ agreements and which takes precedence in a dispute.
Summary
This article includes the following:
- Introduction: Why These Documents Matter
- At-a-Glance: Articles of Association vs Shareholders’ Agreement
- What Are Articles of Association?
- What Typically Goes in the Articles?
- What Is a Shareholders’ Agreement?
- What Typically Goes in a Shareholders’ Agreement?
- Public vs Private: Confidentiality and Visibility
- Who Is Bound? (and How New Shareholders Are Added)
- What Happens If They Conflict? (Alignment & Supremacy Clauses)
- How Each Document Is Amended (and Why It Gets Hard Later)
- Enforcement: What If Someone Breaches the Rules?
- Fundraising Add-On: Investors’ Agreements and the “Deal Stack”
- Clause Checklist for Business Owners (Decisions to Make Before Drafting)
- Common Pitfalls and How to Avoid Them
- Related Documents Owners Often Overlook
Introduction: Why These Documents Matter
Articles of Association and shareholders’ agreements provide the framework for a company, setting out details of how decisions will be taken, what rights individuals have and how potentially divisive issues will be handled.
If they are not robust and drafted with the requirements of the particular business in mind, there could be disputes in the future. Using standard model articles or a template shareholders’ agreement might seem like a quick and easy solution, but they could leave your business in difficulty, should those involved have different opinions about the direction of the organisation.
An experienced corporate solicitor can work with you to identify how you want to structure the company and what rights each individual should have. If you ask us to assist you, we will look at how your business could evolve and help ensure it is supported by clear, robust legal documentation.
At-a-Glance: Articles of Association vs Shareholders’ Agreement
Articles of Association are compulsory for all limited companies and must be filed at Companies House. They are publicly available and are a statutory framework, setting out the basic rules for the running of the company, including issues such as voting rights and directors’ powers.
Shareholders’ agreements are optional, although companies should usually consider putting one in place. They are private and set out shareholders’ rights when dealing with matters such as shareholders’ obligations, protections for minority shareholders, exit strategies and how a deadlock will be handled.
Where shareholders wish to amend a company’s Articles of Association, a special resolution is usually required. If shareholders wish to amend a shareholders’ agreement, the agreement may stipulate the number of votes required. If it does not, then all shareholders must agree to any amendments.
If the Articles of Association are breached, an application can be made to the court requesting that the action be voided.
Where a shareholders’ agreement is breached, shareholders can sue for damages if they have suffered loss as a consequence.
What Are Articles of Association?
The Companies Act 2006 requires that a company has Articles of Association. They make up the legal framework for a company, setting out the basis on which it will operate, and form a contract between the company directors, the shareholders and the company itself.
What Typically Goes in the Articles?
Key provisions that are generally dealt with in Articles of Association include:
- The company’s purpose
- Directors’ powers and responsibilities,
- How directors can be appointed and removed
- Voting rights
- Share capital and how shares will be structured, to include different classes of shares, the voting rights attaching to each and how new shares can be issued
- Drag-along and tag-along rights
- Distribution of profits
- The quorum required for company meetings, notice periods and the requirement for the passing of a company resolution
What Is a Shareholders’ Agreement?
A shareholders’ agreement is a contract made between shareholders that should set out clearly their rights and obligations. It can offer protections to minority shareholders and reduce the risk of disputes.
What Typically Goes in a Shareholders’ Agreement?
Key clauses contained in shareholders’ agreements include:
- Which issues require a unanimous decision
- What veto rights shareholders have
- How company directors can be appointed and removed
- Pre-emption rights allowing existing shareholders the right of first refusal to buy newly created shares or shares being offered for sale
- Drag-along rights, requiring minority shareholders to sell if the company is being sold
- Tag-along rights, requiring majority shareholders to include minority shareholders if the company is being sold
- Good leaver and bad leaver clauses dealing with the exit of a shareholder
- Restrictive covenants, limiting the actions of a shareholder following sale of their shares, for example, limiting where they can set up a rival business after leaving and preventing the poaching of key personnel
- Dispute resolution clauses, setting out how a deadlock will be resolved
- How company dividends will be dealt with
Public vs Private: Confidentiality and Visibility
Articles of Association are filed at Companies House and can be viewed by anyone, including competitors and creditors. For this reason, issues such as how profits are shared and how exits will be managed should not be included.
Shareholders’ agreements are not publicly available, and should include confidentiality clauses requiring the signatories to avoid sharing the information they contain.
Who Is Bound? (and How New Shareholders Are Added)
Articles of Association bind the company, the directors, the company secretary and the shareholders. If a company is limited by guarantee, any guarantors are also bound by the terms of the document.
A shareholders’ agreement binds those who have signed the document. This could be individual shareholders, and can also include a corporate entity. The company in question will usually also be a party to the agreement.
New shareholders are not bound by the agreement until and unless they sign a deed of adherence confirming that they will be bound as if they signed the original document. The other parties to the original agreement will also sign the deed.
What Happens If They Conflict? (Alignment & Supremacy Clauses)
It is important to have Articles of Association and a shareholders’ agreement tailored to your company’s needs. This will ensure that the provisions they contain are aligned and reduce the risk of the two documents conflicting.
If they do clash, the Articles of Association will usually prevail, although the documents can set out an alternative. For example, a shareholders’ agreement can contain a supremacy clause overriding certain provisions in the Articles of Association.
If a conflict has occurred, then as well as resolving the issue, it is also advisable to vary either the Articles of Association or the shareholders’ agreement to avoid further problems in the future.
How Each Document Is Amended (and Why It Gets Hard Later)
To amend a company’s Articles of Association, it is necessary to pass a special resolution. This usually requires approval from at least 75% of the votes cast. A board meeting should be held first, then notice of a general meeting given or a written resolution passed advising shareholders of the proposal.
If agreement is secured, the updated document must be registered at Companies House within 15 days of the change.
To amend a shareholders’ agreement, it is usually necessary for all signatories to agree, unless the document provides otherwise.
Where everyone wishes to make a change, it can be dealt with in one of two ways: either a deed of variation is drafted, setting out any amendments that have been agreed upon, or a new shareholders’ agreement is drawn up.
Over time, it can be more complicated to agree on changes, particularly if parties have differing ideas on the future direction of the business.
Enforcement: What If Someone Breaches the Rules?
If Articles of Association are breached, the court can be asked to make a ruling. Options include:
- Securing an injunction stopping the action from continuing
- Requiring the action to be voided
- Claiming damages, where a loss has been suffered as a result of the breach of the Articles
- An unfair prejudice petition, brought under Section 994 of the Companies Act 2006, where a minority shareholder is being excluded or their rights and interests are not being observed
- A derivative claim, brought by shareholders on behalf of the company, against company directors who have breached their legal obligations and duties
If a shareholders’ agreement is breached, shareholders can ask the court for a remedy. This can include:
- Damages for any losses arising as a result of the breach
- An injunction preventing the breach from continuing
- An order for specific performance, requiring the breaching party to take a particular action
- A compulsory transfer of shares to another party, with an agreed method of valuation
It is generally preferable to try to resolve disputes out of court first. We can advise you of the strength of your case and suggest potential solutions. Where necessary, we can negotiate on your behalf and support you through an alternative method of dispute resolution.
Fundraising Add-On: Investors’ Agreements and the “Deal Stack”
If you anticipate that investors will put money into the company over time, a deal stack can be used to set out how this will be done. In this context, a deal stack means the set of documents used for an investment round, such as updated articles, a shareholders’ agreement, subscription documents and investor rights provisions.
The company’s framework documents should grant directors the necessary authority to allot shares and specify any rights of first refusal.
The investment process will generally have a baseline where the company valuation is stated and shares are sold to new investors. Alternatively, a faster option that does not require a valuation can be used where appropriate. Add-on capital can be included later on.
Clause Checklist for Business Owners (Decisions to Make Before Drafting)
Articles of Association:
- Directors and governance
- Directors’ powers
- How directors will be appointed and removed
- What will constitute a quorum for board meetings
- How voting on resolutions will be dealt with
- What indemnity directors will have in respect of personal liability
- Share capital and structure
- What share classes will be issued
- What rights each share class will have, including voting rights
- How dividend distribution will be handled
- How shares can be sold or transferred, to include the agreed method of valuation
- Meetings and voting
- How a general meeting can be called, to include what notice is required
- Who is entitled to attend meetings
- What constitutes a quorum
- How proxy voting will be permitted
- Administrative issues
- How official company communications will take place
- Whether the company will have a company seal and how this will be used
- What will happen to company assets if the company is wound up
Shareholders’ agreement:
- Shares
- The classes of shares to be issued
- The voting and capital rights each type of share will have
- Pre-emption rights, allowing existing shareholders the right of first refusal when new shares are issued
- Whether there are any restrictions on transferring shares
- Management
- How directors will be appointed and removed
- Issues that will require special consent from shareholders, such as taking on a loan or issuing new shares
- Shareholder protections
- Drag-along and tag-along rights
- Whether shareholders have a right to dividends if a profit is made
- Exit strategies
- Good leaver provisions, for example, what will happen when a shareholder retires or dies
- Bad leaver provisions, such as how shares will be dealt with when the shareholder is dismissed
- How shares will be valued
- How disputes such as a deadlock will be managed
- Restrictive covenants
- Confidentiality clauses
- Non-compete, non-solicitation and non-dealing clauses
- Finance
- How shareholder loans will be dealt with, including the terms and interest rates
Common Pitfalls and How to Avoid Them
Using model articles or a standard template for the shareholders’ agreement rather than having bespoke documents created for your needs can be a major pitfall. If agreements are not tailored to the particular needs of a business, there is an increased risk that they will not be robust enough to handle disputes.
Bespoke documentation should also eliminate conflict between the agreements. Where one document contradicts the other in some way, a precedence clause can be included stating which is to take precedence.
It is also important to review company documentation periodically to ensure it is still fit for purpose. This is particularly necessary as a business evolves, takes on a new direction or expands.
Other common pitfalls include:
- Failure to set out how a deadlock will be handled
- Not specifying when a decision will require unanimous agreement
- Allowing shareholders to veto decisions, resulting in the company being unable to react to market conditions
- Failure to set out clear exit strategies
Related Documents Owners Often Overlook
Other related documents a company should have in place include:
- Directors’ agreements and service contracts setting out what is required of directors and details of their salary, benefits and notice periods
- Confidentiality and non-disclosure agreements to protect data and trade secrets
Conclusion: When You Need One, the Other, or Both
It is often sensible for a company to have both Articles of Association and a shareholders’ agreement prepared by an experienced corporate solicitor. Having the right documentation in place can help reduce the risk of costly and disruptive legal disagreements in the future.
Contact Our Corporate Solicitors
If you need advice, representation, or guidance in respect of articles of association or a shareholders’ agreement, we will be pleased to assist.
For more information on our services, see our corporate solicitors page.
To speak to one of our experienced corporate solicitors, ring us on 0300 303 2071, email us at info@witansolicitors.co.uk or fill in our contact form and we will talk through your situation with you and discuss how we can assist. We have offices in Birmingham, Northampton, London and Wellingborough.
