COMPANY LAW UNIT - 2 CH3: ARTICLES OF ASSOCIATION

 

UNIVERSITY OF DELHI / SCHOOL OF OPEN LEARNING 

B. Com. (Program) / B. Com. (Hons.)

COMPANY  LAW 

N.O.T.E.S 

UNIT - 2

LESSON 3: ARTICLES OF ASSOCIATION

INTRODUCTION :

- According to Section 2 (5) of the Companies Act, Articles of Association refer to a company's original or amended rules and any regulations applied under previous company laws or the current act.

- Articles of Association serve as the internal governance framework for a company, comprising rules, regulations, and by-laws.

- They define the authority and responsibilities of company officers and establish a contractual relationship between the company and its members and among the members themselves.

- The articles outline the methods and procedures for conducting the company's business.

- When drafting the articles, the company should ensure that they align with the powers granted by the Memorandum of Association and comply with the provisions of the Companies Act.

- A court case (Naresh Chandra Sanyal vs. Calcutta Stock Exchange Association Ltd. 1971) supports the understanding that articles of association are legally binding and enforceable in governing a company's internal affairs.

CONTENTS AND FORM OF ARTICLES

- Articles of Association contain rules on various matters such as share capital, share rights, calls, forfeiture, and alteration of share capital.

- They also cover topics like transfer and transmission of shares, capitalization of profits, buy-back of shares, general meeting procedures, voting rights, and proxy.

- The Articles address the board of directors, board proceedings, key executives, company seal, dividends, reserves, books of accounts, winding up, and indemnity.

- The form of Articles is specified in Tables F, G, H, I, and J of Schedule I based on the type of company.

- Companies can adopt the model form of articles with or without modifications.

- Articles of Association must be printed, numbered, and signed by each subscriber, with signatures attested by a witness who provides their own details.

THINK OF IT LIKE THIS { NOTE - JUST FOR UNDERSTANDING }

Imagine you and your friends want to start a club. You need some rules to make sure everyone knows how the club will work. Articles of Association are like the rules for a company, just like the rules for your club. 

These rules talk about many things, like how much money people need to put in to be part of the company. They also talk about what happens if someone doesn't pay their money or if they want to sell their part of the company to someone else.

The rules also say how the company makes decisions. They talk about meetings where people can vote on important things, like what the company should do next. They even explain how someone can vote on behalf of another person if they can't be there.

The rules also talk about the people in charge of the company. They explain how they make decisions and what they can do. They also talk about things like giving money back to the people who own the company, keeping records of what the company does, and what happens if the company needs to close down.

Now, the form of Articles just means that there are different templates or layouts for these rules depending on the type of company. It's like having different designs for different clubs, depending on what they do.

Finally, when the rules are finished, they need to be printed out and each person who wants to be part of the company has to sign their name on the paper. A witness, who is like someone who makes sure everything is done correctly, also signs the paper. This is to show that everyone agrees to follow the rules.

So, just like your club needs rules to work properly, companies have rules called Articles of Association to make sure everything runs smoothly and everyone knows what to do.

ENTRENCHMENT CLAUSE

- Section 5(3) of the Companies Act allows for the inclusion of an Entrenchment clause in the Articles of Association.

- An Entrenchment clause specifies that certain provisions in the articles can only be altered if more restrictive procedures or conditions than those for a special resolution are met.

- The company can include such clauses during its formation or by amending the articles with agreement from all members for private companies, and by a special resolution for public companies.

- If the Articles of Association contain an entrenchment clause, the company must inform the registrar by submitting Form No. INC 2 for One Person Company (OPC) or Form No. INC 7 for other companies.

{THINK OF IT LIKE THIS { NOTE - JUST FOR UNDERSTANDING }

Imagine you and your friends have a special rule in your club that can't be changed easily. Let's say you have a rule that says everyone has to wear a hat at every meeting. But you want to make sure this rule is really important and can't be changed unless everyone agrees.

An entrenchment clause is like that special rule. It's a rule in the Articles of Association of a company that says certain things can't be changed easily. It means that if the company wants to change those special rules, they have to follow extra strict procedures or conditions.

When a company is starting or wants to make changes to its rules, they decide to include an entrenchment clause. They have to agree on it together. For some companies, they need agreement from all the members, and for others, they need a special vote from a lot of people.

If a company has an entrenchment clause, they have to tell the government about it by filling out a special form. It's like saying, "Hey, we have this special rule that can't be easily changed, and we want you to know about it."

So, an entrenchment clause is like a special rule that a company makes to protect certain important things. It's like having a super important club rule that everyone agrees can't be changed unless they follow extra strict procedures.

IN-TEXT QUESTIONS

1 Articles of Association of a company define the scope of its operations.

2 Articles of association of a company are subordinate to the memorandum and the Companies Act.

3 The company may alter its articles of association anytime by following the procedure

as prescribed in the_________

4 The Company may insert _____________ clause in its articles.

5 Any act of the company which is ultra vires the articles can be confirmed by the

shareholders if it is intra vires the___________.

ANSWERS 

1. False. Articles of Association of a company govern the internal affairs and regulations of the company, but they do not define the scope of its operations. The scope of operations is defined in the Memorandum of Association.

2. True. Articles of Association are subordinate to both the Memorandum of Association and the Companies Act. They must not contradict or violate the provisions stated in these documents.

3. Companies Act. 

4. Entrenchment. 

5. Memorandum of Association. 

RELATIONSHIP BETWEEN             MEMORANDUM AND ARTICLES:

1. Subordination of Articles to Memorandum:

- The articles of association are subordinate to and controlled by the memorandum of association.

- The articles accept the memorandum as the charter of incorporation and proceed to define the duties, rights, and powers of the governing body, as well as the mode and form of conducting business and making changes in internal regulations.

2. Constitution and Fundamental Conditions:

The memorandum is the constitution of the company and contains fundamental conditions for the company's incorporation.

- The articles are subsidiary to the memorandum and should not contradict the companies act memorandum or the Law of the Land.

- In case of conflict between the articles and the memorandum, the provisions of the memorandum prevail.

3. Alteration:

- The memorandum can be altered only under specific circumstances provided by the act.

- The articles can be altered by passing a special resolution as they govern the internal affairs of the company.

- Acts beyond the scope of the memorandum are ultra vires and void, without the possibility of ratification.

- Acts contravening the articles are irregular but can be regularized and confirmed by the shareholders.

4. Reading together and Resolution of Conflicts:

- The memorandum and articles must be read together to avoid ambiguity and supplement each other if either document is silent on a matter.

- In case of a conflict between the two documents, the memorandum takes precedence.

{THINK OF IT LIKE THIS { NOTE - JUST FOR UNDERSTANDING }

Imagine you and your friends are building a clubhouse. You have two important papers that you need to make sure everyone follows. One paper is called the Memorandum, and the other is called the Articles.

The Memorandum is like the main rulebook of your clubhouse. It has all the important things that everyone has to agree to. It's like saying, "These are the most important rules that we all have to follow."

The Articles are like a second rulebook that gives more details about how your clubhouse will work. It talks about things like who is in charge, how decisions will be made, and how the clubhouse will run. It's like saying, "These are the specific things we need to know about our clubhouse."

Now, the Articles have to listen to and follow the Memorandum. They can't contradict what the Memorandum says. It's like the Memorandum is the boss, and the Articles have to do what the boss says.

If there is ever a conflict or disagreement between the two rulebooks, the Memorandum is the one that wins. Its rules are more important and have to be followed.

Sometimes, the Articles can be changed if all the members agree. But the Memorandum can only be changed in specific situations, and it's harder to do.

Both the Memorandum and the Articles are important, and we need to read them together to understand all the rules for our clubhouse. But if there is ever a conflict between the two, we have to follow what the Memorandum says because it's like the boss of the rulebooks.

DIFFERENCE BETWEEN MEMORANDUM AND ARTICLES

Memorandum of Association:

1. Meaning: It is the charter of the company, containing fundamental conditions for incorporation.

2. Objectives: Defines and limits the scope of the company's activities.

3. Relationship: Establishes the company's relationship with the outside world.

4. Alteration: Can be altered as per the procedure provided in the Companies Act, requiring approval.

5. Subordinate: Subordinate to the Companies Act.

6. Ratification: Any act beyond the scope of the Memorandum is void and cannot be ratified by shareholders.

7. Compulsory: Must be filed with the registrar by every company.

Articles of Association:

1. Meaning: Lay down rules and regulations for the company's internal management.

2. Objectives: Provide rules for carrying out the objects specified in the Memorandum.

3. Relationship: Define the relationship between the company and its members, as well as among the members themselves.

4. Alteration: Can be altered by passing a special resolution, with approval of the Regional Director or Tribunal in certain cases.

5. Subordinate: Subordinate to both the Memorandum and the Companies Act.

6. Ratification: Acts beyond the scope of the Articles can be confirmed by shareholders if they are within the scope of the Memorandum.

7. Compulsory: A company limited by shares need not have its own Articles and can adopt Table F instead.

ALTERATION OF ARTICLES OF ASSOCIATION

Section 14 of the Companies Act - Power to Alter Articles:

1. Grant of Power: Every company has the power to alter its articles, subject to provisions of the memorandum and Companies Act.

{THINK OF IT LIKE THIS { NOTE - JUST FOR UNDERSTANDING }

Every company has the power to change or alter its rules called "articles." But they have to follow the important rules in the "memorandum" (which is like the main rulebook) and the Companies Act (which is like a big book of rules for all companies).

2. Procedures:

Start --> Board of Directors decides to change the articles --> Shareholders' Meeting held to vote on the proposed changes --> Shareholders vote on the changes --> Agreement? Yes/No --> No: End --> Copy of decision sent to Registrar --> Approval from Tribunal for conversion? Yes/No --> Yes: New rules sent to Registrar --> End

   a. Approval: The Board of Directors approves the proposed alteration.

   b. Shareholders' Meeting: A resolution for amendment is passed at a shareholders' meeting.

   c. Filing Requirement: A copy of the resolution is filed with the Registrar within 30 days.

   d. Conversion to Private Company: If a public company wants to convert into a private company, approval from the Tribunal is required within three months of passing the special resolution. Altered articles must be filed within 15 days of approval.

3. Conditions for Alteration:

   - Special Resolution: Alteration must be made by passing a special resolution, subject to provisions of the memorandum and Companies Act.

   - Bona Fide: Alteration should be for the benefit of the company.

   - Statutory Power: Alteration is a statutory power of the company that cannot be restricted by any contract.

   - Entrenchment Clause: If articles contain entrenchment clauses, conditions of such clauses must be met before making any alteration.

   - Conversion of Company Type: Alterations removing restrictions applicable to a private company cause it to cease being a private company. Conversion from public to private or vice versa requires specific approval from the Tribunal.

   - Notice and Information: Notice of the meeting should provide full information about the proposed amendments.

   - Breach of Contract: Alteration for the company's benefit that results in a breach of contract may be made, but damages must be paid to the affected party

**Conditions for Alteration**

When a company changes its rules, they have to follow some important conditions:

- They have to make the changes by passing a special decision called a "special resolution." This means most of the shareholders have to agree.

- The changes they make should be good for the company, like making things better or easier for everyone.

- The company has the legal power to change its rules, and no other agreement can stop them from making changes.

- If their rules have special clauses that say some things can't be easily changed, they have to follow those special conditions before making any changes.

- If the changes they make remove restrictions that apply to private companies, it means they can't be a private company anymore. But if they want to change from being a public company to a private one (or vice versa), they need special approval from the Tribunal.

- When they tell the shareholders about the meeting to decide on the changes, they have to give them all the information about the proposed changes so everyone knows what they are voting for.

- If the changes they make break any contracts the company has with other people, they have to pay for any problems it causes.

Restrictions on Alteration of Articles:

1. Compliance with Laws: Alterations must not conflict with the provisions of the Companies Act or any other applicable law.

[When a company wants to change its rules, they need to make sure the changes don't break any laws.]

2. Consistency with Memorandum: Alterations must not be inconsistent with the provisions of the memorandum or exceed its authority.

[The rules of the company have to match with what is written in a special document called the "memorandum." They can't go beyond what the memorandum says. ]

3. Compliance with Tribunal's Orders: Alterations must not be against any orders issued by the Tribunal.

[ Sometimes a special court called the "Tribunal" gives orders to a company. The company has to follow those orders when changing its rules.]

4. Legal and Public Policy Considerations: Alterations must not include any provisions that are illegal or opposed to public policy.

[ The company can't make changes that are against the law or things that people believe are not right] 

5. Approval Requirements: Where required, the company must obtain approval from the Tribunal for specific alterations, such as converting a public company into a private company.

[Sometimes, the company needs permission from the Tribunal to make certain changes. They have to ask for approval before making those changes. ] 

6. Bona Fide and for the Company's Benefit: Alterations must be made in good faith and for the overall benefit of the company.

[ The company can only change its rules if it's for the good of the company. They can't change the rules just to be mean or unfair to others. ] 

7. Retrospective Effect: Alterations may be made with retrospective effect if they benefit the company as a whole.

[ Sometimes the company can make changes to the rules that apply to things that happened in the past. This can only happen if it helps the company as a whole. ]  

8. Protection against Minority Oppression: Alterations must not be unfair and should not result in the oppression of minority shareholders. 

[.The company can't change the rules in a way that is unfair to a small group of people who own shares in the company.] 

9. Illegality of Expelling a Member: Alterations made by the Board of Directors to expel a member are illegal and void.

[The company can't change the rules just to kick someone out of the company. It's against the law to do that.]

10. Consent for Increased Liability: Increasing a shareholder's liability or requiring additional contributions without their written consent is invalid. Exceptions apply to clubs or not-for-profit associations with the consent of all members.

[ The company can't make a person pay more money or take more responsibility without asking for their permission. But in some special cases, like clubs or groups that don't make money, they can do this if everyone agrees.]

11. No Justification for Breach of Contract: Alterations cannot be used as a means to justify the company's breach of a contract with a third party. Damages may be payable in such cases.

[ The company can't change the rules just to break a promise they made to someone else. If they do that, they have to pay for any damage or harm caused by breaking the promise.]

DOCTRINE OF CONSTRUCTIVE NOTICE

1. Registration of Documents: The Memorandum and Articles of a company are registered with the Registrar and become public documents available for inspection. 

2. Inspection and Copying: Any person can electronically inspect or obtain a copy of these documents by paying the prescribed fees.

3. Importance for Contracting Parties: Individuals entering into contracts with the company must familiarize themselves with the contents of these documents and ensure that their contracts align with them.

4. Doctrine of Constructive Notice: Every person dealing with the company is deemed to have read and understood the contents of the Memorandum and Articles. They are held to have constructive notice of their provisions.

5. Consequences of Contracting beyond Company's Powers: If a person enters into a contract that exceeds the powers granted to the company or its directors by the Memorandum or Articles, they do not acquire any rights under that contract. They will be personally liable for any consequences arising from such dealings.

Case Example: In Kotla Venkataswamy v. Chinta Ramamurthy, a mortgage deed was executed without being signed by all the required signatories specified in the company's articles. The court held that the deed was invalid because it did not comply with the articles' provisions, and the mortgagee should have consulted the articles before executing the deed.

DOCTRINE OF INDOOR MANAGEMENT

1. Purpose: The doctrine of indoor management is based on convenience and ease of doing business. It acknowledges that outsiders are unaware of the internal proceedings of the company and protects them from irregularities in the company's internal management.

2. Turquand Rule: The doctrine was established in the case of Royal British Bank v. Turquand. It states that when officers of the company act on behalf of the company in a manner that appears to comply with the provisions of the articles, parties dealing with the company are not affected by internal irregularities.

3. Protection of Outsiders: The doctrine of indoor management aims to protect outsiders who rely on the apparent authority of the officers of the company in their dealings.

{THINK OF IT LIKE THIS { NOTE - JUST FOR UNDERSTANDING }

Imagine you have a favorite toy store where you love to buy new toys. Sometimes, you may not know everything that happens inside the store, like how they organize their toys or manage their money. But that's okay because there's a rule called the doctrine of indoor management that helps protect you.

 The doctrine of indoor management is like a special rule that makes it easier for you to trust the people who work at the toy store. It understands that you don't know all the inside details of how the store operates, so it protects you from any problems that may be happening behind the scenes.

Here's how it works: Let's say one day you go to the toy store, and the store manager tells you that you can have a discount on a toy. You trust the manager because they seem to be in charge, and they're following the rules of the store. If later you find out that the manager didn't actually have permission to give you a discount, it's not your fault. The rule says that you can still keep the discount because you trusted the manager, and you didn't know about any problems happening inside the store.

The doctrine of indoor management is there to protect you and other people who do business with companies. It makes it easier for you to trust the people who work at the company and rely on their authority. It's like having a special rule that helps keep things fair and convenient for everyone.

So, remember, if someone at a company acts like they have the authority to do something, and you trust them, the doctrine of indoor management says that you're protected even if there are some problems happening inside the company. It's all about making it easier and more convenient for you when you do business with a company.

Exceptions to the Doctrine of Indoor Management:

1. Notice of Irregularity: The doctrine does not apply if the party dealing with the company had knowledge of irregularities or lack of authority of the person acting on behalf of the company.

[  If someone dealing with a company knows that something is not right or that the person they are dealing with doesn't actually have the authority to act on behalf of the company, then the protection of the doctrine of indoor management doesn't apply. It's like if you see someone doing something wrong and you still go along with it, you might be responsible for the consequences.]

2. Negligence: If the circumstances are suspicious and invite inquiry, and the person enters into a contract without sufficient inquiry, they may be held responsible for the consequences.

[If the situation seems strange or suspicious, and the person doesn't ask enough questions or investigate further before doing business with the company, they might be held responsible for any problems that come up. It's like if someone offers you something that seems too good to be true, and you don't ask any questions or tell someone about it, you might get into trouble later.  ]

3. Forgery: The doctrine does not apply to cases involving forgery. Contracts entered into through forgery are void ab initio, and no rights can be acquired under such contracts.

[  If someone makes a fake document or signature to trick you into doing business with a company, the doctrine of indoor management doesn't protect you. Contracts made through forgery are considered invalid right from the beginning, and you can't get any rights or benefits from them. It's like if someone pretends to be someone else and signs your name on a paper, it's not a real agreement, and you shouldn't be held responsible for it.] 

Ostensible Authority:

1. Company's Liability for Fraudulent Acts: A company may be held liable for fraudulent acts committed by its officers acting within their ostensible authority.

[Sometimes, the people in charge of a company (called officers) may do bad things and trick others. If they do something dishonest while acting like they have the authority to do it, the company can be held responsible for their actions. It's like if someone who works for a company does something wrong while pretending to have permission to do it, the company can get in trouble for it. ] 

2. British Thomson-Houston Case: In this case, a director without authorization gave a guarantee to the plaintiffs on behalf of the company. The court held that a person dealing with a director need not inquire into his authority for acts that directors ordinarily have authority to perform.

[ In this particular case, there was a director of a company who promised to help some people, even though he didn't actually have permission to make that promise. The court said that the people who were dealing with the director didn't need to check if he had the right to make that promise because directors usually have the authority to do certain things. So, in general, if you are working with someone in a high position like a director, you don't have to doubt if they have the power to do the things they say they can do.] 

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