Section 14 of the Companies Act 1985

Title: S.14(1) Companies Act 1985 states: “Subject to the provisions of this Act, the memorandum and articles, when registered, bind the company and its members to the same extent as if they respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and articles” Lord Greene MR said of this provision that it had been “the subject of considerable controversy in the past, and it may very well be that there will be considerable controversy about it in the future” (Beattie v E and F Beattie Ltd [1938] Ch 708 at p.721).

Discuss..

ANSWER

Introduction

Section 14 of the Companies Act 1985, which is currently in the process of being replaced by section 33 of the Companies Act 2006 provides that, when they are registered, the articles and memorandum of a company bind the company and its members to a contract as if these documents were signed as a deed by each member and contained covenants on the part of each member to adhere to the provisions of the articles and memorandum..

In particular, section 33 of the 2006 Act, which will provide the future law on this issue and must therefore be considered as a priority, states as follows:

“The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions.”

The quote by Master of the Rolls Lord Greene, from the case Beattie v E and F Beattie Ltd (1938)^[1] indicates that his Lordship considers that the section 14 provision has been a controversial issue in the past and that it is likely to continue to be the subject of controversy in the future. This paper examines the case law relating to section 14 of the 1985 Act and considers Lord Greene’s point of view, drawing conclusions on the basis of the established jurisprudence.

Case law on the Section 14 Statutory Contract

There are various legal consequences of the so-called statutory contract established by section 14 of the Companies Act 1985. Firstly, it should be noted that the memorandum and articles constitute a binding contract between the company and each member of the company. As a consequence, each company member is bound to observe the provisions in the articles in his or her dealings with the company in their capacity as a member. Furthermore, while section 14 does not expressly provide that the articles bind the company to the members, the company will at law be treated as bound to each shareholder in his or her capacity as member so as to conform with the provisions in the articles.^[2]

In Oakbank Oil Co v Crum (1882)^[3] Lord Selborne LC spoke in the House of Lords on the contractual effect of the articles of association. He stated:

“Each party must be taken to have made himself acquainted with the terms of the written contract contained in the articles of association…He must also in law be taken to have understood the terms of the contract according to their proper meaning, and that being so he must take the consequences whatever they may be of contract which he has made.”^[4]

An often cited case on this issue is Hickman v Kent or Romney Marsh Sheepbreeders’ Association (1915)^[5]. In this case Hickman was in dispute with the Sheepbreeders’ Association.. The articles provided that any disputes between the company and its members should be referred to arbitration. However, Hickman decided to take his claim straight to court, ignoring the articles. The court held that the Association was legally entitled to have the court action stayed. The reason for the ruling was that the articles gave rise to a contract between the company and Hickman to refer disputes to arbitration and that provision should have been complied with.

Moreover, in the case Pender v Slatington (1877)^[6] at a shareholder’s meeting the chairman refused to accept the plaintiff’s votes. The articles of the company allowed one vote for every ten shares held by shareholders. The chairman’s refusal to adhere to the rule resulted in a resolution proposed by the plaintiff being defeated.. As a consequence the plaintiff applied to the court for the grant of an injunction preventing the directors acting contrary to the resolution. The court held that the plaintiff was entitled to the injunction, restating that the articles were a contract binding the company to its members, in precisely the same way as the members were bound to the company. Another case in point is Wood v Odessa Waterworks Co ^[7] where articles provided that the directors must declare a dividend to be paid to the members. Instead of paying a dividend the company proposed that the members would be issued with debentures to be redeemed over thirty years. This was deemed contrary to the articles and the statutory contract.

It is submitted that in such cases a member will always be entitled to bring a straightforward claim against the company to ensure that the company complies fully with its obligations under the articles, in which case the matter will become simply one of construction of the articles and the terms of the statutory contract made. This will prove to be the case despite the fact that a majority of members may actually have approved the transaction proposed by the directors, given that this would constitute an alteration of articles by ordinary resolution which is insufficient at law – a special resolution being required in practice.

As case law confirms, the memorandum and articles of a company are also treated as a binding contract between the shareholders inter se (ie. themselves). As a consequence, one member can sue another if the other fails to adhere to a relevant provision in the articles or memorandum. There is no need to involve the company in the action.. In the case Rayfield v Hands^[8] the articles of a company stated that any members who wished to transfer their shares should inform the directors, who would purchase the shares at a fair value. The plaintiff owned 725 shares in the company and requested that the defendant directors should buy them but they refused to do so. The plaintiff thereafter brought an action relying on the contract created by the articles without joining the company to the suit. It was held by the court that the directors were contractually obliged to take the shares. On the authority of section 14, the articles had established a binding contract between the directors, in their capacity as members, and the plaintiff, in his capacity as a member.

That said, the authority on the rule that members are bound inter se is not particularly strong or clear, being largely a mixture of obiter dicta and first instance rulings. A fairly categorical statement was given by Stirling J to this effect in Wood v Odessa Waterworks^[9], where he held that the articles of association constitute a contract “not merely between the shareholders and the company, but between each individual shareholder and every other.” That said however, in the case Salmon v Quin & Axtens (1909)^[10], Farwell LJ, while approving Stirling J’s statement, stated that the court would not enforce the covenant as between individual shareholders in most cases^[11].

Moreover, in Welton v Saffrey (1897)^[12] Lord Herschell denied the existence of a contract between the individual members of a company and stated that any rights which the articles gave them inter se should only be enforced by or against a member of the company through the company itself^[13]. Lord Herschell opined:

“It is quite true that the articles constitute a contract between each member and the company, and that there is no contract in terms between the individual members of the company; but the articles do not any the less, in my opinion, regulate their rights inter se. Such rights can only be enforced by or against a member through the company or through the liquidator representing the company” (emphasis added)

That said however, the law evolved over subsequent decades. By the 1943 case of London Sack and Bag Co Ltd v Dixon & Lugton (1943)^[14] Scott LJ was moved to state:

“It may well be, even as between ordinary members of a company who are also in the nominal way shareholders, that (what became section 14) adjusts their legal relations inter se in the same way as a contract in a single document would if signed by all.”^[15]

Vaisey J, in Rayfield v Hands as discussed above, commented that he considered Lord Herschell’s statement “somewhat cryptic” and it is submitted that the latter statement cannot be treated as good law today. It makes sense to allow members to bring actions between themselves without involving the company given that this will save time money and administrative effort. In addition, in some cases the members against whom the articles are due to be enforced will be in a position to exercise control or influence over the board of directors, who might then be biased against authorising the use of the company name to enforce the articles-based action.

It is also pertinent to note that no right set down by the memorandum or articles, which applies to a member in an outsider capacity, that is to say in a capacity other than that of member (for example as a director or solicitor) can at law be enforced against the company. This rule is justified by the fact that the memorandum and articles do not comprise a contract with so-called “outsiders” but merely with the members in relation to their rights as members of the company..

In the case Eley v Positive Government Security Assurance Co (1876)^[16] the articles of a company provided that the plaintiff would be employed as the permanent solicitor of the company. The plaintiff later acquired shares in the company, but thereafter the company terminated his employment. The plaintiff subsequently brought an action for breach of the contract established by the articles.. However, it was held that the action could not succeed given that there was no contract between the company and the member in his capacity as solicitor, which was at issue here and which was treated by the law as an outsider interest..

In the case Hickman v Kent or Romney Marsh Sheepbreeders’ Association, as discussed, Astbury J commented on Eley in the following terms:

“an outsider to whom rights purport to be given by the articles in his capacity as such outsider, whether he is or subsequently becomes a member, cannot sue on those articles treating them as contracts between himself and the company to enforce those rights.”^[17]

Astbury J distilled the following principles from his survey of the law in this field. First, he concluded that articles regulating rights and obligations of the company members generally as such establish rights and obligations between them and the company respectively. Second, he found that no article can constitute a contract between the company and a third party. Third, he concluded that no right seemingly given by an article to an individual (regardless of whether or not that person is in fact a member) in a capacity other than that of member (for example as a promoter, director or solicitor of the company) can be enforced against the company itself..

It is submitted that, with a view to the statement made by Lord Greene MR under review, the first two principles ascertained by Astbury are relatively uncontroversial. This is a reliable conclusion, given that those principles are based on long established case and statutory authority, and on the common rule of privity of contract. However the third principle has proved more controversial and difficult to rationalise. Gower has described Astbury’s third principle as the “orthodox view”^[18] and it was reflected in Bisgood v Henderson’s Transvaal Estates (1908)^[19], where Buckley LJ stated as follows:

“the purpose of the memorandum and articles is to define the position of the shareholder as shareholder, not to bind him in his capacity as an individual..”

This has the effect of denying the enforceability of any right unconnected to membership. It is submitted that this reduces articles providing for matters such as that in Eley can be taken only as non-binding statements of intention. This view was applied in Beattie v E and F Beattie Ltd (1938) itself, which is the case that inspired the quote under review in this article. Here a dispute arose between a company and a director concerning an alleged breach of duty. As in Hickman, the articles specified that all such disputes should be referred to arbitration.. The director unsuccessfully attempted to rely on this clause to prevent the matter being aired in court, the reason being that the dispute concerned his capacity as a director, which was classed as an outside interest.

That said, in Rayfield v Hands, as discussed, an obligation requiring company directors to buy the shares of a member wishing to sell was actually enforced against the directors. This case has been viewed as extremely controversial and it is submitted it is hard to reconcile the authority with other cases in point. Vaisey J commented that:

“the relationship here is between the plaintiff as a member and the defendants not as directors but as members.”

However, it is argued that this is an unconvincing distinction and perhaps the only way to rationalise the law is to put Rayfield into the category of cases involving quasi-partnerships, where the courts sometimes take a different approach grounded on principles of equity and justice.

The eminent commentator Wedderburn sought to reconcile the law in this field by stating as follows:

“a member can compel the company not to depart from the contract with him under the articles even if it means indirectly the enforcement of “outsider rights” vested in either third parties or himself, so long as, but only so long as, he sues qua member and not qua outsider.”^[20]

It is submitted that this view is commendable. Furthemore, it coincides with the analysis tendered by Lord Greene MR himself in the case which prompted the comment under review, namely Beattie v E and F Beattie Ltd (1938). In Beattie Lord Greene ruled that if the relevant article had entitled a member to instruct a company to refer a dispute with a director to arbitration, then the appellant should succeed. This argument seems well founded, given that the member is merely enforcing a right common to all members even though, incidentally, he was in fact the director on the facts.

Another eminent commentator Sealy has stated that:

“…our legislators should go back to the drawing-board and replace section 14 with a much more straightforward provision.”^[21]

Of course, the Companies Act 2006 provided Parliament with just such an opportunity. However, the new section 33 merely updates the language of section 14 of the 1985 Act, it does not change the law in substantive fashion. It is submitted that the new provision continues to reflect the law as it has always been: in particular that a company’s constitution binds both the company and its members.

As section 14(1) was, the provisions of section 33 are excepted from the general principle laid down in section 1 of the Contracts (Rights of Third Parties) Act 1999, meaning that the provisions of a company’s constitution do not confer any rights on persons apart from than the company and its members. Unlike section 14(1), section 34 refers to “a company’s constitution”, as opposed to its “memorandum and articles“. It is submitted that this acknowledges the modern division and distinction between formation and constitutional information in the memorandum, articles and other constitutional documents of the company.

Concluding Comments

Master of the Rolls Lord Greene, in the comment under review, noted in Beattie v E and F Beattie Ltd (1938)^[22] that the section 14 statutory contract had proved the subject of considerable controversy in the past, and that there may very well be considerable controversy about it in the future. This remark was undoubtedly well founded, and it did not require the Master of the Rolls to make the observation. Any student of law could reach the conclusion that the section 14 contract, being the nexus between the company and the membership, is likely to prove a fertile field for litigation, and it certainly has.

It is submitted that the new law as set out in section 33 of the Companies Act 2006 will do little to change the nature of the relationship between the company and its members and do little to reduce the number of actions founded in this field. Section 33 constitutes a restatement rather than a reform of the law and therefore the potential for “controversy” in this field remains.

THE END

GLOBAL DOCUMENT WORD COUNT : 2905 (excluding footnotes)

BIBLIOGRAPHY

Companies Act 2006: http://www.opsi.gov.uk/ACTS/acts2006/ukpga_20060046_en.pdf

Companies Act 1985 (now being superseded by the 2006 Act):

http://britlaw..free.fr/company/companies_act_1985.htm

Gower LCB, Modern Company Law, (1992) Sweet and Maxwell

Keenan and Bisacre, Smith and Keenan’s Company Law for Students, (2005) London: Longman

Kelly D. and Holmes A., Principles of Business Law, (1997) Cavendish Publishing

Sealy L S, Sealy: Cases and Materials in Company Law, 7th ed (2001) LexisNexis UK

Wedderburn, Shareholder’s Rights and the Rule in Foss v Harbottle, [1957] CLJ 194

Cases as footnoted drawn from original law reports.

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Footnotes

^[1] [1938] Ch 708 at p..721.

^[2] See for comment: Goulding S., Principles of Company Law, (1996) Cavendish Publishing. p72.

^[3] (1882) 8 App Cas 65.

^[4] Ibid at 70.

^[5] [1915] 1 Ch 881.

^[6] (1877) 6 Ch D 70.

^[7] (1889) 42 Ch D 636.

^[8] [1958] 2 All ER 194.

^[9] As cited.

^[10] [1909] 1 Ch 311.

^[11] Ibid at 318.

^[12] [1897] AC 299.

^[13] Ibid, at 315.

^[14] [1943] 2 All ER 763.

^[15] Ibid, at 765..

^[16] (1876) 1 Ex D 88.

^[17] [1915] 1 Ch 881 at 897.

^[18] Gower LCB, Modern Company Law, (1992) Sweet and Maxwell p283.

^[19] [1908] 1 Ch 743.

^[20] Wedderburn, Shareholder’s Rights and the Rule in Foss v Harbottle, [1957] CLJ 194, at 212.

^[21] Sealy L S, Sealy: Cases and Materials in Company Law, 7th ed (2001) LexisNexis UK..

^[22] [1938] Ch 708 at p.721.