Significance of the Memorandum of Association

There can be no doubt that the significance of the Memorandum of Association (“Memorandum”) has gradually diminished ever since the first limited companies were recognised under English law over 150 years ago. A company’s Articles of Association (“Articles”), once of secondary importance to the Memorandum, have now taken primacy in the relationship between the ‘constitutional’ documents of a company. This shift is due to common law and statutory responses to the challenges faced by modern companies. However, the final implementation of the Companies Act 2006 (the “2006 Act”) which came into force on 1st of October 2009 marked the end of the Memorandum as a document of any ongoing significance for the regulation of a company’s affairs. Rather the Act has rendered the Memorandum nothing more than a ‘historic snapshot’ of the company which simply contains the details of its subscribers on incorporation. This essay examines the role and importance of both the Memorandum and Articles before and after the 2006 Act came into force.

The Joint Stock Companies Act 1856 (the “1856 Act”) first introduced the constitutional framework whereby a company’s external affairs were governed by the Memorandum and its internal affairs regulated by its Articles. Under this arrangement, which continued for over 150 years until 30 September 2009, the Memorandum was a constitutional document which stated the company’s: name; domicile; objects; whether a private or public company; whether limited by shares or guarantee; and the authorised share capital (if limited by shares). When introduced under the 1856 Act, the Memorandum was the most fundamental document which prevailed over the Articles where there was any inconsistency. One essential difference was the company’s power to amend its constitutional documents. Whereas companies could amend their Articles by special resolution, the 1856 Act made no provision for amending the Memorandum. It was not until the Companies Act 1862 (the “1862 Act”) that companies were given the power to amend the Memorandum to allow the company to change its name and capital requirements however any other amendments were prohibited. Subsequent Company Acts widened the scope of amendments to the Articles but there was never a general power to amend and each amendment was subject to special procedural requirements.

Reform of the constitutional documents of companies under the 2006 Act began in 1998 when the Department of Trade and Industry commissioned an independent steering group to carry out a fundamental review of company law. This steering group led the “Company Law Review” (CLR) which was instructed to consider how company law could be modernised so that an efficient, cost effective and simple framework for business could be established. The CLR carried out a comprehensive programme of research and consultation and presented its report to the Secretary of State for Trade and Industry in 2001. The report set out recommendations and areas of reform and included a recommendation that company law should be made as simple for small businesses and their advisers as possible so that cost savings could be made and entrepreneurial dynamism encouraged. This ideal was carried on by the CLR when determining the function of the Memorandum and Articles. The philosophy of simplicity was highlighted by the Standing Committee of the House of Lords when reviewing the bill which was the forerunner to the 2006 Act. Lord Sainsbury summarised the reform to the role of Memorandum very succinctly as follows:

“The Company Law Review looked very carefully at the question of the company’s constitution. It was keen to see the company’s internal rules as far as possible set out logically in one place and pointed out the potential for overlap under current arrangements between a company’s memorandum and its articles… we wanted to do away with any scope for confusion between the memorandum and the articles, and introduce a clear distinction between the information in the memorandum, which will be in effect an historical snapshot, which, once provided, has no continuing relevance, and the constitution of the company properly-so-called, as contained essentially in its articles, which will be of real significance in the company’s life.”

This summary reflects the present position under the 2006 Act. Lord Sainsbury described the new Memorandum as “a historical snapshot, which, once provided, has no continuing relevance”.

Back in the nineteenth century the Memorandum was important because it concisely set out to a company’s creditors or potential investors what activities the company could legally carry out in the objects clauses. The objects clauses reassured investors that their money could only be used for the purpose of the stated activities. The courts supported this by developing the ultra vires doctrine which held that a company was legally incapable of doing something unless it was empowered to do so in its objects clause. In other words, any acts outside the objects were held to be ultra vires and void. Following this decision the law regarding the strict application of ultra vires began to develop and the judiciary sought ways to reform the law.

Within five years the strict rule was relaxed with the allowance of a contract which, whilst outside the remit of the strict objects, were incidental to the main objects. However at this point the courts were still using ultra vires effectively and failure to achieve all its objectives could cause the company to be wound up.

Further changes introduced by the Companies Act 1890 (the “1890 Act”) allowed alterations to the objects to be made with restrictions; it must be for a purpose defined within the act, the company must have the change passed by special resolution and this must go before the court for confirmation. Following the legal amendments and Re: German Date Co., in 1918 the law further relaxed its attitude to the objectives identifying that each object clause was considered to be independent rather than a subsidiary of the main object clause. This judgement led to companies forming long lists of object clauses as an all encompassing strategy. The next significant alteration came in Bell Houses Ltd v City Wall Properties Ltd. Their objects included a generalised clause which allowed the company to “…carry on any other trade or business whatsoever which can, in the opinion of the board of directors, be advantageously carried on by the company in connection with or as ancillary to the general business of the company”. This clause was accepted to be valid by the courts diminishing further the importance of defining object clauses. This was enhanced by the Companies Act 1985 (the “1985 Act”) which subsequently allowed alteration of object clauses by special resolution.

It is important to note that an action of ultra vires can only be held as such if the other party had no actual or assumed knowledge that it was ultra vires. The protection of outsiders was further strengthened by the 1985 Act which confirmed that actions would not be deemed ultra vires providing the company was dealing with a director or responsible representative, they were acting in good faith and had no knowledge or suspicion of ultra vires. Another challenge to the viability of ultra vires came when the courts distinguished pursuance of objects from the exercising of powers contained in the Memorandum.

The Companies Act 1989 (the “1989 Act”) further altered the legal standing of the object clauses. Instead of allowing the doctrine of ultra vires to render an action void, it placed liability onto the Directors of the company for any activities which fell outside the remit of the Memorandum. The liability was in respect to any loss suffered by the company as a result of working outside the object clause. The 1989 Act provided “The validity of an act done by a company shall not be brought into question on the grounds of lack of capacity by reason of anything in the company memorandum”.

The 2006 Act has subsequently removed the need for companies incorporated after 1 October 2009 to include objects in their Memorandum. This disempowerment of members is part of a historical trend for the doctrine of ultra vires although the doctrine is still applicable for Company Directors. The law deems companies to have limitless objects unless there are self imposed restrictions contained in the Articles. For existing companies, the objects contained in the Memorandum are deemed to be transferred to the Articles and held as self imposed restrictions but can be removed by special resolution.

In a similar manner, the requirement to state authorised share capital has also been removed by the 2006 Act. Directors of companies limited by shares incorporated after 1 October 2009 need not include any reference to authorised share capital in the Memorandum or Articles therefore directors will be permitted to issue unlimited number of shares unless a self imposed restriction is contained in the Articles. Nevertheless, directors will generally still require the authorisation of the members before making any allotment of shares to new shareholders. This is subject to a new exception which allows directors of private companies composing only one class of share to allot shares without a shareholder resolution. The only new requirement under the 2006 Act is that directors must file a statement of capital with Companies House stating the number, class and nominal value of the company’s shares in issue. For existing companies the authorised share capital will continue to act as a cap setting the maximum amount of the shares that can be allotted by the directors of the company.

The 2006 Act abolishes the power of companies to place absolute entrenched rights in the Memorandum. Previously a company could place entrenched rights in the Memorandum and provide that they could not be changed or only changed under in accordance with strictly defined rules, although companies were not forced to act in a way that was against their best interests. Under the 2006 Act companies can only conditionally entrench elements of the company’s constitution in the Articles and absolute entrenchment is not permitted for new companies.

The Articles, whilst always part of Company Law have had their importance greatly enhanced by the 2006 Act. Now considered the predominant document encompassing both the internal and external affairs of the company, every company must have Articles. The role of the Articles as internal regulations have not been altered significantly by the 2006 Act it is the addition of the external regulations formally contained within the Memorandum which has meaningfully added to the legal standing of the Articles.

The 2006 Act provides model Articles now distinct for private and public companies which can be adopted by companies in whole or in part or companies can produce their own. When adopting alternative Articles the company can include any clauses it deems appropriate. However this is subject to restrictions. Illegal provisions will be deemed void. Provisions inconsistent with company legislation will be void. Provisions unrelated to membership will not be contractually bound. The company must use forms specified in the Act to transfer fully paid up shares. Limitations on Director power placed in the Articles does not affect the rights of any person dealing with the company who is acting in good faith.

Alterations to the Articles must be made by special resolution, communicated to Companies House and are subject to restrictions; a company can now require greater than the specified seventy five percent support for a designated article alteration enabling certain articles to be further entrenched within the constitution. A company is not able to require any member to invest any additional monies outside the initial agreement.

Individual members are permitted to claim for unfair prejudicial conduct or treatment irrespective of their individual shareholding thus affording protection to minority shareholders. The Articles additionally enable varied voting rights to be applied.

The Articles contain contractual obligations and can bestow rights on the members themselves. However, they also provide private rights for shareholders and members to rely upon although this does not alter the Articles. Where Directors are also members the courts consider the nature of the claim; if the claim relates to shareholding thereby to the external affairs it is deemed contract law but if the claim is in connection with the internal affairs it is deemed a breach of company regulation. Information detailed in the Articles can also be implied into another contract and where the Articles detail terms for non members these are said to be incorporated into the non members contract on appointment. Contractual obligations are set out in Section 33 of the 2006 Act.

The 2006 Act has placed any residual duties once included in the Memorandum into the Articles. This has been seen above by the manner in which objects, authorised share capital and entrenched rights have been either abolished or placed in the Articles. A further change that must not be overlooked is the requirement for companies limited by shares to include a statement limiting liability in the Articles.

The Articles continue to govern the relationship between the company, the shareholders and the company’s officers. However the 2006 Act now specifically states instances where a company can exercise powers even if they are not included in the Articles. For example, private companies no longer require authority in their Articles to issue redeemable shares. Instead the 2006 Act provides a general authority for private companies to issue redeemable shares subject to any constraints in the Articles. Furthermore, companies no longer need authority in their articles to buy their own shares subject to any self imposed restrictions in the Articles which had not previously been the case.

The Memorandum was until very recently the most important constitutional document of UK companies. It set the limits of the company’s business activities and powers and identified the maximum authorised share capital which whilst important for investor reassurance and protection particularly through the development of the ultra vires doctrine, gave no protection for outsiders because the ultra vires doctrine rendered actions and contracts void preventing the trading party from pursuing a court claim even though they may have been acting in good faith. This was unfair and caused the law to be somewhat defective. Nevertheless the Memorandum was not reformed in any meaningful way until very recently, a culmination of a 10 year process including a 3 year programme of research and consultation. The 2006 Act has removed the requirement for stated authorised share capital and objects although if they are included the company would be bound by them.

The 2006 Act has simplified and streamlined company law and the ascendancy of the Articles to the dominant constitutional documents recognises the reality of the modern era and dismisses the old fashioned delineation between external and internal affairs of the company. In modern business practice the Articles are the first place any potential stakeholder looks to determine whether the company has the correct procedures in place to enter into a proposed transaction. The 2006 Act encourages companies to keep their Articles short and simple by creating presumptions in its provisions which presume that companies have certain powers unless they are excluded by their Articles. This is unlike the regime under the 1985 Act where the presumption was that companies lack authority to act unless it was contained in their Articles which caused companies to replicate whole sections of the 1985 Act in their Articles making them increasingly long.

In conclusion, the role of the Memorandum has been rendered largely redundant by the 2006 Act. Modern business practice has led to the emergence of the Articles as the core constitutional document and the Memorandum is no only of historical significance.

Bibliography

Books

LS, Sealy, Sarah Worthington: “Cases and Materials in Company Law” (8th edition Oxford 2008)

Mason, French and Ryan: Company Law (26th edition Blackstone Press, Oxford 2009)

Paul L Davies; Gower and Davies: The Principles of Modern Company Law (7th edition Sweet and Maxwell 2003)

Cases

Ashbury Railway Carriage & Iron Co. v Riche [1875] LR 7 HL 653

Beattie v E and F Beattie [1938] Ch 708

Bell Houses v City Wall Properties [1966] 2 QB 656

Bushell v Faith [1970] AC

Cotman v Brougham [1918] AC 514

Eley v Positive Government Life Security Assurance Co [1876] 1ExD 88

Gaiman v National Association for Mental Health [1971] Ch 317

Guiness Plc v Saunders [1990] 2 AC 663

Hickman v Kent or Romney Marsh Sheep-Breeders’ Association [1915] 1 Ch 881

Re:Jon Beauforte Ltd [1953] Ch 131

Re: New British Iron Co [1898] Ch 342

Re: Peveril Gold Mines Limited [1898] 1 Ch122

Pender v Lushington [1877] 6 Ch D 70

Rolled Steel (Holdings) Ltd v British Steel Corporation [1986] Ch 246

Sidebottom v Kershaw, Leese & Co. [1920] 1 Ch 154

Uiness v Land Corporation of Ireland [1822] 22 Ch D 349, CA

Welton v Saffery [1897] AC 299

Legislation

Companies Act 1862

Companies Act 1985

Companies Act 1989

Companies Act 2006

Joint Stock Companies Act 1856

Transitional rules in the Eighth Commencement Order

Bibliography (Continued)

Websites

Companies House: http://www.companieshouse.gov.uk/

Institute of Chartered Accountants: http://www.icaew.com/index.cfm/route/156661/icaew_ga/en/Library/Links/Law/Company_law/Company_Law_Reform_Bill

Office of Public Sector Information: http://www.opsi.gov.uk/acts/acts2006/en/ukpgaen_20060046_en.pdf

Guidance note issued by the Department of Business Initiative and Skills at: http://www.berr.gov.uk/whatwedo/businesslaw/co-act-2006/faq%20Act%202006/page38503.html#BM45538

Journals

Freedman, J: “Small business and the corporate form: burden or privilege?” MLR 57(4) 1994.

Talbot, L.E: “A contextual analysis of the demise of the doctrine of ultra vires in English company law and the rhetoric and reality of enlightened shareholders” CL 30(11) 2009 p323-327

Miscellaneous

Official Report, House of Lords, 30 January 2006; Vol. 678, c.