The Act, the constitution and a shareholders’ agreement

1. Three writings, and who each one binds

Tamarind Advisory Ltd has 100 ordinary shares. Meera holds 60 and Ravi holds 40. The company was incorporated without a constitution. Meera now wants two things written down. She wants outsiders kept off the share register unless the existing shareholders have been offered the shares. She also wants a private promise, between her and a new investor, about who will be appointed to the board.

Those are different writings. Putting both sentences in the same letter does not give them the same effect.

A company may have a constitution, and it does not need one. With none, the rights, powers, duties and obligations of the company, the board, each director and each shareholder are those set out in the Act. With one, those rights, powers, duties and obligations remain the ones in the Act, except so far as the constitution restricts, limits or modifies them in accordance with the Act. A clause that contravenes the Act, or is inconsistent with it, is void to the extent of the conflict. Subject to the Act, the constitution has effect as a contract between the company and each shareholder, and between the shareholders themselves. Money payable to the company under the constitution is a debt due to the company.

A shareholders’ agreement in the ordinary sense is a contract between the people who sign it. It binds those people. It does not become the constitution, and it does not bind a shareholder who did not agree to it. A later buyer of shares takes the shares subject to the constitution, because that document is the statutory contract. The later buyer does not take over a side letter unless that buyer agrees to it.

A unanimous shareholder agreement is a further document, and only a private company can use it. All the shareholders agree to or concur in an action. That action is then deemed to be validly authorised notwithstanding the constitution, and the sections listed in the Eleventh Schedule do not apply to that action. All the shareholders may also, by a written agreement, restrict the directors’ powers and confer powers on a person who is a party to the agreement. That is section 272. An agreement that Ravi has not signed is not it.

Writing	Who is bound	What it changes
The Act, and no constitution	The company, the board, each director and each shareholder	The rights and duties the Act sets out, including rules a constitution is not allowed to switch off
The constitution	The company and each shareholder, and the shareholders among themselves	Only what the Act allows the constitution to restrict, limit or modify. A contradiction of the Act is void to that extent
A contract signed by some of the shareholders	The people who signed	Their promises to each other. The board still follows the Act and the constitution
A unanimous shareholder agreement under section 272	Every shareholder of the private company	The named action is deemed authorised notwithstanding the constitution, and the Eleventh Schedule drops away for that action

The share terms that a constitution can attach to a class, a transfer, or a new issue are worked in the shares chapter. This chapter is about choosing the document.

Companies Act, sections 39, 40, 41, 43 and 272.

2. How to read a conflict

The Act tells you, in the section you are reading, whether a constitution may move the rule. Three signals recur.

Where the section says the rule applies subject to the constitution, the constitution may restrict that rule. Section 52 is one. Subject to the Act and the constitution, the board may issue shares at any time, to any person, and in any number it thinks fit. The same power is also subject to the Securities Act. A constitution that says the board shall not issue shares unless Ravi has consented in writing is using a permission the section gives. An issue without that consent is not an exercise of the power section 52 confers.

Section 55 is another. A new issue that ranks equally with, or ahead of, existing shares as to voting or distribution rights is offered first to the existing holders, for at least 14 days, subject to the constitution. Tamarind has no constitution, so that offer stands. A constitution may set it aside. The board must still fix consideration that is fair and reasonable to the company and to all existing shareholders.

Section 49 is a third. Subject to any limit in the constitution, a share is transferable. The transfer is still the entry in the share register, and the instrument is still the one section 87 requires. Section 87 applies notwithstanding the constitution.

Where the section says the rule applies notwithstanding the constitution, the constitution does not lower it. Section 105 is the clearest list. Notwithstanding the constitution, the shareholders exercise by special resolution the power to adopt, alter or revoke the constitution, to reduce stated capital, to approve a major transaction, to approve an amalgamation, and to put the company into liquidation. A special resolution is 75 per cent of the votes of those entitled to vote and voting, or a higher majority if the constitution requires one. The constitution may raise that majority. It may not replace the special resolution with an ordinary resolution. On a poll at Tamarind, with both shareholders voting, Meera’s 60 votes are 60 per cent of the votes cast. That adopts nothing on this list.

Where the section is silent, section 40 and section 43 still apply. The constitution modifies the Act only in accordance with the Act, and a clause inconsistent with the Act is void to that extent. Section 61 requires the board, before it authorises a distribution, to be satisfied on reasonable grounds that the company will satisfy the solvency test immediately after. A clause that says a dividend may be paid without that test contradicts section 61. It is void to that extent. The dividend rules themselves are in the company file chapter.

The Fifth Schedule locks some meeting rules in the same way. The methods of holding the meeting apply notwithstanding a contrary constitution. So does the rule that no business is transacted while a quorum is absent, and so does the adjournment of an ordinary meeting, and the dissolution of a meeting the Court ordered, where a quorum is still absent after 30 minutes. The count of that quorum, a majority of the votes to be cast, is in the decisions chapter.

Three sentences Meera drafts

She drafts a constitution and asks what each sentence does. The shareholders have not yet adopted it. On a poll, adoption itself is a special resolution under section 105. If Ravi votes against it, 60 per cent does not adopt it.

Sentence 1. “This constitution may be altered by an ordinary resolution.” Section 105 requires a special resolution to alter the constitution, notwithstanding the constitution. The sentence is inconsistent with the Act and is void to that extent. The special-resolution majority remains.

Sentence 2. “Ravi shall take 20 further shares.” Section 102 says that a shareholder is not bound by an alteration that requires him to acquire or hold more shares than he held on the date of the alteration, or that increases his liability to the company, unless he agrees in writing. A special resolution does not replace that writing. If Ravi does not agree in writing, the sentence does not oblige him to take the 20 shares.

Sentence 3. “The board shall not issue shares unless Ravi consents in writing.” Section 52 makes the board’s power to issue shares subject to the constitution. If this constitution is validly adopted, the board’s power is limited by the sentence. That is a different result from sentence 1, because the Act has said the constitution may limit this power.

Sentence	The signal in the Act	Result if the constitution is adopted
Alter the constitution by ordinary resolution	Section 105 applies notwithstanding the constitution	The sentence is void to that extent. Alteration still needs a special resolution
Ravi must take 20 further shares	Section 102 requires his written agreement	He is not bound unless he agrees in writing
No issue of shares without Ravi’s written consent	Section 52 is subject to the constitution	The board’s power to issue is limited by that consent

Adoption, alteration and revocation are themselves by special resolution. Where the company has no constitution, the shareholders adopt one by special resolution. Within 14 days the board delivers a notice, in a form the Registrar approves, for registration. The constitution, and any amendment, is certified by a law practitioner, a legal consultant or a law firm. It need not be a notarial deed.

A private company’s constitution takes the form in the Second Schedule, and the company may exclude or modify the provisions of that Schedule to the extent the Schedule and the Act permit. The Schedule’s transfer pre-emption, including the notice, the fair price and the offer to existing holders, is in force when that constitution is in force. Tamarind has no constitution, so that pre-emption is not running. The steps of a transfer under the Act are in the shares chapter.

Companies Act, sections 40, 42, 43, 44, 49, 52, 55, 61, 87, 102 and 105, the Second Schedule and the Fifth Schedule.

3. When the promise stays in a contract

A constitution is the right document when the rule has to bind the company and every shareholder, including a person who later buys shares, and when the Act allows the constitution to carry that rule. Class rights, a limit on transfer, a limit on the board’s power to issue, and the Second Schedule’s transfer machinery are of that kind. A right for a minority holder to sell on the same terms when a majority holder sells, and a duty to sell when a stated majority accepts a buyer, affect the register when the constitution creates them. The Act does not confer either right. The shares chapter works through both.

A contract is the right document when the promise is personal, the company is not meant to be bound, and a future shareholder is not meant to inherit it.

Meera and Asha sign a letter. Asha will pay Meera Rs 200,000, and Meera will vote her 60 shares in favour of Asha’s appointment as a director. Ravi does not sign. The letter is a contract between Meera and Asha. It does not amend the constitution, because an amendment is a special resolution followed by the Registrar’s notice. It does not bind Ravi. It does not appoint Asha. Appointment of a director still follows the Act. If Meera then votes against the appointment, Asha’s claim is a claim against Meera on the letter. The company is not in breach of a constitution it does not have, and Ravi is not in breach of a letter he did not sign.

The same letter would still be only a contract if both Meera and Ravi signed it, unless it is adopted as the constitution or it is a unanimous shareholder agreement under section 272. Two shareholders signing a voting promise have made a contract between themselves. They have not, by that signature alone, changed the rules the board must apply when it issues shares or registers a transfer.

That is why the two documents are often used together. The constitution carries the rule that has to bind the company and the register: who may be offered new shares, who may buy existing shares, and what majority changes the constitution. The contract carries the bargain that is meant to stay between the signatories: who will fund the next subscription, who will vote for whose appointment, and what happens between them if one of them wants to leave. A person who later buys Ravi’s shares is bound by the constitution then in force. That person is bound by the old letter only if the person agrees to it.

Companies Act, sections 43, 44 and 52.

4. When every shareholder agrees

Section 272 is available because Tamarind is a private company, and it is available only if Meera and Ravi both agree. Where all the shareholders agree to or concur in an action the company has taken or will take, the action is deemed validly authorised notwithstanding the constitution, and the Eleventh Schedule does not apply to that action. The section lists, without limiting the actions that can be agreed, an issue of shares, a distribution, a repurchase or redemption, financial assistance, a director’s remuneration or a loan to a director, a contract with an interested director, a major transaction, and a later ratification of any action that could have been authorised under the section.

The Eleventh Schedule names the sections that then do not apply to that action. They include the board’s power to issue shares, the dividend section, shareholder discounts, the purchase of the company’s own shares, redemption at the company’s option and the related shareholder approvals, financial assistance, and directors’ remuneration. Section 46, section 55, section 87 and section 114 are not on that list. A class right is still written into the constitution. A distribution that fails the solvency test is not saved by the agreement.

A dividend both of them sign

Meera and Ravi both sign a written agreement that Tamarind will pay a dividend of Rs 200,000. The agreement is unanimous, so the action is deemed authorised notwithstanding the constitution, and the Eleventh Schedule does not apply to that dividend. Assets after the payment would be Rs 800,000. Liabilities are Rs 400,000 and stated capital is Rs 100,000. Liabilities plus stated capital are Rs 500,000. Assets of Rs 800,000 are greater than Rs 500,000, so the assets limb of the solvency test is met, provided the company can also pay its debts as they fall due.

Change the figures. Suppose the dividend left assets equal to Rs 500,000. Assets would not be greater than liabilities plus stated capital. The company would fail the solvency test. Section 272 then deems the distribution not to have been validly made, even though both shareholders agreed. The company may recover it unless the shareholder received it in good faith and without knowledge of the failure, has altered his position in reliance on it, and it would be unfair to require repayment. The same figures are walked through with the private-company limits in the other companies chapter.

Taking the board’s power away

All the shareholders may, by agreement in writing, restrict the directors’ power to manage the business, in whole or in part, and confer powers on any person who is a party to that agreement, whether or not that person is a shareholder or a director. To the extent the agreement provides, that person has the rights, powers, duties and liabilities of a director, and the directors are relieved to that extent, subject to section 131.

Meera and Ravi sign an agreement that the directors shall not issue shares, and that the power to approve an issue is conferred on Ravi. Both shareholders have agreed, in writing, and Ravi is a party. Section 272(7) applies. Ravi has the liabilities of a director in exercising that power. An agreement signed only by Meera, conferring the same power on Asha, is not an agreement of all the shareholders. Section 272 does not treat the issue as authorised, and it does not move the directors’ liabilities.

A unanimous agreement can authorise an action the constitution would have reserved to another procedure. It does not repeal section 105 for the powers that section says are exercised by special resolution notwithstanding the constitution, where the shareholders are not, in fact, all agreed. If Ravi does not agree, the agreement is not unanimous, and a major transaction, an alteration of the constitution, or a liquidation still needs the special resolution section 105 requires. On a poll, with both voting, 60 per cent does not pass it.

Companies Act, sections 6, 105, 131 and 272, and the Eleventh Schedule.

One shareholder, and an old memorandum

Where one person holds all the issued shares of a private company, a written declaration by that person restricting the director’s discretion is deemed to be a unanimous shareholder agreement. Tamarind has two shareholders, so a declaration by Meera alone is not that document.

An existing company that kept its memorandum and articles as its constitution does not alter those documents unless it replaces them with a single consolidated constitution, unless the Registrar grants a dispensation on the ground of undue hardship and the need for a prompt alteration. The Registrar may also require a single document where amendments have become too numerous. Tamarind was incorporated under the current Act without a constitution, so it adopts one under section 44 rather than consolidating a memorandum.

Companies Act, sections 42, 44, 45 and 272.

What you should now be able to explain

With no constitution, Tamarind’s rights and duties are the Act’s. A constitution binds the company and every shareholder, and it modifies the Act only where the Act allows the modification. A clause that contradicts the Act is void to that extent, so an ordinary resolution cannot replace the special resolutions in section 105, and Ravi cannot be forced to take more shares without his written agreement. A contract binds the people who signed it and leaves the board on the Act and the constitution. A unanimous shareholder agreement needs every shareholder. It can deem an action authorised and switch off the Eleventh Schedule for that action, and a distribution that fails the solvency test is still not validly made.

Next: an issue of shares to Asha, the offer Meera and Ravi must receive first, and the loan the company is asked to make.