Shareholders' agreements, company constitutions and the potential for conflict - International Law Office

International Law Office

Company & Commercial - British Virgin Islands

Shareholders' agreements, company constitutions and the potential for conflict

April 26 2010

Introduction
Memorandum and articles
Shareholders' agreement
What does this mean?
Remedies
Comment


Introduction

In many instances, contracting parties embark on joint ventures and enter into shareholders' agreements without fully understanding the consequences of their contractual arrangements. Part of the problem is that the interplay between a company's memorandum and articles of association on the one hand, and a shareholders' agreement on the other, can sometimes be unclear. This interplay is more cumbersome in some jurisdictions than in others. This update examines this dynamic in the context of a BVI company and aims to shed some light on what contracting parties must do and why when using a BVI vehicle and a non-BVI law shareholders' agreement for a joint venture.

Memorandum and articles

The starting point is the company's constitution. This is a statutory contract which, according to BVI law, is binding between (i) the company and each member, and ii) each member.

A BVI company is formed pursuant to an application made to the BVI registrar of corporate affairs for the incorporation of a company. Various documents are required to be filed for that purpose, including a memorandum of association and articles of association. If the registrar is satisfied that the requirements of the Business Companies Act 2004 (as amended) have been met, the registrar must, on receipt of the documents necessary to incorporate a company:

  • register the documents;
  • allot a unique number; and
  • issue a certificate of incorporation.

Therefore, a BVI company comes into existence by virtue of the act and compliance with the requisite provisions.

In order to amend the memorandum and articles, the members (and, in some instances, the directors) must pass a resolution in relation to the provisions to be amended. The amendment to the memorandum and articles has effect from the date of the notice of amendment or the date on which the restated memorandum and articles are registered by the registrar.

The BVI company is a creature of statute; its memorandum and articles are a statutory contract and in order to amend that statutory contract, there is a specific statutorily mandated procedure.

The members of a company, and at times the company, may also enter into a shareholders' agreement. The question that often arises is whether the shareholders' agreement prevails over and therefore effectively amends the memorandum and articles. In the English case of Scott v Frank F Scott (London) Limited,(1) the court was in complete agreement with the first instance decision that:

"the court has no jurisdiction to rectify articles of association of a company although they do not accord with what is proved to have been the concurrent intention of all signatories therein at the moment of signature."

In referring to rectification of documents, including deeds, the court said that:

"This cannot be the case with regard to the memorandum and articles of a company for it is the document in its actual form that is delivered to the Registrar and retained and registered by him and it is that form and no other that constitutes the charter of the company and becomes binding on it and its members."

The judge went further when he said that:

"It seems plain that this section does not admit of any rectification of the memorandum and articles apart from alterations under the express powers of the [UK] Act, for the only contract is a statutory contract in which the company is included by reference to the registered documents and to no other documents."

How then does one reconcile the BVI statutory position with other English decisions such as Re Duomatic(2) and Cane v Jones?(3) Does English law differ from BVI law such that these decisions are not wholly applicable?

Shareholders' agreement

The shareholders' agreement is like any other agreement and is subject to the ordinary rules of contract. Unlike the memorandum and articles, it is constrained by company law only to a limited extent.

Like a resolution, a shareholders' agreement may reflect the will of some or all of the shareholders. In Duomatic it was held that where it could be shown that all the shareholders with the right to attend and vote at a general meeting had assented to a matter which a general meeting of the company could carry into effect, the assent was as binding as a resolution in general meeting. Similarly, in Cane v Jones, where a shareholders' agreement had been entered into, it was held that it was a basic principle of company law that all corporators of a company acting together could do anything which was within the company's legal power. Section 10(1) of the UK Companies Act 1948 (which was the same as Section 10(1) of the UK Companies Act 1929, which applied to Scott) did not undermine that principle, but merely laid down the procedure whereby some of the shareholders of a company could validly alter the articles. Since the 1967 shareholders' agreement in Cane, although not drafted as a resolution and not signed by the signatories in each other's presence, represented a meeting of all the shareholders' minds, and since a meeting of the shareholders' minds was the essence of a general meeting and the passing of a resolution, the 1967 agreement could override the articles in regard to the casting vote of the chairman and accordingly restricted the use of the chairman's vote. However, it should be noted that Cane was a family dispute decided specifically on the facts.

Thus, Cane expanded the Duomatic principle in relation to whether an act of all of the shareholders is sufficient to amend the memorandum and articles effectively. It is clear therefore that as a matter of English law, the decisions in those cases undermine to some degree the decision in Scott v Frank F Scott such that, before the enactment of the new UK Companies Act 2006, the memorandum and articles as available at Companies House in the United Kingdom may not have accurately reflected the full extent of the memorandum and articles.

BVI lawyers have been consistent in rejecting the English formulation, but not always so. Some believe that the Duomatic-type English law principles can be applied fully.

The reason that BVI law differs from English law in this area is a fundamental one. Both Duomatic and Cane are based on an interpretation of the UK Companies Act 1948. Section 143 of that legislation (like Section 118 of the UK Companies Act 1929, which was referred to in Scott) requires special resolutions to be forwarded to the registrar within 15 days after the passing or making thereof. However, save in a few specific instances, the special resolution is effective when it is passed. It need not be filed in order to be effective. The consequence of a failure to file the special resolution is a penalty payable by the company and every officer (under new legislation, it is a criminal offence for the directors involved.(4) Therefore, it is clear that the court in each decision regarded the unanimous agreement as not unlike a special resolution and allowed substance to win out over form. The UK Companies Act 1985(5) was amended after Cane to allow for the filing of agreements pursuant to the same section that requires special resolutions to be forwarded to the registrar. This is recognition that such actions by the members, whether in the guise of a shareholders' agreement or a resolution, amount to the same thing, the only difference being a matter of form.

In contrast, BVI law requires the amending resolution to be filed in order for the amendment to be effective. Unlike English law, the members may execute a shareholders' agreement or pass a resolution and, if it is never filed with the registrar in the BVI, the amendment is never effected.

So where does one go with these decisions that clearly are at odds with each other? The Scott case is now wrong as a matter of English law because it appears to have been expanded by the principles from the Duomatic line of cases, which must be correct. Scott appears to ignore the fact that Section 10 of the UK Companies Act 1929 permits amendments to a company's constitution by special resolution and that such resolutions are, pursuant to Section 118 of that legislation, merely required to be forwarded to the registrar of companies within 15 days after being passed. It is clear that such a resolution was, under the 1929 and the 1948 UK Companies Acts, effective when passed, and accordingly the amendment is effective at that time. If Scott had been decided on the basis of a BVI statute, it would be quite accurate. On the other hand, the Duomatic cases, while taking the correct line, are inconsistent with the BVI position as the underlying BVI legislation precludes the same.

What does this mean?

For parties to a shareholders' agreement where a BVI company is the joint venture vehicle, it means that there are effectively two contracts (the memorandum and articles on the one hand, and the shareholders' agreement on the other) running parallel to each other. The task is to ensure that they do not conflict.

One obvious reason why they should not conflict is that it leaves the contracting parties with an uncertain state of affairs, which is never good. The other reason is that it is not always clear which prevails as a matter of company law. Thus, for example, the Business Companies Act 2004 states that "subject to any limitations or restrictions on the transfer of shares in the memorandum or articles, a share in a company is transferable". If the articles are then silent on this issue, the provisions of the act apply in relation to a transfer of shares, making any share freely transferable as a matter of law. At the same time, restrictions in a shareholders' agreement on the transfer of the same shares will bind the parties to that agreement, but if the shares are transferred in breach of the agreement but in accordance with the law, the transfer cannot be undone (because it is valid as a matter of law) and the normal remedy for breach of the agreement would be damages.

Remedies

Typically, if there is a breach of the shareholders' agreement, the remedy is damages or an injunction. Specific performance is somewhat rare in commercial contracts as the courts are loathe to force parties together. On the other hand, if there is a breach of the memorandum and articles, the thing purported to be done would probably be invalid. This is a big difference between the memorandum and articles and the shareholders' agreement. The typical remedies mentioned above would apply in this case as well, but there may be other remedies such as forfeiture.

Comment

Thousands of BVI companies have been used for joint ventures. A relatively common format is an English or New York law shareholders' agreement and a BVI joint venture memorandum and articles. The key points to bear in mind are: (i) assuming all necessary steps have been taken, the shareholders' agreement is valid, binding and enforceable like any other contract and a remedy for breach will flow in the normal way; and (ii) the BVI joint venture memorandum and articles is a statutory contract separate from a shareholders' agreement and as (unlike English law) amendments to the memorandum and articles are effective only when filed with the registrar, the memorandum and articles should be amended, in keeping with the BVI statutory requirements, to reflect the terms of the shareholders' agreement. Neither a shareholders' agreement nor a resolution, unanimous or otherwise, will by itself be sufficient to amend the BVI memorandum and articles. The real driver in this process is to ensure as far as possible that the parties avoid having two contracts covering the same subject matter, but with the potential for quite different results should there be a breach of one or the other.

For further information on this topic please contact Leonard A Birmingham in Harney Westwood & Riegels's London office by telephone (+44 20 7842 6080), fax (+44 20 7353 0487) or email (leonard.birmingham@harneys.com). Alternatively, contact Jamal S Smith in Harney Westwood & Riegels's Tortola office by telephone (+1 284 494 2233), fax (+1 284 494 3547) or email (jamal.smith@harneys.com).

Endnotes

(1) 1940 Ch 794.

(2) 1969 2 Ch 365.

(3) 1980 1 WLR 1451.

(4) Section 30 of the UK Companies Act 2006.

(5) Section 380(4)(c) (the whole of Section 380 is now replaced by Section 29 of the UK Companies Act 2006).


Comment or question for author

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