In this article, Rituraj Singh Bhati who is currently pursuing M.A. IN BUSINESS LAWS, from NUJS, Kolkata, discusses Ten must-have clauses in Articles of Association that are not prescribed by default under the Companies Act.
Article of Association
Article of association is the backbone of incorporation of any company. Article of Association is the rulebook of any company in which the company’s bye laws and the procedure to be incorporated in running, amalgamating and winding up of a company. The article of association is the extract of all the things a company is run upon; it recognises the rights and duties of directors and chairperson of the company, it defines the nature and the work type of the business to be undertaken etc. the article of association includes Memorandum of Association which in turn contains the name of the companies to be associated with the business, contents and nature of the final product or the service to be delivered to the end user.
The Article of Association is considered to be the 2nd most important document in the incorporation of a company after the Memorandum of Association. The AoA contains the rules and regulations by which a company is regulated; it contains clauses related to amalgamation of the company, winding up of the company, nature of business, issue and allotment of shares, issue and allotment of debentures, it also clarifies the statute to be used in bonds distribution, rights and duties of shareholders, when and where the Annual General Meeting is to be held, how and when the profit will be distributed amongst the shareholders, what will happen upon winding up of the company etc. the Article of Association contains and can contain medley of clauses which may or may not be applied according to the laws of the land where the company is incorporated. The clauses embedded in the article of association define how the company will run but numerous of times it also defines what has to be done at the time of happening of an unexpected event or unexpected situation if faced by the company.
The government of India has made it compulsory for the companies to have an Article of Association while incorporation of the company to attain necessary documents, licences and registration needed by a mandate to run business in India. Any company with collaboration with any company situated out of India will also need the Article of Association to be prepared mandatorily to continue business in India.
The Article of association also provide shareholders certain powers to question the Management of the company as the shareholders are considered to be part owners of the company as they own shares of the company. By the way of Article of Association the shareholders can also question Board of Directors upon their decision related to the company and administer control over the decisions taken by the Board of Directors or the management. The Article of Association gives the shareholders power to question any decision and also binds them in rules according to which the shareholders can attain the profit and bonuses. The Article of Association also puts certain limitation upon the shareholders as a safeguard to the companies from the shareholders and vice versa.
The Article of Association can be amended by resolution whenever the time and situations demand. The amendment or amalgamation of a clause under Article of Association is quite typical and rigid but at the same time flexible in interest of the company. The clauses of the Article of Association are amended on strict needs and by the majority if provided by the shareholders.
The Article of Association is a public document as soon as it is registered with the Registrar of Companies and everyone whether he is an employee of the company or not or whether he is a shareholder of the company or not. The Article of Association is made public by the act of 2013 to keep the management and working of the company transparent and legal.
The Article of Association provides a path on which the company will be run upon. The clauses of the Article of Association provide as its bye laws by which the company will work and the clauses of the Article of Association in themselves serve as contracts signed by the signed parties. Anything which is not according to the Article of Association can be questioned in Annual General Meetings and several other quarterly meetings called by the companies. These meetings are a part of Article of Association and can be called whenever needed with prior intimation and sometimes it is a mandate to call a meeting before taking any further decision as described in the Article of Association.
The Memorandum of Association and Article of Association can be traced back to the 19th century when the Indian Companies Act, 1892 was firstly brought in force by the Britishers. The information given under an Article of Association and Memorandum of Association should be complete and absolute as they are cross checked and passed by the Registrar of Companies. Any clause or information in the Article of Association if in contrary with any provisions prescribed by the law will be invalid in toto.
ten non-default clauses which are not prescribed by law but should be put up with an Article of Association
Valuation of the partner’s properties
A clause relating to the valuation of the partners should be put up in Article of Association as a safeguard to the outsiders and the beneficiaries’ related to the business. The valuation of Intellectual rights and property of the partner should be calculated and mentioned in the Article of Association before registration from the registrar of the Companies. In the same manner a valuation of the partner’s real estate, movable property shall be prepared to keep transparency in the business. This procedure will safeguard the outsiders and the shareholders in case of winding up or in case of insolvency of any partner or directors.
The valuation of the property shall also constitute of the Brand Value of the present company as well as any other brands or companies’ owned by the partners. The valuation of the property will also provide a hustle free inspection and scrutiny to the government authorities. This step will also bring regulation to avoid circulation of Black money in the local and international markets. When all the property will be valued and assessed in a public document a person will hesitate in tax cutting and purposely not paying taxes. The disclosure of valuation of assets should be made a part of the Article of Association to further regularise the system and working of a Company.
Covert Trade Secret
A clause should be put up in Article of Association related to the covertness of trade secret related to the company. The clause should refrain any person related to the company from letting out the trade secret of the company; whether the person may be a top official or a mare employee of the company, there should be strict and harsh punishment to let out a trade secret. There can also be a provision under the clause which describes the law and type of proceeding by which the person letting out trade secret will be prosecuted with.
Trade secret is the main ally of any companies through which different companies refrain each other from using the technology or process used by one company to produce its final product or service.
The clause defending the trade secret of a company should be made a part of the Article of Association and should contain legal and penal consequences as deterrent way to restrict any person letting out a trade secret.
Any information if let out can disturb or even cause to collapse the companies system and its business. Therefore, the covertness of a trade secret should be a company’s first and foremost step to safeguard its business and secret which makes different from any other company in the course of business.
The clause should equally apply to the higher officials of the company as well as the lowest employee working under the company.
Entrenchment Clause
The concept of entrenchment clause is firstly introduced by the Companies’ Act of 2013. The term ‘entrench’ refers to establishment of any belief, style, habit, procedure so firmly that to change it or amend it is a difficult task. The entrenchment clause is necessary in today’s Article of Association because there are also minor shareholders who have invested in the company and they are too part of the company as well as there are work unions and workmen’s lobbies concerned with the betterment of workmen and employees. The entrenchment clause gives them power to change or amend or amalgamate any clause which according to the present time and demand is hindering the employees’ or shareholder’s rights.
The amendment of article is only possible with a majority of consent of the members passing a special resolution to amend or amalgamate an article as per Section 14 of Companies Act 2013. The majority of the members consenting for the amendment of the article should not be less than 75% of the total members of the Company.
The special resolution passed to amend, add or subtract and clause of article from the Article of Association is to be passed according to the Entrenchment Clause present in the Article of Association. If the company is incorporated before 2009 the company can by special resolution also call in for amendment in the article too add such clause which will be profitable to the company in today’s scenario. These articles incorporated in Article of Association are binding upon the signing parties as contract itself to follow and be abided by the clauses of Article of Association
The procedure of inquiry upon the employees and directors
A clause regarding the procedure of the enquiry should be prescribed in the Article of Association or an easy and non-complicated process of enquiry to be carried whenever any bye law or a procedure has been disturbed with. A procedure should be setup in the Article of Association itself through a clause to commence the disciplinary action or enquiry upon an employee of the company or even the director of the company in case of any irregularity with the work of the company or any decision taken which was forbidden by the Article of Association or by the prevailing laws. The clauses in the Article of Association are not legally binding in themselves but can direct towards the law through which the case is to be dealt in case of any irregularity or any action contrary to the laws of the land.
Any rule broken in the company whether by the directors or the employees should attract this said clause and the person not abiding the rules of the company or the rules established by the country should be held and dealt according to this clause and if further needed should also be subjected to legal action.
Interest of Minority shareholders
The Article of Association should also contain clause relating to the shareholders of the company who are not a major investors in the company but are the owners or a small number of shares in the company.
Generally, in Article of Association, the small stakeholders and small shareholders of the company are not sought after. The meetings are attended by the big players of the companies and thus the decisions taken by the company are only a reflection of what its major shareholders think of. The small shareholders of the company are not in positions to attend every meeting called upon by the company and are left aloof from the fact findings and the way of working of the management of the company. Therefore, a clause should be added in the Article of Association describing the rights of minor shareholders, who can advise and put up their view as how should the company be working because after all its also there hard earned money which is invested with the company.
Doctrine of constructive notice
Doctrine of constructive notice is a well-established and followed practice by the companies having shares, debentures and public issues. It being a regular and very sought after practice is still not mentioned in the Article of Association which is a public document. The doctrine of constructive notice should be contained in a clause present in the Article of Association so that laymen investing in your company may not feel cheated regarding not knowing the rules and regulations of a company. Doctrine of constructive notice is followed to safeguard the outsider investing in the company or carrying business with the company.
This doctrine of constructive notice comes into action when an outsider whether shareholder or a person doing business with the company takes the defence of not being aware of the rules and regulations of the company and committing a mistake prohibited by the rules and regulations of the company. At such a point the company has a defence of the doctrine of constructive notice which says that the Article of Association is a public document and the person performing business or investing in the company is considered to be fully aware of the rules and regulations of the company. In such case the outsider cannot take the defence that he was not aware of the rules and regulations of the company. The major reason of making the Article of Association public was duly the same that any person can access the document and be fully aware of the rules and regulations of the company.
Workmen safety and end user safety clause
There should be a clause regarding the safety of the workmen; if the nature of the work is hazardous and risky the workmen should be provided with safety features and compensation if anything happens to them while the period of employment. In same manner the company should also draft a safety clause for the customers of the end product. The company incorporating shall by this clause gain better PR which can be uttering helpful for the future aspects of the company.
Where the workmen work under hazardous conditions, the workmen should be duly compensated and be insured for the damages they would have to suffer due to the nature of the work.
The company should also safeguard the environment from the waste and bye product produced in the production of the final production.
Business expansion clause
The company should also embed a business expansion clause in the Article of Association to save the company from stagnation. The company can incorporate the clause as a term describing the procedure and time barred limitation as to how and when the company needs constant expansion. The clause can explain that upon earning a profit and after paying the profits the company will expand on yearly basis.
Shareholder’s right to appoint directors
The shareholder whether he is a major shareholder or a minor shareholder should be entitled to choose and appoint the director/ directors for the company they have invested in. This process further brings transparency in the running of the company and will also further safeguard the company from frauds as the directors itself would be chosen by the members of the company.
The directors chosen by the members would be more competent towards providing the information the shareholders’ demand. The shareholders should have a right to demand the information about the companies’ affairs and the matters of importance. The shareholders know how the company works and what it produces but the shareholders don’t know the internal working of the companies’ management and the indoor procedures applied by the company. Thus, the shareholders shall have a right to know about the hidden procedures and processes of the company.
Productivity clause
The managers of the company should always emphasize upon the productivity of the company and that the growth of the company should not be hindered. The productivity of the company in return provides the company with a stable backdrop and the company would also run smooth because of growth in the sector. Such a productivity clause would help the company to easily attain public undertakings, shares, bonds etc.
Any violation in the clause may lead to severe dysfunction in the company and may harm the business of the company and also may endanger the company due to proceedings that would be followed by the violation of the procedure.
Through these clauses, the company can attain a better stability and smoothness in the long run. The corporate governance is a must in the present scenario especially for companies either incorporated under the tag of public companies or private companies. These clauses safeguard the company from entering into a loophole. The clauses help in proper functioning of the incorporation.
There is always place for clauses which are future worthy and keep up with the betterment for employees. For example there should also be a clause for a preference to the employees in the process of share issuance and allotment.
The corporate governance of a public company is much typical and complex than of a private company and other unlisted public companies. And still it is a must for the companies to follow corporate governance.
Conclusion
The Article of Association is a public document as soon as it is registered with the Registrar of Companies and everyone whether he is an employee of the company or not or whether he is a shareholder of the company or not.
The companies should try new nature of clauses as per the demand of time and nature of the business to be carried on by the business. The best thing about the Article of Association is that it may not be legally forcing it contains certain clauses which impanel the wrongdoer for a legal and penal proceedings. The clauses in the Article of Association form a contract in itself by the binding both the parties have provided to the documents by agreeing to it and signing the authority.
All the above clauses form significant clauses wherein a company should adopt an appropriate measure of Corporate Governance as the rules have become more stringent in cases of listed public limited companies than that of other public & private limited companies. To have smooth operations in the competitive market, the clauses described in this article is required for the company to avoid loopholes in their corporate governance structure.
