This article is written by Srishti Kaushal, a first-year student of Rajiv Gandhi National University of Law, Punjab, pursuing B.A. LLB. (Hons.). In this article, she discussed the essential clauses that the Articles of Association of a company must have.

Introduction

Have you ever wondered what governs the internal working and management of a company? How are the rights of the members of a company towards each other are determined? How is a change in the internal regulation of a company regulated?

Well, it is the company’s Articles of Association which provides for all this. Articles of Association refers to a document that defines the purpose of the company and specifies the regulations for its operations. It also contains the company’s by-laws and rules and regulations governing the management. 

It is essential for a company to have the articles of association as Section 7(1) of the Companies Act, 2013 states that at the time of incorporation of the company, the articles of association must be filed with the registrar in whose jurisdiction the registered office of the company will be. 

In this article, we will understand the importance of the Articles of Association and the essential clauses it must contain.

Essentials of Articles of Association

Section 5 of Companies Act, 2013 lays down certain essential elements that must be present in the Articles of Association and also provides rules for its drafting. 

This section, clearly specifies that nothing in this section prevents a company to include additional matters which are necessary for the company’s management. 

Let’s look at the essential clauses which the Articles of Association of a company must have.

Company’s Name

• The company’s name must include the word “limited liability company” or the abbreviation “ltd.” 
• If the company intends to use its name in more languages than 1, this clause must contain the name in other languages as well.

Issue of shares and the rights of Shareholders

• This clause must contain the amount of capital to be raised as shares, as well as the number of shares the company proposes to issue. 
• The specific class of shares must also be mentioned, along with the value for which each is being issued. 
• The number of different kinds of share capital like preference share capital and equity share capital etc must be mentioned, along with the value.
• The rights that a shareholder acquires must also be mentioned in this clause.

Lien of Shares

This clause defines the company’s right to retain the shares of any member of the company, in case he/she defaults and fails to pay the debt amount to the company. 

Transfer and Transmission of shares

This clause explains the procedure for the transfer of shares between the transferee and the shareholders, in situations of death, insolvency, succession etc.

Forfeiture and Surrender of shares

This clause in the Articles of Association provides the rules for forfeiture of shares by the company in case a shareholder fails to make the purchase payments for shares. For instance, in case he/she fails to pay the allotment money (money to be paid on the allocation of shares) or call money (money to be paid by shareholders holding partly paid shares when the company demands) on shares etc. 

Conversion of shares into stock

Stock refers to the collection of the shares of a member. These shares are fully paid up. Section 61 of the Companies Act, 2013 allows a company to allow conversion of fully paid-up shares into stock and vice-versa. This clause explains the management and the resolution process through which the shareholders can convert their shares into stock. 

Alteration of capital

The company may be required to increase, decrease or rearrange the capital in the duration of its operations. This clause in the Articles of Association provides the rules and procedures for altering capital as per the company’s interest.

Issue of Debentures

This clause must explain how the debentures can be issued. Whether they can be issued at a premium, discount or otherwise must be mentioned here. It should also tell whether and how the issued debentures can be converted into shares.

Dividend and Reserves

This clause in the Articles of Association of the company explains when and how the dividends would be distributed amongst the shareholders of the company.

Common Seal

Common Seal is a metallic seal of the company which can be affixed only with the approval of the board of directors. It acts as the signature of the company and once signed on a document, it binds the company with all obligations under that document. This clause explains the use and custody rules of the common seal.

Appointment and retirement of the directors

• The Articles of association must contain a clause regarding the appointment of directors. This should mention the qualification they must have and should define the process of appointing directors. For instance, it can be provided in this clause that any person permitted by law can be appointed as a director by special resolution.
• The provisions regarding the retirement of the directors must be mentioned in this clause. It should also provide if the retiring director is eligible for reappointment, and if yes, the procedure for the same must be mentioned.
• This clause should also mention the terms for termination of the appointment of a director.

Powers and responsibilities of the directors

This clause provides different powers and responsibilities given to a director of the company. For instance, it can define and limit the decision making authority of directors. It should also define the borrowing powers of the directors.

Director’s Meetings

This clause must define the powers of the directors with respect to calling a director meeting. It should also state the quorum of the meeting and define the chairing of these meetings.

This clause must talk about the voting power of the directors as well. It should also specify how the meeting would be adjourned.

General Meetings

This clause must define the place of general meeting, the procedure for calling a general meeting and what all would be addressed in the general meeting. 

For instance, this clause may say that the general meeting would be held in the company’s registered office in New Delhi, and it shall be notified through an announcement on the company’s website and an email to the members. 

Remuneration of the directors

The remuneration and expenses of the directors are to be mentioned in this clause. For instance, this clause can say that the company will pay for the traveling and accommodation of a director traveling to attend a meeting for the purpose of business.

Director’s indemnity and insurance

This clause provides the directors with indemnity and insurance. It protects them from personal losses which they might face if they are sued as a result of an act done by virtue of being the director of the company. It may also cover all the costs like legal fees in this regard.

Voting Rights

This clause defines all the matters which are required to be voted upon in the company. It also explains the procedure of voting- through a poll or through proxies.

Audit and Accounting

This provision explains in detail all the guidelines for auditing and accounting of the company. For instance, It can provide for the number of auditors to be appointed, qualifications to be appointed as an auditor, remuneration to be paid to the auditor etc.

However, it must be remembered that this clause in the Articles of Association supplement, but does not replace the statutory requirements in relation to auditing and accounting.

Entrenchment Clause

Section 5 of the Companies Act, 2013 allows a company to provide an entrenchment clause in its Articles of Association. This clause put some restrictions on alteration and amendment of certain clauses. It allows alteration in these specified clauses only when certain conditions or procedures (which are more restrictive compared to the conditions provided for special resolution) are met with.

Winding Up

This clause is an absolute essential in the Articles of Association of the company. Winding up is the process through which all the assets of the company are liquidated and all debts are cleared off and paid. After the debt is paid and expenses are covered, the remaining money is distributed amongst the shareholders, in accordance with the number of shares they own. This procedure and provisions related to it need to be provided in this clause. 

Importance of Articles of Association 

Drafting the Articles of Association is like laying down the foundation stone of the company. Thus, it is among the earliest steps that need to be followed in the formulation of a company. The significance of the articles of association cannot be undermined. Let’s understand why.

• They play an important role in ensuring the smooth and efficient working of the company by laying down the responsibilities of the managers and the purpose of the company.
• They are binding upon the members of the company. This means that the members must ensure that they are following the articles. Thus, the articles keep them on track of achieving the purpose of the company. While at the same time, they are binding upon the company as well.
• The articles go a long way in helping the Company to make decisions. For instance, in terms of audit, the Articles of Associations clearly lay down the procedure of appointing and remunerating accountants, making it easy for the company to keep a check on its accounts. 
• It provides the procedure for appointing the managers and Board of Directors which helps in avoiding unnecessary disputes.
• By providing for exact procedure to call for a general meeting and the purpose of the general meeting, it helps in ensuring ease in carrying out the large meeting. 
• It ensures that there is no confusion in regards to the shareholder’s rights and responsibilities, by expressly mentioning and explaining them. 
• By providing the procedure for winding up and handling expenses and remaining money, the Articles ensure efficiency in the process of winding-up.

Do’s and Don’ts to remember while drafting the Articles of Association

While drafting the Articles of Association, it is essential to keep in mind certain things. These are discussed further.

Do’s

• The articles must be printed.
• They must be divided into paragraphs and numbered consecutively.
• They must be signed by all the subscribers to the memorandum of association of the company. Subscribers of a company are the first shareholders of the company.
• The Articles of Association must be in the form specified in Table F, G, H, I or J as given in Schedule 1 of the Act. All these are for different types of companies.

• They must be filed along with the memorandum of association, with the registrar of companies.
• The articles must be made bona fide, for the benefit of the company as a whole.

Dont’s

• They must not contain anything illegal.
• They must not contain anything which is ultra vires to the memorandum of association.
• They must not contain anything which is contrary to the provisions of the Companies Act 2013.

Conclusion

The Articles of Association of a company is a crucial document, particularly in the sphere of corporate governance. Along with the Memorandum of Association, the Articles basically form the constitution of the company. It holds a position of high importance in the company and deals with all important aspects of its management.

It binds the Company to its members and the members to the company, and thereby it becomes a contract between the company and members and protects their rights. The Articles of Association acts as a rule book that defines the powers and responsibilities of the directors, the way shareholders are managed, how an audit is to be carried out, how winding up is carried out etc. Clearly, their importance cannot be undermined and they must be drafted with utmost care and consideration.

References

1. https://www.elanders.com/about-elanders/corporate-governance/articles-of-association/
2. https://www.investopedia.com/terms/a/articles-of-association.asp
3. https://www.techmahindra.com/sites/ResourceCenter/Financial%20Reports/Draft-Articles-of-Association.PDF
4. https://swaritadvisors.com/learning/articles-of-association-aoa-and-its-importance/

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skill.