Articles of association and shareholders’ agreements are two related types of legal documents, and understanding the difference between them is very important for many business owners.

The articles of association are a public document setting out the rules for how a company is run, whereas a shareholders’ agreement lays out the terms and rights for the business shareholders.

In this post, we will explain what each of these documents does and cover some common considerations for inclusion when creating them.

What are the articles of association?

Under the Companies Act of 2006, every business must register its articles of association with Companies House. These articles set out the rules for how the company is to be run and administered.

Companies House provides ‘model’ articles that new businesses can adopt. These will cover all of the required areas such as:

• How company directors are appointed or terminated
• The directors’ powers and obligations
• How big decisions will be made, including dealing with conflicts of interest, chairing meetings, and so on
• How shares are to be issued and transferred, how dividends will be paid, and so on
• Administrative matters (such as director’s insurance and indemnity)
• How shareholders will be involved in the decision making process

New businesses will automatically be assigned these model articles when incorporating with Companies House unless they provide their own. Three different types of model articles are provided for different types of companies (private companies limited by shares, private companies limited by guarantee, and public companies limited by shares).

A business is free to modify these model articles or create their own to suit their unique needs, as long as they fulfil the requirements of the Companies Act. If they do this, company incorporation cannot be completed online and the articles must be mailed to Companies House for approval.

Once completed and accepted, two copies of the articles will be kept – one by the business at their registered premises, the other by Companies House (where they will be accessible as a public document).

On occasion, a business may wish to include entrenched provisions in its articles. This means that there are special restrictions which stipulate that these provisions cannot be altered after incorporation, or that particular requirements must be met for some decisions (100% approval from all shareholders, for example). However, the Companies Act of 2006 (unlike its 1985 predecessor) does not allow for absolute entrenchment – provisions can now only be restricted on a conditional basis.

In some cases, a company may wish to update its articles of association down the line. To do this, they will need to hold a general meeting with the shareholders and agree to a special resolution (with a 75% majority as a minimum requirement). Proof of this special resolution is then sent to Companies House along with the newly updated articles within 15 days of the resolution being passed.

In some cases, the shareholders may wish to expand on the contents of the articles of association. This can be done with the creation of a shareholders’ agreement.

What is a shareholders’ agreement?

A shareholders’ agreement is essentially an optional supplement to the terms laid out in the company’s articles of association.

Whereas the articles act as a contract between the shareholders and the company, a shareholders’ agreement lays out additional obligations between the shareholders themselves. Unlike the articles of association, a shareholders’ agreement is not a public document and does not have to be registered with Companies House.

This document is drawn up in the interests of the shareholders, not the company, and is signed by each member when the agreement is created.

Whereas the articles of association are subject to the Companies Act, there is no legally mandated process for making amendments to a shareholders’ agreement. Therefore, it’s usually specified in the agreement that changes can only be made with all of the shareholders’ consent.

The contents of a shareholders’ agreement might include:

• Whether directorial decisions require approval from the shareholders
• How the business is to be run in general – appointing directors, organising board meetings, financial planning, and so on
• Provisions protecting the interests of minority shareholders (in other words, those with less than a 50% stake in the company)
• The rules for issuing and transferring shares
• How dividends are handled
• Restrictive covenants
• Tag-along and drag-along stipulations for when shares are sold or transferred
• What happens in the event of a shareholders’ death

A shareholders’ agreement can help to ensure that the rules are fair for both majority and minority shareholders. For example, the agreement can contain provisions for making sure minority holders get an equal say in important decisions and cannot get steamrolled by majority holders. On the other hand, it can also lay out rules preventing minority stakeholders from transferring their shares to a competitor or to some other unwanted third party.

Dispute resolution is another area often covered by a shareholders’ agreement. Essentially, this involves establishing ahead of time the approved process for settling disagreements – perhaps involving the services of a professional mediator or arbitrator.

However, nothing in a shareholders’ agreement is obligatory. The contents will vary depending on the situation, and may contain a long list of provisions or only a few key points. It is also not necessarily a given that the agreement will need to be signed by every shareholder if it only applies to some of them.

Future shareholders who join the company after the formation of the shareholders’ agreement will usually be required to sign a document known as a deed of adherence. This confirms their acceptance of the terms by which all of the other shareholders are already bound.

Both the articles of association and the shareholders’ agreement are legal documents of fundamental importance for the running of the business.

By enlisting good legal help, you can ensure that these documents are created correctly and work for the best interests of everybody involved – setting out the rules for the company’s operation and the rights and interests of shareholders for years to come.

This post was written by Girlings Solicitors – an established and well-respected law firm offering Business, Personal and Third Sector legal services in Kent.