If you are planning to start a business and set up a limited company one thing is for certain. There will be lots and lots of company and legal jargon to get your head around from the outset.
This can be both confusing and challenging.
Most importantly it can take away critical focus and energy from actually building your new business.
So to help make things a bit easier we have written this blog to let you quickly get your head around the differences between two of the main company documents you will hear a lot about during the process of setting up your limited company – articles of association and shareholders agreements.
1. You are not legally required to have both documents
A limited company’s articles of association, often referred to as ‘the Articles’, are effectively the rules of the company and ensure its’ smooth running by setting out how decisions have to be made.
They also act as a contract between each of the company’s shareholders, and between the shareholders and company itself.
When you register a company with Companies House, you are legally required to have Articles under the Companies Act 2006.
They must be contained within a single document and will take one of the following forms:
- The statutory default ‘model’ Articles;
- ‘Model Articles’ with amendments;
- ‘Bespoke’ Articles which are customised to a particular company’s needs.
A shareholders’ agreement by comparison is an agreement entered between only the shareholders of a company and it regulates their relationship and actions.
It is a private contract between them containing the rules for running and owning the company and is entered into for the benefit of the shareholders and not for the benefit of the company.
Crucially therefore it is not legally required when you start a new company.
Although not legally required this does not mean that there is no requirement for a shareholders’ agreement for your limited company if there is more than one shareholder.
There are many items – such as dealing with disagreements on how key issues are going to be resolved or dealing with what happens if someone in the business gets ill or wants to leave – which are not dealt with by model Articles but are essential components in any shareholders agreement.
As a start up business will frequently involve friends or colleagues it is critical that these conversations are had to ensure everyone is on the same page and those friendships are not jeopardised down the line by not writing down everything that is agreed at the outset.
Professional advisors will often have different ideas about which areas should be covered in the Articles and which in a shareholders’ agreement.
The truth is however that the majority of areas, although not all, can be included in either document and it is a personal decision for those involved.
2. Articles of Association are a Public Document. Shareholders’ Agreements are Private
Every limited company must submit Articles to Companies House as part of its application.
As a result, the Articles of all companies are public documents and any member of the public is therefore entitled, and able to, view their contents at any time.
In contrast a shareholders’ agreement is a private document between those involved and no 3rd party has a right to see it.
That shareholders’ agreements are private is therefore often seen as a key attraction to having it govern many of the matters as to how a company is going to be run.
The loss of privacy must therefore be weighed against the advantage that third parties may be deemed to have notice of the Articles.
3. Articles of Association are Governed by Statutory Law. Contract Law Governs Shareholders’ Agreement
The legal requirement under the Companies Act 2006 for a limited company to have Articles means also that Articles are governed by, and must comply with, statutory law.
In contrast shareholders’ agreements are governed by contract law like any other contract formally agreed between private parties.
The main impact of this relates to the options available when a party breaks either document.
A breach of the shareholders’ agreement would trigger contractual resolutions such as damages although these may be difficult to quantify.
An action breaking a company’s Articles is by comparison simply invalid as a general rule of thumb. For example, a transfer of shares to a 3rd party in breach of the Articles is simply likely to be ruled as invalid.
It is important also to avoid conflicts between the two documents if they both exist. Either document can prevail depending on the stated intention of those involved.
In practice, it is common that the shareholders’ agreement will take precedence over the Articles. This is largely because in practice, people tend to spend more time drafting and negotiating the bespoke terms for a shareholders’ agreement.
4. New Shareholders Are Only Automatically Bound by the Articles.
When someone new buys shares in a limited company these new shareholders are automatically bound, and therefore need to comply with, the Articles of that company.
By contrast they are not automatically bound by any shareholders’ agreement that exists.
Existing shareholders would therefore need to amend the existing agreement to include the new shareholder or shareholders to make them a party to it and bound by what it states.
Alternatively, if shareholders are likely to frequently change the important provisions which are intended to bind all of the shareholders could be included in the Articles to avoid the need to keep re-executing the shareholders’ agreement.
That approach however would have an impact on the privacy of those provisions as highlighted point 2 above.
5. You Don’t Need a Lawyer To Put Together a Shareholders’ Agreement
Like any private agreement between private parties it is not compulsory to have a lawyer draft it for you to make it legal.
The process of working through the content of a shareholders’ agreement is a critical one for any new business involving two or more people to help make it clear where everyone stands from the start.
It is normal for people to want to avoid disputes rather than deal with them when they arise.
Therefore simply by working through the questions involved in putting together a shareholders’ agreement – what happens if someone who owns part of the company wants to leave? how do you exclude people if things don’t work out? what happens if someone gets ill? – early stage businesses, can have an insurance policy to protect everyone against unforeseen things that may come up in the future.
That is not to say that legal advice is not of value in putting together a shareholders’ agreement but there is inevitably a cost with engaging a lawyer to draft it for you.
For small, cost conscious businesses this is often not an option with funding tight in the beginning and often inexperienced start ups can take what a solicitor offers rather than really thrashing out what each shareholder wants.
The process of talking everything through in putting together a shareholders’ agreement is not just a legal one and it is more important than the legal aspect.
It creates a strong foundation of understanding in the business itself and an agreed platform to move forward.
That is the crucial thing and you can always of course get a lawyer to ratify the agreement once you have agreed the main content.
In summary, in most limited companies with more than one shareholder it is preferable to have a shareholders’ agreement in addition to the Articles and careful consideration should be given to the contents of both.
However, their contents, the importance of them, and the level of detail required will vary from company to company.
One final point, and quite possibly the most important, is to remind everyone involved in a company that they must be fully aware of their rights and obligations under the Articles and any shareholders’ agreement at all times.
It is surprising how many times these are only reviewed when things go wrong!
Before You Go …
No matter how much we may want to businesses can not avoid the law and not dealing with key legal points at the outset can quickly add to the problems companies face when getting started.
Check out our next post for a summary of the most common legal mistakes start ups can make
8 Big Legal Mistakes Start-ups Make
Remember the information and products on this website do not constitute legal advice. If in doubt always seek professional advice.
