Drafting the Articles of a Private Company

Drafting the Articles of a Private Company

With India’s Startup India Action Plan in force, it is expected that in the coming years a large number of entrepreneurs would incorporate their entities to enter a startup friendly Indian market. Any startup would need its very own constitutional documents, i.e. articles of association and memorandum of association. While incorporating a company with the standard documents available online is more pocket-friendly, drafting the constitutional documents to one’s specific need is always more effective and ideal. Especially with subsequent amendment to the Companies Act, 2013 and the exemptions provided to the private companies under the notification dated June 5, 2015, every startup has the advantage of drafting its constitutional documents accordingly, which allows it to comply with less strict provisions. This post discusses the exemptions available to private companies or the amended provisions to be kept in mind while a startup drafts its articles of association or an existing private company alters its existing articles.

Effect of the Exemption Notification

Under the provisions of Section 462 of the Companies Act, 2013 (“Act”), the Central Government has the power to declare which provisions of the Act shall not be applicable to a certain class/classes of companies, if it thinks it is necessary for public interest. The Central Government, exercising its power, has published the exemption notification on June 5, 2015. This notification is applicable only to private companies as defined under Section 2(68) of the Act and shall not be applicable to deemed public companies. A private company is defined as a company which has a minimum paid-up capital and which restricts the right to transfer its shares. Such a company shall have at most 200 members. Whereas, a subsidiary of a public company is deemed to be a public company for the purposes of the Act, even if such company is incorporated as a private company. The exemptions available to a private company, which can be incorporated in its articles, are discussed below.

Relaxation in Related Party Transaction: If one wishes to incorporate the matter of related party transactions, it is necessary to remember the relaxation provided therein for private companies. As per the exemption notification, a private company shall not be a related party of:

i.               its holding, subsidiary or an associate company; or

ii.              a subsidiary of a holding company to which the private company is also                    subsidiary.

Hence, any contract or arrangement of such nature shall not require any approval under section 188 of the Act. Moreover, in accordance with the provisions of the exemption notification, a member shall not be disqualified to vote on the resolution required to be passed to approve any arrangement or contract to which such member is a related party.

Kinds of Share Capital and Voting Rights: Section 43 of the Act lays down that, a company, limited by shares, shall have two kinds of share capital viz. equity share capital and preference share capital. Section 47 deals with the voting rights attached to the shares. These provisions, read with the rules made thereunder, restrict the rights of a company limited by shares to issue shares with differential rights and require strict compliance with the rules made for this purpose. The exemption notification lays down that if the articles or memorandum of association so provide(s), the provisions of Sections 43 and 47 shall not be applicable to private companies.

The implication of this exemption is that, a private company shall have the liberty to decide the kind of share capital it wishes to have or the voting rights attached to any class of shares. So, the startup drafting its articles, or a company amending its existing articles can now amend its articles in a way which would allow them to issue equity shares of a new class which may or may not contain any voting rights, while under the provisions of Section 47, the equity shareholders always enjoyed the right to vote at all resolutions placed before its members. Again, a company can even issue preference shares with such mandatory voting rights, i.e. the preference shareholders shall have the right to vote in resolution placed before the members, even if such resolution does not concern those shareholders.

However, one must keep in mind that if the memorandum or articles of a company do(es) not provide that the provisions of sections 43 and 47 shall not be applicable, such private company would continue to be bound by the provisions of those two sections. In addition to section 47, section 106 of the Act also provides for certain restriction on voting rights. The exemption notification lays down that the provisions of that section shall continue to be applicable on private companies unless the section provides otherwise, or unless the articles of the company provide otherwise.

ESOP: If the articles are to provide for the issuance of shares through any employees’ stock option plan as per the provision of section 62(1)(b), now they might state that such issuance shall be made through an ordinary resolution passed by the members at a general meeting, although the company is free to continue to insert more restrictive provisions than the ones prescribed under the Act.

Borrowing Powers: While drafting the articles related to the borrowing power of a private limited company, one must remember that although the provisions of sections 73 shall continue to be applicable to private companies, the prohibition on acceptance of deposits from public would not be applicable in case a private company accepts from its members any amount exceeding 100% of aggregate of the paid-up share capital and free reserves.

Notice of Meeting: Section 101 of the Act and Secretarial Standard on General Meetings lay down that a company requires to provide at least 21 days’ clear notice before commencing a general meeting, annual or otherwise. A meeting can also be convened at a shorter notice if at least 95% of the members give their consent for the meeting. A company shall also be free to impose stricter provisions than the prescribed ones. The exemption notification has, however, relaxed these provisions and it lays down that if the articles of association of a private limited company otherwise provide, the provisions of section 101 shall not be applicable to such company. Hence, the company shall be at liberty to decide the provisions governing the notice of general meetings.

Explanatory Statement, Quorum, Chairman, and Proxy: Sections 102 to 105 lay down the provisions governing explanatory statements, quorum for general meeting, the procedure to elect the chairman of a general meeting, and the procedure to provide proxies. While the provisions of these sections would continue to govern private companies, if however, the articles of a private company provide otherwise, such provisions would not be applicable. Hence, a private company now has the option to provide for its own regulations with respect to notice of general meeting, statement to be annexed to notice, quorum for meetings, chairman of meetings and proxies in its articles. In addition to the foregoing, each private company would also have the power to decide its own regulations regarding voting by show of hands and/or demand for poll, as provided under section 107 and section 109 of the Act respectively. The relaxation provided under the exemption notification is expected to reduce the compliance requirements with respect to general meetings of a private limited company, subject to its articles.

Appointment & Powers of Directors: Although a private limited company has the liberty to provide in its articles that any retiring director shall not be eligible to stand for directorship, the provisions to that effect provided in the Act would not be applicable to such a company. Hence, any such requirement would solely be subject to the choice of the company. In addition to the foregoing, none of the restrictions applicable to the board of directors, under the provisions of Section 180 of the Act, shall be applicable to the board of a private company. Any interested director of such company can now participate in any meeting where such subject of interest is discussed, subject to disclosure of his/her interest. Hence, a company drafting its articles may want to keep this in mind.

Appointment of WTD/MD/Manager: As per the provisions of section 196(4), every company shall appoint a whole time director (“WTD”), managing director (“MD”) and/or manager with the approval of the board (obtained at a board meeting), which shall be approved by the members at the next general meeting of the company. Such appointment would also require compliance with the provisions of Section 197 and Schedule V of the Act. Any variation to the conditions specified under Schedule V would, in addition, require the approval of the Central Government. Every company usually specifies the manner in which such WTD, MD or manager can be appointed, in its articles. The private companies are now exempted from this requirement, as the provisions of both sub-section 4 and 5 of section 196 shall not be applicable to such companies. Thus, no approval is required by a private company at its board meeting or at a subsequent general meeting. They do not need to comply with the provisions of section 197 of the Act, dealing with managerial remuneration or, the conditions laid down under Schedule V. Hence, any variation thereto would not require any approval from the Central Government either. A private company, thus, has the liberty to lay down the procedure for such appointment in its articles in any matter it deems fit.

Effect of the Companies Amendment Act

In order to facilitate ease of doing business in India, the Act was further amended by the Companies (Amendment) Act, 2015 (“Amendment Act”), which received the assent of the President on May 25, 2015. This amendment was a welcome move and a private company might want to keep few provisions of the Amendment Act in mind while drafting its articles or restated articles.

Common Seal: While the Companies Act 1956 and the Act (of 2013) both required every company to have a common seal, and the model articles of association of a private limited company (as provided in Table F of Schedule I) also contains provisions as to such common seal, the Amendment Act has made the requirement of having a common seal, optional. Every place where authorisation by means of such seal was required, has been amended to require authorisation by two directors or by one director and the company secretary, where there’s no such seal. Hence, while drafting the articles, a private company (although, it is applicable for every company) should keep this in mind.

Related Party Transactions: While the exemption notification has relaxed the definition of related party for private companies, the Amendment Act has relaxed the procedural aspect as well. A related party transaction (which crosses the prescribed threshold) required the consent of the members obtained at a general meeting, by passing a special resolution. Under the Amendment Act, a company can now pass an ordinary resolution to that effect. The provision requiring passing of a special resolution by the holding company has also been done away with. Although, as the exemption notification excludes the holding companies from the definition of related party, this provision holds little importance to private companies.

Payment of Dividend: Section 123 of the Act lays down the provisions for declaration of dividend. The Amendment Act has modified this Section to add a new provision which lays down that no company shall declare dividend unless the carried over previous losses and the depreciation not provided in previous year or years are set off against profit of the company for the current year. If a company wishes to lay down detailed regulations governing the distribution of dividend, it might add the amended provisions of Section 123 thereto.

The constitutional documents of a company are the most important documents. The articles lay down regulations for operation of the company. For this reason, having detailed articles of association helps a company in various ways. The Indian judiciary has, time and again, given more preference to the articles over any other agreement. If a company reflects the abovementioned provisions in its articles, it would be fruitful to incorporate the amendments made to the applicable laws and to avail the relaxations provided by the Government.

Thanks & Regards,

Meetesh Shiroya