Business Associations

Constitution & Corporate Liability

Eva Tam 2023
Articles &
Shareholders’
Agreement

2
Memorandum of
Association
 Historically, two documents were
required – memorandum of association
and the articles of association,
collectively referred to as
“memorandum and articles” or “M&A”

 CO does away with the memorandum of

association (s98(1) and (5) CO)

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Articles of Association
 Prescribe the regulations of the company (s75 CO)
 Constitute a contract under seal (“statutory contract”) as between:
 the company and the members; and
 the members inter se
(s86(1) CO)
 Enforceable by:
 the company against each member
 a member against the company
 members against each other
(s86(2) CO)
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Limitations on Enforcement of
the Articles
 Qua member only:
 no right given by a company to a non-member (i.e. an outsider) may be
enforced against the company,
 articles create rights and obligations as between the members and the
company only (Hickman v Kent or Romney March Sheep-Breeders’
Association)
 enforcement by members of rights in articles may benefit outsiders
(Ramkissendas Dhanuka v Satya Charan Law)
 The rule in Foss v Harbottle:
 proper plaintiff limitation - s86 CO is a statutory exception
 irregularity principle

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 Mandatory Articles
 Company name (s81 CO)
 Company’s objects not mandatory
(except for s103 licence companies)
(s82(1)-(2) CO)
 Whether members’ liability is
limited or not (s83 CO)
 How members’ liability is limited
(by shares or by guarantee),
(s84(1)-(2) CO)
 Capital and initial shareholdings at
incorporation (s85 CO)

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Other Articles
 Other regulations by which the company is to be operated
and which usually cover the following areas:
 directors and company secretary
 members and their meetings
 share issues/transfers and distributions
 corporate communications and miscellaneous administrative
arrangements

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Model Articles
 Financial Secretary may prescribe model articles (“Model Articles”) (s78(1) CO)
 A company may adopt Model Articles (s80(1) CO)
 Model Articles for private companies are set out in Schedule 2 of the Companies
(Model Articles) Notice (Cap.622H) (previously in Table A of the repealed First
Schedule to old Companies Ordinance, Cap.32)
 Model Articles are the default so that:
 on incorporation, model articles are adopted if articles do not prescribe any
regulations, i.e., only contains the mandatory articles
 model articles will apply if not expressly excluded by the registered articles
or modified by the regulations set out in the registered articles
(s80(2)&(3) CO)
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Model Articles (Structure)
Model Articles for private companies cover:
 directors (Articles 3 to 32)
 company secretary (Article 33)
 members and their meetings (Articles 34 to 55)
 shares and distributions (Articles 56 to 79)
 corporate communications and miscellaneous administrative
arrangements (Articles 80 to 84)

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Alteration of Articles and
Objects
Company may:
 alter its articles by passing a members’ special resolution
(at least 75%) (s87(1) and s88(1)-(2) CO)
 change company name by special resolution (s107 CO)
 alter the maximum number of shares to be issued by
ordinary resolution (more than 50%) (s88(3) CO)
 alter the objects stated in the articles by a special
resolution (s89(1)-(2) CO)
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Statutory Limitations
to the Power to Alter the Articles
 Cannot alter statements in its articles relating to liability for a
company limited by shares (s87(2) CO) and for a company
limited by guarantee (except to increase the amount
undertaken) (s87(5) CO)

 Alterations after the date a person becomes a member, which

require that person to subscribe for more shares or increases
that member’s liability to contribute to the share capital or
pay money to the company are not binding on that member
(s92 CO)
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Common Law Limitations
to the Power to Alter the Articles

 Courts may impose limitations on the power to alter articles

as part of their efforts to impose limitations on the
members’ right to vote as they please

 To be explained in the lecture on ‘Members’

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Joint Venture Agreement/Shareholders’
Agreement (for Company)

Party A Party B

Joint Venture Vehicle

- Formation
- Ongoing relationship/respective parties’ obligations
- Termination/Exit
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Shareholders’ Agreement
 What is it?
 an agreement between some or all of the shareholders to regulate
their rights and obligations in the company
 in addition to the shareholders, the company may be a party to the
agreement
 a private agreement and needs not be registered where it can be
inspected by the public as of right
 Reasons for having one?
 to provide for manner of operating the company either not
provided for or differently from what is provided for under the CO
or in the articles of association
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Typical Provisions in a
Shareholders’ Agreement (1)
 Scope of business
 usually a Board matter
 Share capital
 shareholders and their shareholdings
 Board composition, quorum and decision making process
 who gets to appoint the directors
 special quorum requirements to ensure representation
 Matters requiring unanimous consent (“reserved matters”)
 cut across line between Board and shareholders’ matters
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Typical Provisions in a
Shareholders’ Agreement (2)
 Reporting of information to the shareholders

 Future financing obligations

 Dividend policy to stipulate a minimum percentage of

profits to be declared as dividends

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Typical Provisions in a
Shareholders’ Agreement (3)
 Pre-emption provisions:
 giving a first right of refusal to buy out the shares of a shareholder who
wishes to sell to an outsider
 selling shareholder must give notice to the other shareholder(s) offering to
sell his shares to them at a specified price
 other shareholder(s) may accept offer and may opt to buy at market value
instead of specified price
 once offer accepted, share purchase must be completed within a certain
time period
 if offer not accepted, selling shareholder may then sell to outsider

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Typical Provisions in a
Shareholders’ Agreement (4)
 Compulsory transfer of shares:
 death
 bankruptcy of individuals
 winding up of companies
 breach of shareholders’ agreement triggering the pre-emption
provisions
 Binding incoming shareholders only upon execution of a
deed of adherence

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 Russell v
Northern
Bank
Development
Corp Ltd &
others

20
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Russell v Northern Bank
Development Corp Ltd & others (2)
 Company’s statutory powers cannot be fettered - Provisions
in the shareholders’ agreement which would constitute a
fetter on the company’s statutory powers is void in the
same way as a provision in the articles of association to the
same effect would be
 However, shareholders’ agreements are different from
articles of association - The subject provision in the
shareholders’ agreement also creates personal obligations
only and is enforceable by the shareholders inter se
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Articles vs Shareholders’
Agreement
Articles Shareholders’ Agreement
Parties Company and all shareholders Company and/or all or some
shareholders
Binding on a share Yes Not binding on share transferee
transferee? except by deed of adherence
Alteration By special resolution By all the parties to the agreement
Enforceability Statutory and common law On ordinary contract law principles
limitations
Statutory provisions Can be overridden by statutory Can be overridden by statutory
provisions provisions

Confidentiality May be inspected by public Private agreement and is

confidential as among the parties
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Corporate Liability 23
Corporate Liability -
Contractual
 A company cannot act pro se, i.e., by itself

 The decision-making bodies – “primary rules of attribution”

– directors and shareholders (each of these bodies
collectively)

 Others including individual directors – “general rules of

attribution” – agency principles

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Ultra Vires Doctrine
In the past:

 corporate acts which are ultra vires the company are wholly
void

 the meaning of ‘ultra vires’ was made clear in the Rolled

Steel Products case

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Rolled Steel Products case
Mr S
100% 100%
Debt owed
Scottish to BSC British Steel
Rolled Steel Corporation
Steel Sheets
Products Guarantee
to BSC

Clause 3(k) in memorandum of Rolled Steel Products:

“To lend and advance money or give credit to such persons, firms or companies
and on such terms as may seem expedient, and in particular to customers of
and others having dealings with the company, and to give guarantees or
become security for any such persons, firms or companies.”
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Ultra Vires Doctrine – Still
Applies?
 Transactions are “ultra vires” if they are beyond the company’s
capacity (Rolled Steel Products)
 Objects clause in memorandum of association
 Objects v powers (Rolled Steel Products)
 Ultra vires rule as it applies externally abolished (s115 CO)
 Ultra vires rule still applies internally (s116 CO)
 Members cannot bring proceedings to enjoin company’s acts
done in fulfilment of a legal obligation (s116(4) CO)
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Agents Acting on behalf of the
Company
 Power of persons (other than the Board or the shareholders) to bind
the company governed by the general rules of attribution
 Principles of agency:
 Actual authority (express or implied)
 a matter to be determined on the basis of the agreement
between the principal and the agent
 Apparent/ostensible authority:
 authority a person is held out to have
 a matter to be determined on the basis of the interaction
between the principal and the third party
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Action Outside Scope of Authority -
Apparent/Ostensible Authority
 The 4 conditions:
 representation made to contractor
 representation must be made by a person or persons having actual
authority
 contractor induced by such representation to enter into the contact and
in fact, relied upon it (for quality of reliance – see Akai Holdings case)
 company not deprived of capacity to enter into the contract (no longer
relevant because of s115 CO)
Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB
480 (Court of Appeal)

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Akai Holdings Case

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Akai Holdings Case (2)
In Akai Holdings, the Bank’s reliance was irrational:
 the Switch Transaction was so extraordinary as to take it outside of the
scope of Ting’s apparent authority (by virtue of his position in the company)
 the Switch Transaction benefitted only Singer NA and the Bank but not Akai
Holdings
 Ting was in obvious conflict of interest
 the Bank did not ask for commercial justification for Akai Holdings to enter
into the Switch Transaction
 the matter was left to be decided by an executive committee without a
Board meeting
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Akai Holdings Case (3)
 Third party’s reliance on the representation:
 cannot have actual knowledge of lack of authority
 cannot be reckless in his belief or guilty of turning a blind eye
 reliance cannot be irrational

 Agents cannot be “self-authorising”, so Ting who does not have

authority cannot represent himself as having authority

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(Previously) Constructive
Notice of Public Documents
 Acts of directors and shareholders outside scope of authority do
not bind the company if outsiders know that the directors and
shareholders are acting outside their authority unless company
ratifies the contract

 In the 19th century, anyone dealing with a registered company is

taken to have “constructive notice” of its public documents
including the articles of association

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Turquand’s Rule/Indoor
Management Rule
 To mitigate the harshness of the constructive notice
doctrine, the courts developed the rule in Turquand’s case –
“indoor management rule” (Royal British Bank v Turquand
(1856) 6 E. & B. 327)

 This rule allows a person to assume, in the absence of

circumstances putting him on enquiry as to any irregularity,
that all matters of internal management and procedure
have been duly complied with

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Turquand’s Rule/Indoor
Management Rule (2)
 Indoor management rule only applies in favour of persons who deals with the
company in good faith. Persons who have notice of relevant irregularity
cannot avail themselves of the indoor management rule (Rolled Steel Products
(Holdings) Ltd v British Steel Corporation [1986] Ch 246)
 Would not apply to “insiders” -- persons who by virtue of their position in the
company are in a position to know whether or not the internal regulations
have been observed
 Has only been applied in limited circumstances – due execution of documents,
passing of authorising resolutions and regularity of elections and appointments
 Constructive notice of the articles now abolished (s120 CO) but the indoor
management rule remains
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Re Moulin Global Eyecare
Holdings Limited Case
Ma family
members Other
Personal (also directors shareholders
guarantee of Moulin)

Active Base
Moulin Global Eyecare
Holdings Ltd
(Bermuda incorporated
Loan company listed on the
HK Stock Exchange)

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Re Moulin Global Eyecare
Holdings Limited Case (2)
 Active Base tried to recover a loan made to Moulin Global
 The liquidator of Moulin Global resisted on the basis that the loan was
unauthorised due to the lack of a properly convened Board meeting (not properly
notified to all the directors)
 Active Base was unsuccessful in the application of Turquand’s rule because it had
been put on inquiry of the irregularity arising from the lack of a properly
convened board meeting:
 substantial loan
 Moulin Global’s chairman had wanted a personal loan, keeping Moulin Global
out of the picture
 only the directors of the chairman’s family were present at the Board meeting
 chairman’s family provided security for a corporate loan
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S117 of CO
 In favour of a “person dealing with a company in good faith”, the power of the
company’s directors to bind the company, or authorize others to do so, is to be
regarded as free of any “limitation” under any “relevant document” of the
company (s117(1) CO)
 “person in good faith”
 “person” – includes directors (also see s118 CO)
 presumed to have acted in good faith so burden of proof on company (s117(2)(b)
CO)
 not to be regarded as acting in bad faith by reason only of knowledge that act is
beyond the director’s powers under any relevant document (s117(2)(c) CO)
 not required to inquire as to the limitation in the power of the company’s
directors to bind the company or to authorise others to do so (s117 (2)(d))
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S117 of CO (2)
 “dealing with a company”:
 party to a transaction to which the company is also a party
 party to an act to which the company is also a party

(s117(2)(a) CO)
 a gratuitous transaction is not “dealing with a company”, EIC Services Ltd
v Phipps [2004] 2 BCLC 589 (CA)
 “relevant document” (s117(6) CO)
 the company’s articles
 any members’ resolutions of the company
 any agreements between members of the company

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S117 of CO (3)
 Does not affect:
 Right of a member to bring proceedings to restrain the doing
of an act that is beyond the directors’ powers (but such
proceedings must not be brought in respect of act done in
fulfilment of a legal obligations arising from a previous act of a
company)
 Any liability incurred by the directors by reason of the
directors’ exceeding their powers
(s117(3)-(5) CO)

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S118 of CO
 Applies to s117 CO transactions
 S118(2)&(3) CO limitations - transaction is voidable at the
instance of the company except where:
 restitution is not possible;
 company is indemnified for loss;
 third party has acquired rights for value without
notice; or
 company has affirmed the transaction

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S118 of CO (2)
 Whether the transaction is avoided or not, a director who
has authorized the transaction, amongst others, is liable to
 account to the company for any gain that the director
has directly or indirectly made from the transaction;
 indemnify the company against any loss or damage
resulting from the transaction
(s118(4) CO)

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Turquand’s Rule and s117 CO
 S117 CO – a statutory version of the Turquand’s rule?
 S117 CO applies to “limitations” contained in “relevant documents”
but Turquand’s rule focuses on compliance with procedural
requirements
 Turquand’s rule does not apply to “insiders” but s117 CO may
 A person who knows or has been put on enquiry of irregularity cannot
avail themselves of the Turquand’s rule but someone who simply
knows the act is beyond the director’s powers under a “relevant
document” is not considered to be acting in bad faith (s117(2)(c) CO)

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