The Company Constitution and Capacity

The Company Constitution and Capacity

Syllabus tag: KASNEB CPA | Intermediate Level | CA21 Company Law | Topic 3 The Company Constitution and Capacity

Lesson objectives

By the end of this topic, you will be able to:

• Identify what makes up a company's constitution
• Explain the contractual effect of the articles
• Explain how the articles may be altered and the limits on alteration
• State the modern position on capacity and ultra vires
• Explain the rule in Turquand's case

Why this matters

The articles are the rulebook the members agreed to. Whether a member can enforce them, and whether an outsider is affected by them, are two different questions with two different answers — and both are examined.

What the constitution comprises

Under the Companies Act 2015 the constitution is the articles of association, together with any resolutions and agreements affecting it.

The memorandum of association survives only as a short document recording that the subscribers wish to form a company and agree to take shares. The older practice of setting out an objects clause in the memorandum has gone.

A company may adopt model articles prescribed by regulation, adopt them with modifications, or register its own. Where a company registers nothing, the model articles apply by default.

The articles as a contract

The articles bind the company and its members as if each had signed a covenant to observe them. The effect is a statutory contract:

Between	Enforceable?
Member and company	Yes
Company and member	Yes
Member and member	Yes, on matters of membership
Company or member and an outsider	No

The last row is the examinable one. A provision in the articles appointing a named person as the company's solicitor for life does not give that person a contract, because the articles bind only in the capacity of member.

A person who is both a member and a solicitor cannot enforce the solicitor provision through the articles. They may have a separate contract, and the articles may be evidence of its terms — but the articles themselves do not supply it.

:::checkpoint The articles provide that Mr Okoth shall be managing director for ten years. He is also a shareholder. The company removes him after two years. Explain whether he can sue on the articles, and what he would need instead. :::

Altering the articles

Alteration requires a special resolution — not less than 75%.

Three limits:

• The alteration must be bona fide for the benefit of the company as a whole
• It cannot require a member to take more shares or increase their liability without written consent
• It cannot override the Act or a court order

A company cannot contract out of its power to alter its articles. An agreement purporting to freeze them is ineffective, though a member may have a separate remedy in damages.

Entrenchment is possible: specified provisions may be made alterable only on more restrictive conditions. Even entrenched provisions may be altered with the agreement of all members or by court order.

The "benefit of the company as a whole" test is applied to the hypothetical member, not to the majority who voted. An alteration designed to expropriate a minority's shares for the majority's advantage fails it.

Capacity and ultra vires

Historically a company could act only within its objects, and an act beyond them was ultra vires and void — which could leave an innocent third party without a remedy.

The modern position reverses that priority:

• A company has unrestricted capacity unless its articles restrict it
• The validity of an act is not called into question on the ground of anything in the constitution
• A third party dealing in good faith is not bound to enquire into any limitation on the directors' powers

So a restriction in the articles remains real internally — a director who breaches it breaches their duty under section 142 and may be liable to the company — but it does not invalidate the transaction with the outsider.

The doctrine has moved from protecting the company against its directors to protecting outsiders against the company's internal rules.

The rule in Turquand's case

A person dealing with a company is entitled to assume that its internal procedures have been properly complied with.

If the articles require board approval for a particular contract, an outsider need not verify that approval was given. The requirement is a matter of the company's internal management, and the outsider cannot see inside.

The exceptions:

• The outsider knew of the irregularity
• The circumstances were such as to put them on enquiry — a transaction that is obviously unusual or that benefits a director personally
• The outsider is an insider, such as a director, who is expected to know the position
• The document relied on is a forgery

The rule and the statutory protection now work together: the statute protects good faith, and Turquand supplies the presumption of regularity. Both fail where the outsider is not acting in good faith.

:::checkpoint A supplier contracts with a company through a director who, unknown to the supplier, lacked authority under the articles. The transaction is on ordinary commercial terms. Advise the supplier, and say what would change if the contract had been on terms plainly favourable to the director personally. :::