Shares and shares alike: When was the last time you checked your articles of association?

 

 

When was the last time you checked your company’s articles of association (AoA)? If your copy is currently languishing in a drawer in a forgotten corner then you’re not alone. From our dealings with shareholders and directors of limited companies, Drewberry has found that many businesses rarely re-examine this initial paperwork once it’s filed with Companies House. 

 

Yet companies are living, breathing, evolving entities that grow and change with time – and so should their AoA.

 

Most companies use boilerplate AoA offered by Companies House – indeed, Companies House still doesn’t permit you to register your company online unless you use their standard AoA. It’s recommended that you tailor your AoA to suit you but, if you do, you’ll have to register your new company offline.

 

If you registered your company prior to 1st October 2009, then your AoA are probably  ‘Table A’ articles, or at least based on them. The Companies Act 2006 brought in new AoA, known as ‘Model Articles’, which are the newer standard for AoA and apply from October 2009 onwards. So if your company is more than seven years old then your AoA could already be out of date and in need of re-examination to ensure they still fit your company’s needs.

 

AoA govern the ways shareholders can dispose of their shares, usually either when they’re sold or gifted (‘transferred’) or pass as a result of the holder’s death or bankruptcy (‘transmission’).

 

Standard Model Articles may allow directors to veto the transfer or transmission of shares, but often only in a unanimous decision. So when one of two equal partners dies and the beneficiaries of the deceased partner want to sell the shares but the surviving partner would rather they didn’t, there’s no way to break the tie unless the AoA have been amended to take into account such a situation.

 

That’s even if the directors have a veto at all. It was only introduced as standard into AoA from the Model Articles onwards, so if your company is more than seven years old this is another reason to reread your AoA to see where your company stands on this issue.

 

While the process of transfer and transmission of shares is dealt with under standard AoA, it’s best dealt with in a shareholders’ agreement. Shareholders’ agreements are specifically focused on shares and shareholders, so they’re a more precise tool than the AoA, which have a much broader remit and function. 

 

A shareholders’ agreement can prevent the transfer of shares to unwanted third parties and dictate the rules a company wants shareholders to follow when disposing of their shares. These rules might include an agreement that a majority of shareholders must approve, for instance (a majority of directors is generally the case under standard AoA).

 

However, because a shareholders’ agreement isn’t required when setting up a company, it’s often overlooked. Drewberry helps businesses prepare for the unexpected death of a shareholder by arranging Shareholder Protection Insurance but, during the sales process, we’ve often found that companies don’t have a shareholders’ agreement and haven’t amended the standard AoA to suit their company’s needs.

 

Shares become part of a deceased’s estate when they die and pass to their beneficiaries. If the company is using off-the-shelf AoA and doesn’t have a shareholders’ agreement, however, then it may be harder to refuse the transmission, especially if the deceased was a majority shareholder or it’s a joint partnership. This could result in a situation where a beneficiary of the deceased is able to draw dividends from the company but has no business acumen to add to the company’s growth.

 

One of the most common amendments to AoA is the inclusion of pre-emptive rights on share transfers and transmissions that give the other shareholders the right of first refusal to buy the shares before they’re offered anywhere else.

 

Inheritance tax is levied at 40% on the value of an individual’s estate worth more than £325,000. Business property relief (BPR) allows shares in qualifying companies to pass tax-free to beneficiaries, but if the amendment to the AoA or the shareholders’ agreement isn’t carefully considered there could be some significant tax implications for the deceased’s estate. 

 

The amendment is worded so that the beneficiaries have to sell their shares back to the company, even when the company has received a payout from a Shareholder Protection policy specifically to buy the shares. Otherwise, this could be classed as a transfer of cash rather than of shares and the value of the shares could therefore be added to the estate for inheritance tax.

 

To prevent this, a cross-option agreement should be drafted giving the surviving shareholders the option to buy the deceased’s shares and the beneficiaries the option to sell them to the company. This way, there’s no obligation on the part of either party and so the shares remain eligible for BPR. The cross-option agreement can also pre-set the value of those shares so there are no disagreements at the point of transfer (naturally this value should be updated from time to time as a business grows).

 

Losing a shareholding director is a tragedy, both personally and professionally. But not having well-drafted AoA and a shareholders’ agreement can complicate the succession process significantly. It could result in a stalemate between the bereaved family and the surviving shareholders at what is already a very difficult time, leaving no one sure where they stand.

 

Shareholder Protection Insurance combined with a cross-option agreement can certainly help smooth the transition, but these hinge on how well a company’s AoA are drafted in the first place. It’s also far easier if there’s a shareholders’ agreement, also.

 

That’s why it’s time to open that drawer, dig out the paperwork and ensure the foundations you’ve built your company on are still appropriate for the business it is today.

 

Please note: Drewberry does not provide legal advice and the above information should not be considered as legal advice. You should consult your solicitor for advice on your articles of association and / or setting up a shareholders agreement and / or a cross-option agreement. As financial advisers Drewberry only provides advice on implementing a shareholder protection insurance policy to provide the funds needed to facilitate a transition of business ownership.