Relationship between Companies Act and constitutional documents

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During the transitional period, those provisions of a company's existing articles of association (deemed to be the company's memorandum of incorporation (MOI) under the Companies Act) that were in conflict with the provision of the Companies Act, would, to the extent of the conflict, prevail.

There were a few exceptions to this rule, such as the provisions of the Companies Act concerning directors' duties and liability, and fundamental transactions. Importantly, in addition, any pre-existing shareholders agreement prevailed over both the MOI and the Companies Act in the case of any inconsistency.

However, after the transitional period (from 1 May 2013), each provision of a company's MOI must be consistent with the Companies Act and is void to the extent that it conflicts with, or is inconsistent with, the Companies Act. And further, the shareholders agreement is now subordinate to the MOI and the Act, by virtue of section 15(7) of the Companies Act.

No penalties

If a company failed to adopt a new MOI, the existing articles of association would still govern the affairs of the company during the transitional period. Following the transitional period, in the event of a conflict between the articles of association and the Companies Act, the provisions of the Companies Act will apply.

At present, the Companies Act does not make provision for penalties to be levied against a company (or its directors) for its failure to adopt a new MOI that is consistent with the Companies Act, save that the Companies and Intellectual Property Commission (CIPC) may levy a fee on the registration of the company's new MOI if lodged after 30 April 2013.

The relationship between the Companies Act and a company's constitutional documents, particularly in the matter of an inconsistency and more particularly in the context of director appointments, was considered in Verso Financial Services (Pty) Ltd v Burger and Others (case no 9600/2013), Western Cape High Court, Cape Town, 12 August 2013.

The primary issue for determination in Verso was the lawfulness of the appointments of four directors of the company. At the heart of the case was the interpretation and applicability of the Companies Act in circumstances where the company was in the process of conducting negotiations concerning a new MOI to comply with the provisions of the Act.

Facts of case

The facts are briefly as follows: Four additional directors were elected by the shareholders, based on the provisions of the MOI (still comprising the old articles of association) governing the appointment and election of directors, while the shareholders and the company were still in the process of negotiating a new MOI. In particular, the shareholders and the company were still in the process of negotiating the provisions concerning the appointment and election of directors.

The company's articles of association provided that an unlimited number of directors could be appointed by the majority shareholders. The company's shareholders agreement, however, provided that the applicant (Verso) was entitled to appoint three directors. The shareholders agreement furthermore provided that the first and second respondents were each entitled to appoint one director.

The central issue for determination was whether the provisions in the articles of association that regulate the appointment and election of directors were consistent with the Companies Act. If this was the case, these provisions would remain in full force and effect and if the respondents did indeed comply with these provisions, the appointments would be found to be lawful.

In terms of the Companies Act, there are three ways in which directors can be appointed:

• they can be appointed directly by the board;
  
• they can be elected by a majority of shareholders; and
  
• they can be ex officio directors appointed by virtue of the position held within a company; provided that at least 50% of a company's directors are elected by shareholders.

This is by virtue of section 66(4)(b) of the Companies Act which provides that shareholders must elect at least 50% of the directors of a company. This is an unalterable provision of the Companies Act which cannot be amended in a company's MOI, or by agreement between shareholders.

Nyman AJ confirmed the position that the company's articles of association constitute the MOI for purposes of the Companies Act, as it is the document in terms of which the company was incorporated and governed prior to the date of commencement of the Companies Act, as per the definition of MOI in the Companies Act. As a consequence, to the extent that the relevant provisions in the shareholders' agreement may be at variance with the articles of association, regard should be had to the articles of association.

Unalterable provision

Accordingly, the court found that, as the Companies Act contains an unalterable provision that mandates at least 50% of the directors to be elected by a majority of shareholders, the majority shareholders were permitted to elect the additional directors, notwithstanding that the shareholders agreement has a different regime regarding the composition of the company's board.

As the articles of association did not conflict with section 66(4)(b) of the Companies Act, and given that the articles now trumped the shareholders agreement after the lapse of the two year grace period, the election of the additional directors was in order, despite such election being inconsistent with the provisions of the shareholders' agreement. The court did not in fact do a detailed analysis or comparison of the articles and the shareholders agreement, but curtly stated that if there was any conflict at all, it did not matter and did not affect its findings because the Act is clear that the MOI prevails in any event.
This case highlights the importance to companies of ensuring that the provisions of their MOIs are consistent with the provisions of the Companies Act, and ensuring that all relevant provisions of their shareholders agreements are migrated into their MOIs - and the risks of not doing so.

In summary, the following principles are important to bear in mind:

• Firstly, if a company fails to adopt a new MOI, the existing articles of association are the company's MOI under the new Companies Act and will still govern the affairs of the company to the extent that the articles of association do not conflict with the Companies Act. This may be particularly problematic where companies have adopted shelf company articles of association, and regulated material aspects of the company's business and governance in the shareholders agreement;
  
• secondly, following the transitional period (from 1 May 2013), in the event of a conflict between the articles of association of a company and the Companies Act, the provisions of the Companies Act will apply. And in the event of a conflict between the articles and the shareholders agreement, the articles will again apply; and
  
• thirdly, a company will not suffer any financial or other penalty for its failure to adopt a new MOI that is consistent with the Companies Act, save that the CIPC may levy a fee on the registration of the company's new MOI if lodged after the expiry of the transitional period.