Articles of association vs shareholders' agreement: which to use and how to alter articles

When shareholders want to change how their company is run, there are two ways to do it: alter the articles of association, or put a shareholders' agreement in place. A shareholders' agreement will often do the job, and usually more cheaply and privately. But there are certain things that only the articles can achieve, and a shareholders' agreement that contradicts the articles can leave you paying for both. This article sets out the advantages and disadvantages of choosing a shareholders' agreement over altering your articles, and then gives an overview of the procedure for altering the articles if that is the route you need.

What are articles of association?

In short, the articles of association are the bylaws of a company: the rules for how that company is run. They tell the directors and the shareholders how to manage decisions, from how board meetings are held to how shares can be transferred. Every company has them, and they are filed at Companies House. For a fuller explanation see what are articles of association.

A shareholders' agreement is different. It is a private contract between the shareholders about how they will deal with each other and with the company. The two documents overlap in what they can cover, which is why the question of which one to use comes up so often.

Advantages of a shareholders' agreement

There are three main advantages of choosing a shareholders' agreement over altering your articles.

It is confidential

A shareholders' agreement is not published at Companies House. It is kept within the shareholders. The articles of association, on the other hand, are publicly accessible via Companies House, so anything you put in the articles can be read by anyone, including competitors, customers and future investors. Anyone can download them in a few clicks, as shown in how to find articles of association on Companies House. If the arrangements between the shareholders are commercially sensitive, that alone can decide the question.

It is usually cheaper

Usually a shareholders' agreement is less costly to produce, from a legal fees perspective, than amending your articles of association. The reason is that when amending or altering your articles, there are several documents that need to be produced, not just the amended or bespoke articles themselves. You need to follow a specific corporate procedure to comply with the Companies Act, which means board minutes, a shareholders' resolution and filings at Companies House, all of which take time to prepare. A shareholders' agreement is one document signed by the shareholders.

It can be easier to amend later

A bespoke shareholders' agreement can, for example, state that you only need more than 50% of the shareholders to be in agreement to amend it. The threshold is whatever the shareholders choose.

Altering the articles again in the future is a different matter. You will typically need at least 75% of the shareholders to agree or, if voting on a poll, which is where you vote according to the number of shares that carry the right to vote, at least 75% of the voting shares in favour of the new alteration. That is a much higher bar, and it means a minority holding just over 25% can block any future change to the articles.

Disadvantages of a shareholders' agreement

Against those advantages, there are three disadvantages of using a shareholders' agreement instead of altering your articles.

New shareholders are not automatically bound

If you want new shareholders who later join the company to be bound by the shareholders' agreement, they need to sign, typically, a deed of adherence. That means they physically need to sign something, whether on paper or electronically, agreeing to be bound by the existing agreement.

With the articles, this problem does not arise. Anyone new who joins the company, whether as a shareholder or as a director, is automatically bound by the articles of association. There is nothing extra to sign and no risk of someone slipping through.

It might conflict with the articles

The second disadvantage is that the shareholders' agreement might conflict with the articles of association. Where that happens, typically the articles of association take precedence over the shareholders' agreement.

So it is best practice, while drafting your shareholders' agreement, to cross-check the articles to make sure there is no conflict. If it turns out that there is a conflict, you should go and alter your articles nonetheless. That brings you back to square one: you are now spending legal fees on both a shareholders' agreement and an alteration of your articles, which removes the cost advantage you were hoping for.

It does not bind directors

The last disadvantage is that the shareholders' agreement does not bind directors. As the name implies, it is an agreement between the shareholders. A director is not always a shareholder; they can be two different people. A director who is not a party to the shareholders' agreement is not bound by it.

The articles of association, by contrast, bind everyone in the company, both shareholders and directors. If what you want to control is how the directors behave, the articles are the document that reaches them.

Articles or shareholders' agreement: which should you choose?

In practice the answer often depends on what you are trying to achieve.

• Choose a shareholders' agreement when confidentiality matters, when you want to keep legal costs down, and when you want a lower threshold for future changes.
• Alter the articles when you need the rules to bind every current and future shareholder and director automatically, or when what you want conflicts with the existing articles anyway.

Many companies end up with both, with the articles setting the public framework and the shareholders' agreement dealing with the private commercial arrangements. If you take that route, make sure the two documents are drafted together so they do not contradict each other. How a shareholders' agreement is put together is covered in how to structure a shareholders' agreement.

How to alter articles of association

If altering the articles is the right answer, here is an overview of the process. The full step-by-step walkthrough, with templates, is in how to amend articles of association.

• Step 1: hold a board meeting. The directors of the company need to come together and approve the proposed alterations to the articles.
• Step 2: send the amended articles to the shareholders for a vote. The shareholders vote on the new articles in their amended form. You need a special resolution to pass the decision, which means at least 75% of the shareholders or, on a poll vote, at least 75% of the voting shares. In a small company this is often done as a written resolution signed by the shareholders rather than at a physical meeting.
• Step 3: file at Companies House. Submit the documents to Companies House, including the special resolution of the shareholders and the amended articles of association.

Tip: remove e-signature audit trails

One practical point that catches people out. If you are going to sign the special resolution using electronic signatures as a written resolution, make sure to remove the signature trail that the e-signing software produces. It is typically found at the very bottom of the document, as a page recording who signed and when.

Remove that before you submit the documents to Companies House, because Companies House will reject your special resolution if the signature trail is still attached at the end of the document. It is a small thing, but it means re-doing the filing.

Next steps

Start by reading your current articles, so you know what they already say and whether what you want conflicts with them. If the change is private, commercial and needs a lower amendment threshold, a shareholders' agreement is usually the cheaper route. If it needs to bind directors and future shareholders automatically, alter the articles by board approval, special resolution and filing at Companies House. A corporate solicitor can tell you which document, or combination, fits what you are trying to do.