Limitations on altering articles of association: sections 25, 630 and 22 explained

Can you change your company's articles of association however you like? Largely yes, but only to an extent. The Companies Act places three main limitations on the kinds of changes you can make, and each one comes with its own formality: written consent from an affected shareholder, approval from 75% of a class of shares, or unanimous consent for entrenched provisions. Below I go through each limitation and then the procedure you need to follow to make a valid alteration.

Why there are limits on altering articles of association

The articles of association are the rules of the company. In most cases the shareholders can rewrite those rules by special resolution. But the Companies Act recognises that some changes affect particular shareholders more than others, and that some provisions are deliberately designed to be hard to change. For those situations the Act sets a higher bar. The three sections that matter are section 25, section 630 and section 22.

Section 25: changes that increase a shareholder's liability

Section 25 of the Companies Act deals with alterations that would require an existing shareholder to do one of two things:

• subscribe for or buy more shares in the company; or
• take on increased liability to the company.

If you intend to alter the articles in either of these ways, the company needs the written consent of that specific shareholder. This is not a majority vote. It is individual, written consent from each shareholder who is affected.

If an affected shareholder does not give their written consent, the consequence is simple: they are not bound by that alteration. The change may still go into the articles, but it cannot be enforced against the shareholder who did not agree to it. In practice that makes the alteration pointless unless everyone it affects signs up to it. A common example is a proposed clause that would oblige existing shareholders to put further capital into the company on demand. However popular that idea is with the majority, each shareholder who would be required to put money in has to consent in writing, or the obligation simply does not apply to them.

Section 630: varying the rights of a class of shares

The second limitation is related but very different. Section 630 applies where your alteration would vary the rights attached to a specific class of shares, or remove rights from that class.

Many companies have more than one class of shares, for example ordinary shares and preference shares, or A shares and B shares, each carrying different rights to dividends, voting or capital. If the proposed change to the articles would vary or strip away the rights of one of those classes, you need at least 75% of that class of shares to be in favour of the alteration.

The point is that a majority of the shareholders as a whole cannot simply vote through a change that takes rights away from a minority class. The class whose rights are being varied gets its own say, and 75% of that class must agree.

Section 22: entrenched provisions

The third and final limitation is found in section 22 of the Companies Act, which deals with entrenched provisions. These are provisions in the articles of association that are made very, very hard to amend.

In practical terms, a special resolution needs 75% of the shareholders to be in favour. If a specific provision in the articles states that you need more than that, for example more than 80% of the shareholders in favour before it can be changed, then that would be recognised as an entrenched provision. The provision has been given a higher threshold than the ordinary special resolution, which is exactly what makes it entrenched.

How to validly include entrenched provisions

You cannot simply drop an entrenched provision into the articles by a normal special resolution. There are two main ways to make sure your entrenched provisions are legally and validly included:

• Option one: include them on incorporation. Put the entrenched provisions into the bespoke articles of association that you adopt when the company is incorporated. That means the very first articles of the company already contain the entrenched provision.
• Option two: unanimous consent. If that is not the case for you, because the company already exists and you want to add an entrenched provision later, you need the unanimous consent of all of the shareholders to that alteration of the articles.

So if you are setting up a company with partners and you know you want certain protections to be hard to remove, the cleanest route is to build them into bespoke articles from day one.

How to alter your articles of association

On the topic of altering your articles, there is a specific procedure that needs to be followed to comply with the Companies Act. It has three steps.

• Step 1: board meeting. Hold a board meeting of the directors of the company. The directors need to approve the proposed alterations to the articles.
• Step 2: special resolution. Move on to a special resolution passed by the shareholders of the company. The exception is where you are dealing with entrenched provisions, where you need unanimous consent as explained above, and where section 25 or section 630 applies, where you also need the specific consents those sections require.
• Step 3: file at Companies House. File the documents at Companies House, which means your resolution and the amended articles of association.

If you want a step-by-step walkthrough of exactly how to do this, see how to amend articles of association.

Next steps

Before you draft any change to your articles, check whether it would increase a shareholder's liability, vary the rights of a class of shares, or touch an entrenched provision, because each of those changes the consent you need. Then follow the board meeting, special resolution and Companies House filing in order. If the change is anything other than routine, or you are adding entrenched provisions to an existing company, speak to a corporate solicitor before you pass the resolution.