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The replaceable rules and a company’s constitution govern the internal management of a company. The replaceable rules are set out in the Corporations Act and are a basic set of rules for the company’s management. A constitution is a contract between the company, its directors and its members which covers, for the most part, very similar matters to the replaceable rules. When forming a company,  you have the choice to either:

  • use the replaceable rules;
  • draft your own company constitution; or
  • use a combination of the two.

Whichever you choose for your company, company directors and shareholders should understand the rules which govern their company. While a company constitution covers a broader range of matters, the replaceable rules are cost-effective and effort-free. This article will discuss the difference between choosing replaceable rules or a company constitution. It will also explain why some companies choose to draft their own constitution.

What Happens if I Don’t Have a Company Constitution?

If you registered your company after 1 July 1998, the replaceable rules will automatically apply if your company does not have a constitution. The only exception to this is if your company has a single shareholder who is also the sole director.

The Corporations Act includes 39 replaceable rules that apply to companies without a constitution. The replaceable rules cover areas such as:

  • appointment and removal of directors;
  • remuneration of directors;
  • powers of directors;
  • directors and members’ meetings; and
  • dealings with company shares and dividends.

A breach of the replaceable rules is not treated as a breach of the Corporations Act. This is because the obligations are contractual between the company and its members. Instead, the breach is treated as a breach of contract.

What Happens if I Want a Company Constitution?

Unlike the replaceable rules, a constitution will not automatically apply to your company. If you would like to adopt a company constitution, you will need to draft one. If you engage the services of a lawyer to do so, this will attract additional fees.

You can replace the replaceable rules with your constitution explicitly stating in your constitution that it will override the replaceable rules. If you wish to replace only a few rules, you must state the specific rules you wish to override. In addition, you can choose to implement or amend a company constitution at any time by passing a special resolution. A special resolution requires the approval of the holders of more than 75% of the voting rights to pass.

Why Choose a Constitution Over the Replaceable Rules?

The replaceable rules can be a cost-effective solution when starting up your business. However, there are several reasons why drafting a company constitution can be more advantageous than relying on replaceable rules.

A company constitution can be advantageous because:

  • it is a bespoke agreement that you can tailor to the specific needs of your company;
  • it is practically simpler to have your corporate governance rules in the one place rather than having to refer to the Corporations Act;
  • the replaceable rules give powers to shareholders which can be undesirable. For example, the right to appoint a director and in some circumstances, the right to take control of directors meetings in the absence of the usual directors;
  • it enables the company to issue partly paid shares and regulate calls on these shares. Calls on shares are the company’s demands to shareholders holding partly paid shares to pay the part or full unpaid amount on the shares;
  • it provides more comprehensive guidelines which are more suitable for larger companies;
  • it enables the company to have multiple classes of shares which can have different rights relating to voting rights or dividends;
  • the company can control the sale of shares, for example, offering them to existing shareholders first; and
  • you can easily modify and amend a company constitution. On the other hand, replaceable rules can only be changed through legislative reform.

Interaction With the Company’s Shareholders Agreement

A shareholders agreement is another a key corporate governance document which clarifies the rights of shareholders in conjunction with your constitution. This agreement also sets out the relationship between the shareholders in the company. In addition, it sets out how shareholders deal with their shares.

As mentioned above, if you want to use a constitution and override the replaceable rules, your constitution needs to explicitly state that it overrides those rules. In situations where a company has a shareholders agreement as well as a constitution, the shareholder’s agreement often will override the constitution.  However, only a formally adopted constitution can override the replaceable rules. Conversely, a shareholders agreement cannot override the replaceable rules.

Here is an overview of how these three documents interact with each other.

Replaceable Rules Company Constitution Shareholders Agreement Implication
Company 1 Yes No Yes The replaceable rules and shareholders agreement will apply to the company together.
Company 2 No Yes Yes Usually, the constitution will override the replaceable rules. In addition, the shareholders agreement will usually take priority over the constitution.
Company 3 Yes No No The replaceable rules will apply in the absence of a constitution.
Company 4 No Yes No Usually, the company constitution will override the replaceable rules.

Key Takeaways

The replaceable rules are a uniform set of rules that you can use for your company’s internal governance. In the absence of a company constitution, the replaceable rules will apply. This will generally override the operation of the replaceable rules. A constitution provides broader coverage as well as flexibility over a company’s internal affairs. Having the rules in the one document also provides practical simplicity. If you have any questions about the replaceable rules or company constitutions, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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