Differences Between a Company Constitution and Replaceable Rules

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 a company’s management. A constitution is a contract between a company, its directors and shareholders which covers, for the most part, very similar matters to the replaceable rules. 

Whichever you choose for your company, directors and shareholders should understand the rules which govern the 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 and explain why your company may want to draft its own constitution.

What is a Company Constitution?

A company constitution is a document that contains the rules governing a company’s operation. It can determine the threshold for making certain decisions and the processes in certain situations, amongst other matters. 

It also governs the relationship between your company’s shareholders and directors. As a result, the constitution provides the company with methods to resolve disputes and outlines your company’s expectations, goals and purposes. It defines the rules your company’s directors and shareholders must follow when operating the company.

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 outlines the rules that apply to companies where it does not have a constitution that replaces the replaceable rules. 

The replaceable rules cover areas such as:

• appointment and removal of directors;
• the right of shareholders to inspect the company’s books;
• remuneration of directors;
• powers of directors;
• directors and members’ meetings; 
• what happens to shares in certain events, such as death or bankruptcy of a shareholder; and
• rights attached to shares.

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 shareholders. 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.

To replace the replaceable rules, the constitution must explicitly state that it is doing so. 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 the shareholders passing a special resolution, provided that the company’s existing constitution does not set out additional requirements. A special resolution of shareholders requires the approval of shareholders holding more than 75% of the voting rights in the company.

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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 and implementing a company constitution can be more advantageous than relying on replaceable rules. 

Broadly, a company constitution 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 one place rather than having to refer to the Corporations Act. Likewise, it provides more comprehensive guidelines which are more suitable for larger companies. 

There are additional reasons why a company constitution can be advantageous:

• the replaceable rules give powers to shareholders, which may be undesirable in some circumstances. For example, the shareholders’ right to remove a director or replace that director;
• 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 owed by the shareholder on the shares;
• it enables the company to have multiple classes of shares, which can have different rights relating to voting rights or dividends;
• the company can insert pre-emptive rights on the issue or transfer of shares to control the sale of shares; and
• you can easily modify and amend a company constitution to suit the needs of your business from time to time. On the other hand, replaceable rules can only be changed through legislative reform.

Interaction With the Company’s Shareholders Agreement

A shareholders deed is another key corporate governance document that builds on and outlines the rights and processes of situations regarding shareholders and directors. It operates alongside a company constitution. 

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 clause in the constitution dealing with the same matter. 

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.

Key Takeaways

Replaceable rules are a uniform set of rules that automatically apply to your company’s internal governance in the absence of a company constitution. A constitution will override the operation of the replaceable rules if it explicitly does so. A constitution provides broader coverage as well as flexibility over a company’s internal affairs. Finally, having the rules that govern your company in one document provides practical simplicity. 

If you have any questions about the replaceable rules or company constitutions, our experienced business lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.

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