You’ve incorporated your company and have turned your attention to the legals including drafting a company constitution and a shareholders agreement. But, does your company need both, or either? We set out below the relationship between your company’s constitution and shareholders agreement.

What is a Company Constitution?

There are three different ways in which the rules governing the internal management of a company can apply, namely:

  1. Written down in a company constitution;
  2. The replaceable rules as set out in the Corporations Act 2001 (Cth) (the Act);
  3. A mixture of the constitution and the replaceable rules.

There is no prescribed form that a written constitution should take. It will depend on what the shareholders decide are the company and business needs. Typically, a company constitution will address the day to day matters and management including:

  • The appointment, powers and removal of directors;
  • Meetings of directors and how they are called and organised;
  • Issuing shares and the rights of shareholders depending on their class of shares, including their rights to payment of dividends; and
  • Matters dealing with the conflict of issues between directors personal interests and the interests of the company.

A company’s shareholders can adopt a constitution by a special resolution only which requires the agreement of at least 75% of the votes cast.

Section 141 of the Act sets out 39 provisions of what is known as the replaceable rules. It’s important to realise that the replaceable rules will apply to your company unless they have been modified or amended by your company’s constitution.

What is a Shareholders Agreement?

A shareholders agreement can be between all of the shareholders and the company, or the shareholders of a particular class of share (e.g. ordinary shareholders and preference shareholders). Shareholders invest in the company by giving money in return for part ownership in the company by way of shares. A shareholders agreement then aims to protect the shareholders investment as well as find ways in which the shareholders work together to grow the business.

The content of a shareholders agreement depends on the circumstances and focus of a company as agreed by the shareholders. Standard clauses, however, found in an Agreement include:

  • The relationship between the directors of a company and the shareholders;
  • The rights and ability to issue new shares;
  • Payment and calculation of dividends;
  • Transfer of shares either to other shareholders or third parties outside of the company; and
  • Dealing with deadlocks and disputes.

Specific terms of the shareholders agreement will depend on multiple factors however, some points to consider include:

  • The nature of the business
  • Potential for growth;
  • Future third party financing; and
  • Any other matters particular to the industry.

Technically speaking, you should enter into a shareholders agreement once your company has more than one shareholder – whether or not the shareholders are made up of friends and family. Conflicts can arise, however, between minority and majority shareholders. By way of explanation, a minority shareholder is one who does not exert control over a company, and a majority shareholder almost always exercises control over the company, its internal management, the board of directors and other fundamental business matters.

A minority shareholder may then want to include provisions protecting their right to participate in the decision-making process. Conversely, a majority shareholder will be looking to include provisions which give them the flexibility in making decisions for the company without the minority shareholders holding them hostage.

How Does a Constitution and Shareholders Agreement Work Together?

At first glance, a shareholders agreement and a company constitution look to provide similar functions regarding governing the rights and obligations of the company’s shareholders and documenting the rules regulating the internal management of the company through the board. So why does your business require both documents?

There could be many reasons why a company has both, such as:

  • A shareholders agreement is confidential between the relevant shareholders and the company whereas a company’s constitution may be publically available.
  • A shareholders agreement is typically more cost-effective and easier to enter into as it follows standard contract law and doesn’t require a special resolution to be effective and enforceable.
  • The shareholders of a particular class may wish to enter into a private arrangement as between themselves. It could, therefore, be a question of practicality.

To the extent the shareholders agreement and constitution deal with similar issues, and there are any inconsistencies, it is common to provide that the shareholders agreement prevails to the extent of the inconsistency. Case law would suggest that just stating this in a shareholders agreement may not be enough, and the parties should amend the constitution by special resolution as soon as any inconsistency arises.

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If you would like assistance with reviewing or drafting your company constitution or shareholders agreement, or if you have any questions, get in touch with our commercial lawyers on 1300 544 755.

Natalie Dickson

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