A company incorporated under the Corporations Act 2001 (Cth) does not require a constitution, and there are many companies that operate without one. Under section 135 of the Act, the Replaceable Rules apply to each company until displaced or modified by the Constitution. As a result, a company may have no need for a constitution if the Replaceable Rules are sufficient. This article sets out some reasons why a constitution may be needed, and what provisions it might contain.
Recording and Changing Share Structure
Where a company is structured with different classes of shares and there are specific rights that apply to each class, nothing specifically requires the class rights to be recorded in a constitution. An example of a class right would be a share without the right to vote in member meetings, but still having the right to receive dividends. The rights which apply to shares issued can be determined by the company under s.254B and could simply be recorded in an appropriate resolution. In relation to preference shares, s.254A specially authorises the rights attached to be set out either in the constitution or approved by special resolution. However, from an administrative perspective it is often neater to record such rights in the constitution itself, and it makes share class details much easier to locate and verify many years after the structure has been set up.
Where the constitution sets out the procedure for varying or cancelling class rights, that procedure must be followed under section 246B(1) of the Act. If a company does not have a constitution setting out those rights, the rights may be varied or cancelled by a special resolution passed by a meeting of the class of members holding shares in the class (s.248B(2). This difference means that inserting class rights in the constitution can give more certainty as to the process which will apply if change are proposed in the future.
Pre-Emptive Rights for Sale and Issue of Shares
Section 254B provides pre-emption rights to existing shareholders for the issue of new shares, which might not be appropriate for all companies. A Constitution could provide more flexibility. While contractually a pre-emption for the sale of existing shares is more common in a Shareholders Agreements, procedures relevant to pre-emption may also sit within a constitution.
Acting for Benefit of Group Companies
Directors have the obligation to act in good faith in the best interests of the company. This can create problems though if the company takes an act that does not benefit the company itself, but does create a benefit elsewhere in a corporate group. An example is where one subsidiary entity guarantees an obligation owed by a different subsidiary. The parent company of the group may benefit from the additional work and potentially dividends achieved by providing the guarantee, but the subsidiary providing the guarantee is unlikely to receive that benefit.
The Act offers directors protection in the form of Section 187, which states that a director is taken to have acted in good faith in the best interests of the wholly-owned subsidiary if they act in the best interest of a holding company, provided that two conditions are satisfied:
- The subsidiary cannot be insolvent at the time or become insolvent by the action; and
- The constitution of the subsidiary must expressly authorise the director to act in the best interests of the holding company.
The appropriate clause in the constitution could be as simple as the following:
XX. Authorisation to Act in Best Interests of Holding Company
Notwithstanding any other provision of this constitution, the directors are authorised to act in the best interests of a holding company, as defined in the Corporations Act 2001 (Cth).
The clause does not apply to a subsidiary which is not a wholly-owned subsidiary. If that were the case, as might be the case in an incorporated joint venture where one party holds the majority of shares, there would be a risk that the company’s actions in the best interests of a parent entity could be oppressive to minority shareholders.
Calling Meetings
The Replaceable Rules impose the following terms in relation to the calling of meetings:
- Directors’ meetings can be called by any director giving “reasonable notice” to every other director (s.248C)
- A director can call a meeting of members (s.249C)
These provisions are very simple, and in practice it might be preferred to have more specific procedures in the constitution to avoid dispute.