Company Constitutions & Shareholders Agreements: When and why?

A well-drafted company constitution and shareholders' agreement are indispensable tools for any company. They not only ensure compliance with legal requirements but also provide the flexibility needed to address the specific needs of shareholders. Many business owners are familiar with shareholders agreements and company constitutions, but do you know when and how each should be used?

Article Summary

Company constitutions and shareholders' agreements serve different but complementary roles in governing Australian companies. While constitutions set the statutory framework for internal management, shareholders' agreements provide tailored protections and commercial rules that help prevent disputes and protect shareholder interests.

Company constitution

A company's constitution is a contract that binds the company, its shareholders, directors and company secretary. It operates under section 140 of the Corporations Act 2001 (Cth) (the Act) and governs the internal management of the company. A constitution is primarily a standard document that covers the basic terms needed for the internal management of a company. Some of the key features of a company constitution include:

• Rules for the appointment and removal of directors;
• Procedure for conducting meeting of shareholders and directors; and
• The classes of shares and rights attaching to shares.

The constitution can be amended or repealed by a special resolution of the shareholders, subject to any additional requirements specified within the constitution itself. For a public company, amendments to the constitution also require notification to the Australian Securities and Investment Commission (ASIC).

Often, the constitutions for private companies are issued by the party (which may be an accounting or law firm, or third party provider) that incorporates the new company with ASIC without specific instructions from the client. As such, the constitutions for private companies are often generic and have not been prepared with consideration to the shareholders/directors specific requirements.

Shareholders Agreement

In contrast, a shareholders' agreement is a legally binding contract between the shareholders and, in some cases, the company. Shareholders' agreements allow more flexibility in managing the business and include bespoke provisions that are tailored to the specific needs of the shareholders.

A shareholders' agreements is a tailored document which can include provisions covering:

• Appointing and restricting the appointment of directors and managing board composition;

• Restrictions and requirements on the transfer of shares, pre-emptive rights and permitted transferees (so that the shareholding of the company is not 'open' to anyone a shareholder may want to sell to);
• Obligations of shareholders and specific requirements for decision making and resolutions;
• Dividend policies;
• Provisions for buying out shareholders for events of default, retirement, incapacity and death;
• Tag along and drag along provisions for selling shares to third parties; and
• Confidentiality, restraint of trade and dispute resolution provisions.

Unlike a constitution, a shareholders' agreement is not binding on transferees of shares unless they expressly agree to be bound by it.

Distinctions between the two company documents

While both documents govern aspects of a company's operation, their scope and enforceability differ:

• A constitution is a public document that applies to all shareholders and officers of the company, while a shareholders' agreement is a private contract that applies only to the parties who sign it;
• A constitution is primarily concerned with the internal management of the company, while a shareholders' agreement focuses on the rights and obligations of shareholders; and
• Amendments to a constitution usually require a special resolution, while changes to a shareholders' agreement typically require unanimous consent from the parties (as with any contracts).

Benefits of using both documents

Having both a company constitution and a shareholders' agreement provides a comprehensive framework for governance and shareholder relations. The constitution ensures compliance with corporate law and provides a standardised approach to internal management. Meanwhile, the shareholders' agreement allows for bespoke arrangements that address the unique needs of the shareholders. Importantly, a shareholders' agreement can supplement or modify the constitution, but it cannot require the company or its officers to breach the constitution or statutory duties.

Why both documents should be used together

Using both documents in tandem ensures that the company operates efficiently while safeguarding the interests of its shareholders.

By implementing these documents, your company can:

• Attract investors by demonstrating strong governance practices;
• Protect shareholder rights and ensure fair treatment;
• Establish clear processes for decision-making and dispute resolution; and
• Adapt to the evolving needs of the business and its stakeholders.

These two documents are fundamental for ensuring effective governance, protecting shareholder interests and fostering a well-structured corporate environment. By understanding their unique roles and how they complement each other, companies can establish a robust framework for internal management and shareholder relations. By leveraging the strengths of both documents, your company can achieve effective governance, minimise disputes, and create a solid foundation for long-term success.

If you would like further advice on your company documents or would like assistance with preparing a shareholders' agreement for your company, please reach out to our Business + Corporate Advisory team.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.