4 Binding Effects of Memorandum and Articles of Association

Members may sue to restrain a company from doing any ultra-vires or illegal acts or from acting on a resolution obtained by fraud or which is inconsistent with the Articles.

Members may also sue the company for the enforcement of their personal right under the Articles, e.g., right to receive divided which has been declared. However, only a shareholder or a member of the company, in the capacity of a member and not in any other capacity, can enforce the rules and regulations contained in the Articles.

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The case of Wood v Odessa Waterworks Co. provides an illustration of binding of articles on the company to its members.

The articles of the Waterworks Co. provided that ‘the directors may, with the sanction of the company at general meeting, declare a dividend to be paid to the members’. Instead of paying the dividend in cash to the shareholders a resolution was passed to give them debenture bonds.

In an action by a member to restrain the directors from acting on the resolution, the Court held: “The question is whether that which is proposed to be done in the present case is in accordance with the articles of association of the company.

Those articles provide that the directors may, with the sanction of a general meeting, declare a dividend to be paid to shareholders. Prima facie that means to be paid in cash. The debenture bonds proposed to be issued are not a payment in cash.” Accordingly the directors were restrained from acting on the resolution.

2. Binding on members in their relations to the company:

An article of Association is a ‘contract of the most sacred character’ between the company and each member, binding the members to the company under a statutory covenant.

All money payable by any member to the company under the Memorandum or Articles shall be a debt due from him to the company. Articles are taken to be signed and agreed to be observed by each member. Members are bound by the articles just as if every one of them had contracted to conform to them. A company can sue its members for the enforcement of its Articles as well as for restraining their breach. A case in point is:

Borland’s Trustees v. Steel Bros. & Co. Ltd. (1901):

The articles of association of the company provided that in the event of the bankruptcy of a member his shares would be sold at a price to be fixed by the directors. Borland became bankrupt. His trustee in bankruptcy wanted to sell these shares at their true value contended that he was not bound by the articles. It was held that he was bound to abide by the provisions of the company’s articles.

3. Binding between members:

The contractual force given to the articles is limited to the matters arising out of company’s relationship of the members as members and does not extend beyond the company relationship. The articles constitute a contract between each member and the company. The articles do not regulate their rights inter se.

Such rights can only be enforced by or against a member through the company. However, this is not without exception. Courts have extended the articles to constitute a contract between individual members qua members without joining the company as a party to the action. The case of Rayfield v Hands (1960) is a pointer to the issue.

Rayfield was a shareholder in a company. He was required to inform the directors in the event of his intention to transfer the shares. The directors were required to take the shares at a fair value. Rayfield informed the directors in accordance with the articles. The directors contended that they were not bound to take and pay for Rayfield’s shares and the articles could impose no such obligation on them.

The court set aside this argument by treating the directors as members and compelled them to take Rayfield’s shares at a fair value. The court also held that it was not necessary for Rayfield to join the company for bringing a suit against the directors.

4. No binding in relation to the outsiders:

The memorandum and articles do not constitute a contract between the company and the third party. Neither the company nor the members of the company is bound to the outsiders to give effect to the provisions of the memorandum and the articles. For example:

In Browne v La Trinidad, the articles of the company contained a clause to the effect that Browne should be a director and should not be removable. He was, however, removed and had brought an action to restrain the company from excluding him.

It was held that there was no contract between Browne and the company. No outsider can enforce articles against the company even if they purport to give him certain rights.

Thus, an outsider cannot take advantage of the Articles to found a claim thereon against the company. Even a member enjoying certain rights in a capacity other than a member cannot enforce them against the company. The member would be an outsider for those ‘outside rights’. The leading case is that of Eley v Positive Government Security Life Assurance Co.

The articles of a company contained a clause that Eley would be the solicitor of the company and would not be removed except for misconduct. He became member in the company also. He acted as solicitor of the company but the company removed him. He brought an action against the company for breach of the articles.

His suit was dismissed. The Court held, “An outsider to whom rights purport to be given by the Articles in his capacity as such outsider, whether he is or subsequently becomes as member, cannot sue on those articles to enforce those rights”.