Why a tailored Constitution is important for your company

A Company Constitution (“constitution”) is vital for a company, no matter big or small, because the default rules found in the Companies Act 2016 (“CA 2016”) will automatically apply without a constitution. “Replaceable Rules” are the provisions provided in CA 2016 that may be incorporated into a constitution. These rules are customisable and modifiable depending on what suits the company best.

There are currently 62 identifiable replaceable rules that can be divided into “presumptive provisions” and “optional provisions”. However, these replaceable rules are scattered across the CA 2016, making it potentially difficult to locate. 

Presumptive provisions & Optional provisions

Presumptive provisions do not require an active opt-in on the part of the company. Meaning, these clauses will operate by default in accordance with the CA 2016 and can be amended. Presumptive provisions commonly employ phrases like “unless otherwise stated in the constitution” or “subject to the constitution” to indicate that the provision shall apply by default, unless the constitution provides otherwise.

Optional provisions, on the other hand, will apply only if the company chooses to expressly adopt them in the constitution. Companies that seek to incorporate these provisions must explicitly state them in the constitution, as the CA 2016 does not recognise them by default. By illustration, a constitution may dictate a fixed duration in which the company may be wound up voluntarily, in accordance with section 465 CA 2016. 

What happens if your company does not have a Constitution?

Without a constitution, the relevant provisions of the CA 2016 will act as the default constitution for all companies pursuant to section 31(3) CA 2016. In the context of replaceable rules, not adopting a constitution means that companies will miss the boat on adapting a tailored constitution most suitable for their nature of business. As the internal management and governance of each company comes with its own nuances and shareholder dynamics, it is hardly realistic to suggest that the CA 2016 provides a one-size-fits-all solution to all possible scenarios that may arise from the management and governance of the company.

This may lead to some hiccups as elaborated below:

  1. It makes it harder to interpret the rules governing the company.  These rules are significantly more difficult to locate because the CA 2016 is extremely lengthy and contains a lot more provisions. These rules are scattered throughout the CA2016 making it difficult to locate them for different situations. With a written constitution, it’s far easier to locate the rules for the different situations or scenarios which a company may from time to time face.
  1. There are times when the founders of the company find that the default rules in the CA 2016 are inappropriate for their company, or worse, may even have unintended adverse consequences on the company. By the time an issue has arisen, it may be too late as a dispute or an ongoing lawsuit could have commenced between the shareholders. Having a customized constitution would help to avoid this.

Some examples of default rules that founders may wish to modify are illustrated as follows:

Quorum

The CA 2016 provides for Board Proceedings by default in the Third Schedule. Some founders may find the provisions not appropriate for their administration and may wish to customize the default provisions. One example may be the quorum at directors’ meetings, where founders may want to customize the constitution such that a particular class of director or directors (representing certain shareholders) must be present in order for the quorum to be met.

Pre-emptive rights

The CA 2016 also applies its own default rules for pre-emptive rights.  This means shares must first be issued to shareholders on a pro-rata basis to maintain the existing shareholding proportions, after which the directors can dispose of the unsubscribed shares in their discretion. In this situation, some founders/shareholders may want to ensure that the shares are offered to them or specific individuals first (rather than on a pro-rata basis), before being offered or disposed of by the directors. (section 85 of CA 2016).

Variation of Rights

Section 91(5) of CA 2016 also deems further issuance of preference shares as a “variation of rights”.  This means that the approval from the existing class of preference shareholders must be obtained before a new issuance of preference shares, and also allows a certain percentage of the preference shareholders to go to Court to invalidate the new issuance of preference shares.  Founders who need to raise capital in subsequent rounds may face some difficulty in this scenario.

Power of Interested Directors to Vote

The default rule under section 222 of CA 2016 does not bar directors of private companies (except for private companies which are subsidiaries of public companies) from voting in transactions and agreements where they are personally interested in as long as their interest has been declared.  Some founders/shareholders may be uncomfortable with this and want to incorporate stricter provisions in the constitution to exclude them from voting in such matters.

The Board’s Right to Approve Directors’ Fees

The default rule under section 230 of CA 2016 allows the Board to approve directors’ fees in private companies (except for private companies which are subsidiaries of public companies).  Shareholders or founders may be uncomfortable with this arrangement and may want to ensure that this approval is done by shareholders.

*** If you wish to know more, please click here to access our article on the importance of having a company constitution.***

What if your company has an existing Memorandum and Articles of Association (“M&A”) which was drafted before CA 2016 was in force?

Potential conflicts between Memorandum and Articles of Association (“M&A”) and CA 2016 could lead to disputes between shareholders and lawsuits due to the inconsistencies.

In the Fourth Schedule of the Companies Act 1965 (“Old Act”), we can find a table comprising of internal management rules (“Table A”). The regulations in Table A are a good refence for specimen clauses, available for companies to cherry-pick to include in their M&A. While some of these Table A clauses have already been incorporated into the CA 2016 itself, several provisions have been amended and the CA 2016 requires companies to update some of these provisions.  Hence, companies should review their Articles of Association and decide the next step forward to reduce the possibility of disputes between members of the company.

What should your company do now?

  1. Companies limited by shares incorporated prior to 2016
    • These companies were statutorily required to adopt a M&A prior to 2016. Companies may amend and update the Table A provisions in their M&A to be aligned with the CA 2016; or
    • Revoke the M&A and operate without a constitution. This would mean that all the default rules of the CA 2016 would apply with no tailoring or modifications made to suit the management and governance of the company. The founders/shareholders may not be aware of the implications of such default rules and this may lead to a difficult situation or a conflict later when it is discovered; or
    • Revoke the M&A and adopt a new constitution in line with the CA 2016. This is probably the best and cleanest option.
  2. Newer companies incorporated after the enactment of the CA 2016
    • The most strategic choice is to have a constitution tailored to their needs; or
    • Companies may also choose to operate without a constitution. This would mean that all the default rules of the CA 2016 would apply with no tailoring or modifications made to suit the management and governance of the company. The founders/shareholders may not be aware of the implications of such default rules and this may lead to a difficult situation or a conflict later when it is discovered. 

In a nutshell

The Constitution of a company is an extremely important document.  It provides the structure for the management and governance of the company.  Although the CA 2016 has default rules applicable where the company has no Constitution, it would be risky to just rely on the default rules without considering the implications of the default rules on their specific company.   The ability to tailor the Constitution of a company is an important consideration for founders, investors and shareholders.  It provides the flexibility to adopt a Constitution which they feel is optimal for their specific company.  It is submitted that founders and shareholders should take advantage of this flexibility and have a tailored Constitution which provides the best framework for the management and governance of their company.

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This article was written by Shawn Ho with assistance from Tiffany Chin (Intern). Shawn leads the corporate practice group of Donovan & Ho, and has been recognised as a Notable Practitioner, whilst the firm has been recognised as a Notable Firm for Corporate and M&A by Asialaw Profiles 2020 and 2021. We are also ranked as a Recommended Firm by IFLR1000 2020 and 2021.

Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysia start-up founders and can assist with venture capital funds in Seed, Series A & B funding rounds.  Feel free to contact us if you have any queries.

 

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