Shareholders' Agreements and Company Constitutions: A Case of No Inconsistency

A company constitution and a shareholders’ agreement both regulate the rights and obligations of shareholders. It is not unusual for a particular subject matter to be dealt with in both a shareholders’ agreement and the company constitution.

To address potential conflicts between the two documents an “inconsistency clause” is often used to determine which document will prevail. An “inconsistency clause” states the order of precedence of documents in the event of an inconsistency between documents.

When an inconsistency clause is used within shareholders’ agreements, the constitution is often not amended to remove potential inconsistencies with the shareholders’ agreement.

The decision of the New South Wales Supreme Court in Cody v Live Board Holdings Limited [2014] NSWSC 78 demonstrates that a shareholders’ agreement with an inconsistency clause will not automatically take precedence over the terms of a company’s constitution.

Facts

Live Board Holdings Limited issued 5,226,550 preference shares to new shareholders and 3,323,324 ordinary shares to existing shareholders to raise approximately $1 million.

An existing shareholder, and company director, challenged the validity of the capital raising and share issue, on the basis that the board had not complied with relevant provisions of the company’s constitution and shareholders’ agreement when issuing the shares.

The board sought a declaration from the New South Wales Supreme Court that it had the power and authority to issue the shares.

The inconsistency

The Live Board Holdings’ constitution stated that the company’s directors were entitled to cause the company to issue shares, including preference shares, with such rights and in such numbers as the directors determined. However, if the share issue directly or indirectly varied the rights of a class of shares, then the approval of at least 75 percent of the shareholders of that class was required.

The shareholders’ agreement stated that certain matters, including the issue of shares, required approval of only a simple majority of shareholders.

The shareholders’ agreement included an inconsistency clause which provided that where there was a conflict between the provisions of the shareholders’ agreement and the constitution of the company, the provisions of the shareholders’ agreement would prevail. The clause further stipulated that, in the event of an inconsistency, and upon a written request from any party, the parties must cause the constitution to be amended in order to remove the conflict.

The parties agreed that, if there was an inconsistency between the constitution and the shareholders’ agreement, the terms of the shareholders’ agreement would prevail and a simple majority resolution would be sufficient to provide the board authority to proceed with the share issue. The Court questioned whether “a shareholders’ agreement could control the constitution in this way” but did not have to decide this point because it held that there was no inconsistency.

The Court found that there was no inconsistency between the shareholders’ agreement and the constitution.

Justice Brereton reasoned that whilst both the company constitution and shareholders’ agreement addressed the issuing of shares, the purpose of the requirements differed.

The relevant provision within the constitution protected the interests of existing shareholders and the issuing of preference shares would mean that the rights attached to the ordinary shares would be affected.

The relevant provision within the shareholders’ agreement reserved the power to issue shares to the shareholders.

The Court held that the two provisions were not inconsistent and both the constitution and shareholders’ agreement must be complied with. The requirement for approval of 75 percent of the shareholders must be complied with in addition to the requirement for approval of a simple majority of shareholders. Accordingly, the issue of the preference shares was held to be invalid.

Considerations for companies

An “inconsistency clause” in a shareholders’ agreement will not necessarily resolve all disputes on the application of two different clauses in a constitution and shareholders’ agreement on the same subject matter.

It is important to have a company constitution and shareholders’ agreement reviewed to ensure that the parties’ intentions are achieved when both documents are read together.

Amendments may be necessary including specifying topics that are to be governed by the shareholders’ agreement, specifying provisions of the constitution which do not apply, and addressing what would constitute an “inconsistency.” The adoption of confining certain topics to the company constitution may also assist.

How Opportuna Legal can help

Opportuna Legal advises on the review of company constitutions and shareholders’ agreements. If you need guidance on how these documents interact, contact Opportuna Legal.

Anthony Jarvis | Managing Partner, Opportuna Legal