INTRODUCTION
Corporate governance is often a balancing act between business flexibility and shareholder protection. Nowhere is this tension more evident than in the issuance and modification of preference shares—should companies always alter their Articles of Association (AOA), or does existing law provide enough leeway? The Companies Act 2013 grants boards the authority to issue preference shares, but the question remains: Is AOA alteration a necessity or merely a safeguard against legal disputes?
This is not just an academic matter; it has direct economic and legal consequences in shareholder ownership. Additionally, preference shares give some control over corporations even though they do not vote, mainly when the shares are convertible, pay preferential dividends, or have liquidation rights. Investors depend on the AOA provisions in the current law to guard against the dilution of their stakes. Still, there is a possibility of going overboard by insisting on changing the AOA every time preference shares are issued.[1]
According to the Companies Act, 2013, the boards of the companies have the power to issue preference shares, but the question of whether there is a necessity of changing the AOA or not depends upon several factors. Preference shares, although they have no right to vote they do have an important position when it comes to the finances of the company and the rights of other shareholders, especially in the matters of dividends and rights in case of liquidation. The AOA is the charter document of the company that outlines the provisions for its inner functioning; making any changes to it is possible only after completing legal procedures such as the passing of a special resolution.[2]
This article focuses on the issues that arise when the AOA is changed about preference shares, investigating the legal requirements and the balance between maintaining corporate agility and ensuring robust investor protections.
DECODING THE LEGAL FRAMEWORK: STATUTORY PROVISIONS Vs. PRACTICAL IMPLICATIONS
The Companies Act 2013 provides the framework for initiating the shareholder rights concerning the right issues and managing the preference shares. However, one must go beyond pure reliance on laws—the real issue lies at the utmost level: how does this law manifest itself in the corporate context? Though companies can issue the preference shares without changing the AOA, some legal requirements may force the company to amend it. The following section will outline certain pieces of legislation and consider how they have affected corporations’ governance.
The Rulebook: Key Provisions of The Companies Act, 2013
1. The Corporate Constitution- “The articles shall contain the regulations for management of the company and include matters as may be prescribed. The articles may contain provisions for entrenchment, which makes specified provisions difficult to alter.”(Section5)[3] The AOA is an internal regulation of the company that describes the rights of shareholders and the internal structure of the company. These clauses impede the alteration of certain provisions of the company, and this, in turn, affects the issuance of preference shares.
2. Locked-in Rights?– “Where the share capital of a company is divided into different classes of shares, the rights attached to any class may be varied only with the consent of at least three-fourths of the shareholders of that class.”(Section 48) [4]Preference shareholders, like any other shareholders, cannot have their financial entitlements changed by the company without their agreement, which has to involve at least three-fourths of a particular class.
3. The Redemption Game- “No company limited by shares shall issue any preference shares which are irredeemable. A company may issue preference shares redeemable within a period not exceeding twenty years”(Section 55) [5]This section requires that preference shares shall be redeemable not later than 20 years in a bid to ensure that organizations cannot emit non-redeemable preferential stakes that might affect equity control.
4. The Gatekeeper Clause-“Subject to the provisions of this Act and the conditions contained in its memorandum, a company may, by a special resolution, alter its articles.”(Section 14) [6]Only special resolution amendments are possible in the AOA, but the actual issue is, when mandatory?
Judicial Interpretations: When the Law Meets the Courtroom
1. Shanti Prasad Jain v. Kalinga Tubes Ltd.– The Hon’ble Supreme Court of India, regarding affairs of oppression and misconduct of directors and management, underlined the function of the AOA in corporate management. The case has arisen between three principal groups of shareholders, all owning equal one-third stake in the company. The inability to generate adequate funds in the earlier years led to an understanding in 1954 that Shanti Prasad Jain entered into share capitalization and took several shares equivalent to the other two groups. However, in 1958, without offering them to the existing shareholders, the Patnaik and Loganathan groups issued 39,000 new shares to seven persons to reduce the percentage of Jain’s holding. They changed the control structure of the firm. This was given even though the company was in desperate search of funds, and two years later 39, 000 share monies remained unpaid, which was a serious implication on the company. Jain filed the present appeal while challenging the above action on the grounds of oppression. The Premier stated that the Supreme Court upheld the fact that the majority’s actions, such as arbitary issue of shares and the failure to consult other shareholders, were oppressive and amounted to management of the affairs of the company in an undesirable manner thereby advancing the protection of minority shareholders from oppressive conduct by the majority. This case is a good example of the need to follow the AOA to provide accountability to the shareholders and safeguard the company’s reputation.
2. Miheer H. Mafatlal v. Mafatlal Industries Ltd.- The Apex Court of India thereby discussed the problem of oppression and issues of management, which underlined the importance of AOA in corporate manageability. The case has arisen between three principal groups of shareholders, all owning equal one-third stake in the company. The inability to generate adequate funds in the earlier years led to an understanding in 1954 that Shanti Prasad Jain entered into share capitalization and took several shares equivalent to the other two groups. However, in 1958, without offering them to the existing shareholders, the Patnaik and Loganathan groups issued 39,000 new shares to seven persons to reduce the percentage of Jain’s holding. They changed the control structure of the firm. This was given although the company was in desperate search of funds, and two years later 39, 000 share monies remained unpaid, which was a serious implication on the company. Jain filed the present appeal while challenging the above action on the grounds of oppression. The Premier stated that the Supreme Court upheld the fact that the majority’s actions such as arbitary issue of shares and the failure to consult other shareholders, were oppressive and amounted to management of the affairs of the company in an undesirable manner, thereby advancing the protection of minority shareholders from oppressive conduct by the majority. This case is a good example of the need to follow the AOA to provide accountability to the shareholders and safeguard the company’s reputation.[7]
WHEN IS AOA ALTERATION MANDATORY?
Altering a company’s Articles of Association (AOA) becomes mandatory under specific circumstances to ensure compliance with the Companies Act, 2013, and to uphold equitable shareholder rights. Key scenarios necessitating such alterations include:
1️. Issuance of Preference Shares When AOA is Silent: The existing legislation does not allow the companies to issue the preference shares without providing the permission of the shareholders by altering the AOA specifically in this regard. This will help the company to ensure that it operates in the friendly territory to its constitution and in compliance to the laws governing such actions.
2️. Implication for Existing Shareholders: in cases where the amendment of the AOA affects existing shareholders’ rights for instance through changing the voting rights, dividend entitlements or other privileges, including liquidation preferences, the amendment is appropriate. This amendment also ensures that all the shareholders are made to understand the changes to be made and they all agree to it hence making it fair.
3️. Issuance of Convertible Preference Shares: They should clearly show the terms and conditions regarding the conversion of these shares, price as well as time frame for conversion in the AOA. This inclusion also elaborates on how it is possible to convert these shares into equity, and when, to protect the company’s and the shareholders’ interests.
4️. Exceeding Authorized Share Capital: It always affects the Memorandum of Association (MOA) as well as the Article of Association (AOA) if the new preference shares issued are more than the authorized share capital. This is aimed at ensuring that the legal provisions as provided under the law are followed while formulating the structure of the company capital in the contracts.
Case Study: Tata Sons v. Cyrus Mistry
Taking into account the Tata Sons against Cyrus Mistry case, it can be stated that the AOA plays an important role in corporate governance. Cyrus Mistry, the former head of Tata Sons – the main investment holding company of the Tata group- was ousted from his position, and this was regarded as a case of oppression and mismanagement. At the heart of the matter was certain sections of the Tata Sons’ AOA, particularly Article 75, that allowed the company to fetch a shareholder to sell his shares.
He argued that such provisions apprehending oppression could be oppressive itself since it offered an unfair preponderance of power to the Tata Trusts to dominate the management of Tata Sons and, ultimately, the companies run by it. In an earlier decision, the National Company Law Appellate Tribunal (NCLAT) favored Mistry by admitting that these provisions in the Articles of Association (AOA) were oppressive. Nevertheless, the position of the Supreme Court of India in this regard was different as it stated that the provisions of the AOA were not unlawful as well as not oppressive as they passed through the shareholder’s approval and within the lawful terms. [8]
The present case vividly shows that different provisions in the AOA may greatly affect the level of control in a business entity as well as the rights of shareholders. This emphasizes the importance of ensuring that organizations pay immense attention to the formulation of the AOA and where there is a need to change certain sections of it, due care has to be taken to ensure that the work relation power balance between the members and the organizations is well done.
In conclusion, just as a well-tailored suit ensures confidence and professionalism, a meticulously crafted and updated AOA ensures a company’s governance is compliant and equitable. Neglecting necessary amendments can lead to misalignments that disrupt corporate harmony and expose the company to legal challenges. Therefore, proactive and thoughtful management of the AOA is essential for sustaining organizational integrity and fostering trust among stakeholders.
WHEN AOA ALTERATION MAY NOT BE REQUIRED?
Altering a company’s Articles of Association (AOA) is not always mandatory. Certain scenarios allow a company to operate without immediate amendments:
1️. Existing Provisions Covering New Actions: No additional amendments to the AOA are needed if the AOA already contemplates provisions for those other specific actions, like the issue of a new class of shares or a change in the policy relating to payment of dividends. For instance, a company may offer preference shares to the public without any amendments to the AOA if ever it has a legal bare provision of doing so.
2️. Compliance with Statutory Requirements: In matters that have been provided understatutes, the necessity to alter AOA may not be necessary as the actions will already be governed by the statutes. For instance, some of the changes brought about by the Companies Act, 2013 may not necessarily call for an AOA amendment since such change may be as a result of the Act’s provisions.
3️. Non-Conflict with Existing Articles: It may be possible to avoid amendments when he or she introduces changes that do not violate the existing AOA. For instance, putting in place internal policies or procedures that are not inconsistent with the provisions of the AOA can go on without amendments.
4️. Actions Within Directors’ Discretion: Some of them are considered to be within the management and general discretionary power of the Board of Directors as provided by the AOA. Certain decisions that are made within an organization and vested to directors only can easily be implemented regardless of the AOA; such are appointments of officers or formation of committees.
5️. Minor Operational Changes: Changes in operations of the business that cannot be construed to change the positions of the shareholders or the organization’s corporate kind cannot be considered as requiring the amendment of Articles of Association or AOA. For example, the altering of a company’s registered address within the same country may not require a change.
6️. Temporary Measures: Measures that are not likely to affect the company’s governance structure for the shareholders or long-term shareholder rights may not necessitate a change of AOA. For instance, it is possible to appoint interim policies for a crisis management process without the need to make other alterations.[9]
Case Study: All India Railwaymen’s Benefit Fund v. Jamadar Basheswarnath Bali
In the case of All India Railwaymen’s Benefit Fund v. Jamadar Basheswarnath Bali, the court addressed a proposed alteration to the company’s Articles of Association that aimed to favor majority shareholders over minority shareholders. The amendment sought to grant exclusive benefits to the majority, creating an imbalance in shareholder rights. The central legal issue was whether such a discriminatory alteration was permissible under Indian company law. The court held that any alteration to the AOA must not discriminate between majority and minority shareholders to the detriment of the latter. It emphasized that amendments should benefit the company as a whole and not just a specific group of shareholders. Therefore, the proposed alteration was deemed invalid as it was prejudicial to the interests of the minority shareholders. This case highlights that while companies have the power to alter their AOA, such alterations are subject to limitations. Specifically, amendments must not contravene the Memorandum of Association or the Companies Act, discriminate against minority shareholders, or violate public policy or legal principles. The case serves as a crucial reminder that alterations to a company’s AOA must be made with caution and fairness, aiming to benefit the company as a whole and ensuring equitable treatment of all shareholders. [10]
Therefore, it is not always a necessity to amend the Articles of Association of the business and can be done but under some circumstances only. In this context, when the existing provisions are sufficient for new actions, statutory provisions apply to specific issues, alterations do not violate the current articles, actions may be made solely by the directors, if operational changes are minimal or if measures are temporary, there may be no need to amending the AOA. However, any decision to forsake such alteration must be made after a keen analysis of legal requirements and implications for all the stakeholders. This is crucial to meet the letter of the law and keep up corporate and shareholders’ credibility.
CONCLUSION
In conclusion, while the Companies Act, 2013 provides companies with a measure of flexibility to issue preference shares without necessarily amending their Articles of Association (AOA), such non-alteration is not without its risks. When the AOA already contains provisions for issuing new share classes or managing dividend policies, further amendments may seem redundant. However, failing to update the AOA when new preference shares alter fundamental shareholder rights such as dividend entitlements, conversion privileges, or liquidation preferences—can leave the door open to governance loopholes and potential exploitation of minority shareholders. Landmark cases like Tata Sons v. Cyrus Mistry and All India Railwaymen’s Benefit Fund v. Jamadar Basheswarnath Bali demonstrate that neglecting necessary AOA amendments can lead to significant disputes and undermine corporate control. Critics argue that a minimalist approach to AOA alterations might be a convenient loophole, compromising long-term corporate integrity and stakeholder trust. Therefore, a proactive and thoughtful management of the AOA is essential—not only to comply with legal requirements but also to ensure equitable shareholder treatment and robust corporate governance. As Benjamin Franklin wisely stated, “By failing to prepare, you are preparing to fail”
REFERENCES
- Articles of Association under Indian Company Law, iPleaders, available at http://blog.ipleaders.in/articles-of-association-under-indian-company-law/#What_is_Article_of_Association_AOA.
- Alteration of Articles, CA2013.com, available at https://ca2013.com/alteration-of-articles/.
- The Companies Act, 2013, Ministry of Corporate Affairs, Government of India, available at https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf.
- Shanti Prasad Jain v. Kalinga Tubes Ltd., [1965] 2 S.C.R. 720 (India), available at https://indiankanoon.org/doc/1687638/.
- Tata v. Mistry: A Case for Greater Protection of Minority Shareholders’ Rights, SCC Online, available at https://www.scconline.com/blog/post/2021/05/15/tata-v-mistry-a-case-for-greater-protection-of-minority-shareholders-rights/.
- Articles of Association and Its Alteration, Jus Scriptum Law, available at https://www.jusscriptumlaw.com/post/articles-of-association-and-its-alteration.
- Alteration of Articles of Association Post Company Incorporation, ClearTax, available at https://cleartax.in/s/articles-of-association-process-company.
- Shareholder Rights and Powers in India, Lexology, available at https://www.lexology.com/library/detail.aspx?g=c644e5fb-de6e-461c-886e-56aba0902939.
- Section 55: Issue and Redemption of Preference Shares, CA2013.com, available at https://ca2013.com/issue-and-redemption-of-preference-shares/.
- Private Companies Can Now Breathe Easier in India, Majmudar & Partners, available at https://www.majmudarindia.com/private-companies-can-now-breathe-easier-in-india/.
- Articles of Association under Company Law, LawBhoomi, available at https://lawbhoomi.com/articles-of-association-under-company-law/.
- Preference Shares Role in Indian Companies, SSRN, available at https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2595036_code1641223.pdf?abstractid=2595036&mirid=1.
- Understanding Alteration of Article of Association under Companies Act, 2013, TaxGuru, available at https://taxguru.in/company-law/understanding-alteration-article-association-companies-act-2013.html.
[1] http://blog.ipleaders.in/articles-of-association-under-indian-company-law/#What_is_Article_of_Association_AOA
[2] https://ca2013.com/alteration-of-articles/?
[3] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf?
[4] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf?
[5] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf?
[6] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf?
[7] https://indiankanoon.org/doc/1687638/?
[8] https://www.scconline.com/blog/post/2021/05/15/tata-v-mistry-a-case-for-greater-protection-of-minority-shareholders-rights/?
[9] https://www.jusscriptumlaw.com/post/articles-of-association-and-its-alteration?
[10] https://www.jusscriptumlaw.com/post/articles-of-association-and-its-alteration?
This article has been written by Utsavi Doshi. For any other queries, reach out to us at: queries.ylcc@gmail.com
