A shareholders agreement supplements a company’s constitution by providing greater detail regarding the company’s activities and decision making. Typically, a shareholders agreement will contain a clause providing that, to the extent of any inconsistency with the company’s constitution, the shareholders agreement prevails. However, the recent case of Cody v Live Board Holdings Limited1 (Cody) indicates that courts may read such clauses narrowly.
Shareholders agreements often cover a range of issues not comprehensively dealt with in a standard constitution, including the following:
- decision making of shareholders
- transferring shares
- management and appointment of directors.
As a company’s constitution will also deal with these issues at a high level, it is common for a shareholders agreement to contain an inconsistency clause providing that it overrides the company’s constitution in the event of a conflict. Cody demonstrates that these clauses may not be absolute as, so far as possible, courts will attempt to read a shareholders agreement together with the constitution, to ensure consistency.
In Cody, the board of Live Board Holdings resolved to proceed with a capital raising and issued preference shares to new shareholders and ordinary shares to existing shareholders.
An existing shareholder challenged the validity of the capital raising and associated share issue, following which the board sought a declaration from the NSW Supreme Court that it had the power and authority to issue the shares.
Issues in dispute
Live Board Holdings’ constitution provided that the company’s directors could cause the company to issue shares, including preference shares. 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.
On the other hand, the shareholders agreement provided that certain matters, including the issue of shares or other securities of the company (or the grant of rights over any shares or other securities in the company), required approval of only a simple majority of shareholders.
The shareholders agreement included a standard inconsistency clause, as well as a clause requiring that, in the event of an inconsistency, the parties must also cause the constitution to be amended in order to remove the conflict.
Because of the inconsistency clause, the parties agreed that if there was an inconsistency between the constitution and the shareholders agreement, then the latter would prevail and a simple majority resolution would suffice to give the board authority to proceed with the share issue. The Court expressed some doubt that a shareholders agreement could control the constitution in this way, but proceeded on the basis that it could. Accordingly, the issue in dispute was whether there was an inconsistency between the constitution and the shareholders agreement.
Justice Brereton found that there was no inconsistency between the shareholders agreement and the constitution, despite the fact that the words of those clauses seemed to deal with the same subject matter. Justice Brereton did this by analysing the purpose of the clauses. Justice Brereton found that:
- the purpose of the relevant provision in the constitution was to the protect the interests of holders of the class of shares being varied (in this case, ordinary shareholders whose rights were varied by the issue of preference shares)
- the purpose of the relevant provision in the shareholders agreement was to reserve to the shareholders, rather than the directors, the power to issue shares.
Because these purposes were not inconsistent with each other, Brereton J did not consider there to be any conflict between them and held the requirements set down in both had to be complied with. This was despite both provisions by their written terms appearing to cover the same topic, namely the issuing of shares.
Accordingly, the share issue was invalid as it had not received approval from 75 percent of the shareholders of the relevant class, as required by the constitution.
Cody signals that courts may in some cases be reluctant to find an inconsistency between a shareholders agreement and a constitution, and instead make every effort to read the two documents together. Where a shareholders agreement contains an inconsistency clause, the likelihood of its application and its force will, in our view, be assisted by clearly articulating that specific topics are to be governed by the shareholders agreement, and identifying those specific provisions of the relevant constitution which do not apply.