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Issue
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Further comments
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UC
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Conditions precedent
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The coming into effect of the Constitution can be made conditional on one or more matters first being attended to, for example, adjustments to shareholdings and appointments of Directors.
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Compliance with the Corporations Act
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A number of matters must be included either in the Constitution, or by virtue of the adoption of the "Replaceable Rules" in the Corporations Act 2001. This includes matters such as:
- A statement that the Members intend to avail themselves of the "limitation of liability" to their contributed capital;
- A limitation on the number of Members that can hold Shares in the Company to no more than 50;
- Public capital raising limitations. A proprietary limited company is not able to raise money from the general public; and
- A statement as to adoption or exclusion of some or all of the "Replaceable Rules". The Replaceable Rules are rules contained within the Corporations Act 2001 that govern the administration of a Company, unless the Company's Constitution specifically displace the operation of one or more rules.
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Share capital
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The Directors are given very broad powers with respect to issuing new Shares, and creating "classes" of Shares with different rights.
These powers must be exercised taking into account the rights of existing Members, and also other more restrictive provisions within the Constitution (and the Law).
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Pre-emption rights on the issue of new shares
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In the absence of "pre-emption rights" on the issue of new shares, existing Members can be unfairly diluted by an issue of Shares to some only of the existing Members, or to an outsider.
Pre-emption rights on issue require Directors to first offer new Shares to the existing Members, and in proportion to their existing shareholdings.
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Granting of Options
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The Directors are given very broad powers with respect to the granting of Options over new (unissued) Shares.
These powers must be exercised taking into account the rights of existing Members, and also other more restrictive provisions within the Constitution (and the Law).
It is possible to incorporate provisions that create a "reserve" or pool of Options that are available to the Directors to issue to certain categories of persons (a.g. to employees) at their discretion.
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Pre-emption rights on Share transfers
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The ability of a Member to transfer their Shares to another person is limited in a number of respects.
A familiar limitation on Share transfers are "pre-emption rights" on transfer in favour of the other existing Members in the Company. Such rights require the Member wishing to transfer their Shares to first offer the Shares to the other Members. If the other Members do not wish to take up the offer, then the transferring Member may then sell the Shares to an outsider - but on terms no more favourable than was offered to the other Members.
The Company may also have the right to repurchase the Shares prior to them being offered to the existing Members or to a third parties. If this power is exercised, then effectively all of the Members acquire a proportionate interest in the sale Shares, by virtue of the fact that the total number of Shares on issue is reduced.
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Sale Price on pre-emption
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If the Company considers that the Sale Price for Shares that are offered under the pre-emption rights is not fair and reasonable, then the Company can refer the determination of an appropriate price to a third party independent valuer.
This ensures the other Members are protected from a potentially unfair or non-arm's length transaction in Shares.
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Qualifying Offers ("Come Along")
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Come Along provisions are designed to protect the majority of Members from being "green-mailed" or held to ransom by a minority of Members when the majority attempts to sell their Shares to a third party.
If certain a majority of Members receive an offer from a third party to acquire their shares, and the third party will only conclude the transaction if it acquires 100% of the Shares in the Company, then the majority of Members can require the minority of Members to accept the offer from the third party.
In this manner, all of the existing Members sell all of their Shares to the third party - and all receive the same Share Price.
The minority of Members are given the option to acquire the majority's Shares at the same offered price (in preference to the third party offeror) - in which case the sale to the third party is frustrated - but the majority still achieve their fair exist from the Company.
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Qualifying Disposals ("Tag Along")
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"Tag Along" rights are the corollary of "Come Along" rights.
They are designed to protect a minority of Members from not being able to participate in the "control premium" ordinarily associated with a sale of a majority of Shares to a third party.
If a majority of Members wish to sell their Shares to a third party, then the minority of Members can require the majority of Members to procure for them the sale deal, i.a. they can prevent the sale of the majority's Shares unless the third party also agrees to purchase the minority's Shares in the Company for the same price.
In this manner, the minority of Members are not left behind, unable to sell their Shares, when a change in the control of the Company occurs.
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Take-Over of a Member
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It would ordinarily be possible for a Member of the Company to achieve a change in the ownership of their Shares without triggering the pre-emption and other transfer rights, by selling a controlling stake in themselves. In this way, a third party could acquire an "indirect" interest in the Company.
The Take-Over provisions operate to deem a transfer of Shares in the Company when there is a change in control of a Member holding Shares in the Company.
The change in control of the Member triggers the pre-emption and other transfer rights with respect to that Member's Shares.
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Member Warranties
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Each class of Member in the Company is required to warrant certain "generic matters" are all in order to the other Members.
This includes such things as the capacity of the Member to hold Shares in the Company, and to comply with the terms of the Constitution.
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Member Representatives
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It is very common for another company to hold shares in (and therefore be a Member of) the Company.
It is also common for the Constitution to require a Member to undertake certain things, such as attending meetings of Members.
For this reason the Constitution provides for each Member to appoint a "representative" who is an individual. The Member Representative is then obliged to carry out those matters in person that would otherwise be required of the Member.
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Employee "Leaver" provisions
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It is often the case that employees and directors associated with the Company are provided with a shareholding in order to align their interests more closely with those of the other Members.
While this is often good in theory, it does have the potential to give rise to increasing complexity over time - particularly as employees and directors come and go, and their minority shareholdings remain. This can cause frustration for both the former employees and the ongoing Members.
The "Leaver provisions" are designed as an orderly mechanism for cleaning up these shareholdings.
In the event that a Member who has acquired their Shares in the context of employment or contracting leaves the Company, the Company has the option to re-acquire their Shares at a pre-agreed price.
The price that is adopted for this purpose is dependent on whether the Member is a "Good Leaver" or a "Bad Leaver", and the extent to which any "vesting conditions" on their Shares have been satisfied before leaving.
If the Member is a Good Leaver, then the price is generally the fair market value of their Shares. If the Member is a Bad Leaver, then the price is usually the lower of the price they originally paid and the current market value of the Shares.
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Member Defaults
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In our view it is very important that the rights and obligations in the Constitution "have teeth", in that there is some real incentive for a Member not to simply ignore their obligations.
We achieve this by including within the Constitution provisions to deal with defaults on the part of a Member in complying with their obligations.
If, after a series of notices and time periods to make good any default, the Member is still in default of its obligations, the Company or another Member can deem the defaulting Member to have server a "Transfer Notice" under the transfer provisions within the Constitution. This invokes a right in the other Members to acquire the defaulting Member's Shares at a calculated price.
In order to provide some sanction for the default - and thereby an incentive not to default in the first place - the price at which the Shares may be acquired is usually set at some discount to fair market value. This discount is in effect "liquidated damages" in favour of the other Members.
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Partly paid shares and Calls
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The Constitution provides the Directors with the authority to issue Shares "partly-paid", and then to make Call on the Members holding such partly paid Shares to pay up the balance.
If a Member defaults in paying up the balance when called to do so, a number of sanctions apply, including potential forfeiture of Shares.
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Meetings of Members
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The Members of the Company as a group conduct their dealings with the Company through General Meetings.
The Constitution contains comprehensive provisions dealing with the calling and holding of such meetings, including:
- The ability for Members to requisition a meeting;
- The ability to hold a meeting in more than one place, and with technological assistance;
- The ability to send Proxies to a meeting in place of the Member;
- The ability to pass Member resolutions by way of a circular resolution, as opposed to having to call and hold a physical meeting.
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Unanimous Member Decisions
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A central tenant of company law is a separation of "ownership" from "day-to-day control". The Members own the Company, and the Directors manage the Company on behalf of the Members (and other relevant stakeholders).
That said, in the case of a company with a relatively concentrated Member base, it is quite common for the Members to reserve for themselves a number of "vetos" over certain actions that may otherwise be taken by the Company without reference to the Members.
To achieve these veto rights, the Constitution may list one or more matters that require the unanimous consent of Members.
If the consent required is unanimous, then every minority Member in the Company effectively has a say in the decision.
Such decisions are generally limited to very important issues, that have a fundamental bearing on the very reason for the Company's existence, or that may have the potential to cause a significant disruption to the ongoing affairs of the Company.
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Director Appointments
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The general position is that the Members in a General Meeting are able to appoint and remove Directors, as well as set their authority and limitations.
The difficult with this general position is that the majority of Members are then able to determine all of the Director appointments, without any input from the minority of Members. This may be what is intended, but in many instances, the Members intend for more than a majority of Members to have input into these appointments.
The Constitution may provide for a Member holding a certain level of Shares in the Company to have a right to appoint and remove a Director. For example, if the maximum intended number of Directors is five, then the Constitution may provide that each Member (or group of Members) holding at least 20% of the Ordinary Shares may appoint one Director. In this manner, each Member (or group of Members) gains representation within the management forum of the Company.
The Directors may appoint one or more other persons as a "Board Appointed Director". A Board Appointed Director may be reappointed every 18 months, but is otherwise subject to compulsory resignation.
There is no requirement for a Director to hold Shares in the Company, or otherwise be employed by the Company.
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Directors' interests and conflicts
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It is important that the Members agree on whether or not a Director is able to be involved in a decision of the Board in which the Director has an interest or potential "conflict of interest".
It is common for closely held private Companies to provide Directors with the ability to participate in decisions where they have a conflict of interest - provided the conflict is first openly disclosed to the other Directors.
However, it is also possible for the Members to agree that a Director is not able to participate in (and must excuse themselves from deliberations on) a matter in which they are conflicted.
It should be noted that there are obligations on Directors under the Corporations Act 2001 with regard to conflict of interest that cannot be "contracted out of", i.a. that apply irrespective of the terms of the Constitution.
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Powers of Directors
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The Constitution confers very broad management powers on the Board.
The Board may also delegate powers to a Committee of the Board, as well as third parties.
The authority of the Board may be constrained by Unanimous Member Decision Matters, and Unanimous Director Decision Mattes (as discussed elsewhere).
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Powers of the Managing Director (or CEO)
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The Constitution confers very broad powers of day-to-day management on the Managing Director. With these additional powers comes a higher level of responsibility.
It is possible for the Board to curb or increase these general powers and authorities of the Managing Director, by way of a Board resolution.
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Meetings of Directors
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The Directors as a group conduct their dealings in Board Meetings.
The Constitution contains comprehensive provisions dealing with the calling and holding of Board Meetings, including:
- The appointment of a Chair;
- The ability to appoint Alternate Directors and proxies to attend and vote at Board Meetings;
- The ability to hold a meeting in more than one place, and with technological assistance; and
- The ability to pass Board resolutions by way of a circular resolution.
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Unanimous Director Decisions
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Ordinarily decisions of the Board are made by a majority vote.
That said, in the case of a company with a relatively concentrated Member base, and few Directors, it is quite common for each of the Directors to be granted a "veto" over certain actions that may otherwise be taken by the Company.
If the consent required is unanimous, then every Director has a say on the issue.
Such decisions are generally limited to very important issues, that have a fundamental bearing on the very reason for the Company's existence, or that may have the potential to cause a significant disruption to the ongoing affairs of the Company.
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Business Plan
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The Managing Director must prepare a Business Plan, and update the Business Plan at least annually.
The Board must approve the Business Plan.
The Business Plan is then used as the guiding document with reference to which management decisions are made.
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Annual Budget
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The Managing Director must prepare an Annual Budget each financial year.
The Board must approve the Annual Budget.
The Annual Budget is then used as a means of regulating authority in respect of such things as operating the Bank Account, acquiring assets and employing people.
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Dividends
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At general law there is no requirement for a Company to pay Dividends to Members.
Members may have different expectations with respect to what return they are to receive on their Shares.
For this reason, we recommend that the Company adopt a policy with respect to the payment of Dividends (and inversely, the retention and reinvestment of working capital).
The Board has the ability to pay dividends in cash or in kind, and to allow for reinvestment of dividends back into more Shares in the Company.
The Constitution contains provisions enabling the Company to pay "differential dividends" on different classes of Shares. This means that the Board may resolve to pay one level of dividends on one class of shares, and another level of dividends on another class of Shares.
The Board may also establish more than one profit reserve, and attach a particular profit reserve to a particular class of Shares.
The ability to invoke these provisions is dependent on the issuing of more than one class of Shares.
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Alternations to capital
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The Company has the ability - with approval from the requisite majority of affected Members - to alter the Share capital of the Company, including by way of consolidation, division and merger.
The Company also has the power to cancel or buy-back Share capital - once again, with approval from the requisite majority of affected Members.
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Loans to Members
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The Company has the authority to make loans to Members.
Loans to Members in a private company can have significantly adverse tax outcomes, if not implemented and maintained properly. In particular, the loan may be treated as an "unfranked dividend" under Division 7A of the Income Tax Assessment Act 1936 - this can mean an effective tax rate on the underlying profits of around 70%.
In order to mitigate the chances of an adverse tax outcome arising inadvertently from a Company loan, the Constitution contains a standard Division 7A Loan Agreement that applies automatically to all loans made by the Company to a Member.
The Company and Member may agree to override these provisions.
Furthermore, even though the loan is documented in the Constitution, it is still critical for the Company's accountant to properly account for the loan, and the associated interest and principal repayments.
IMPORTANT NOTE: You should not rely solely on the Company loan agreement in the Constitution. Please seek appropriate professional advice from your accountant and lawyer.
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Inspection of Documents and access to financial information
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Under the Corporations Act 2001, a Member with at least 5% of the votes in the Company can give the Company a direction to:
- Prepare a Financial Report and Directors' Report for a financial year; and
- Send them to all Members.
The direction from the Member must be signed and giving to the Company no later than 12 months after the end of the financial year concerned.
The direction from the Member may specify all or any of the following:
- That the Financial Report does or does not have to comply with some or all of the accounting standards;
- That a Directors' Report, or a part of that report, need not be prepared; and/or
- That the Financial Report is, or is not, required to be audited.
The Constitution may confer on a Member the right to additional and more regular financial information about the affairs of the Company. This right may be accompanied by a corresponding obligation to maintain the confidential nature of this information.
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Commercial restraint
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Whether to incorporate a Commercial Restraint into a Constitution is a vexing one. This is because the restraint has potential application to each Member and Director, who may have different levels of shares, and been involved in the Company for different time periods.
For very closely held companies, a commercial restraint is often appropriate - as it represent a "pre-agreement" to the terms of a restraint that will apply if someone exits the company.
However, where there are minority shareholders, or non-executive directors, a restraint may be less appropriate.
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Common Seal
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Most proprietary limited companies no longer have a common seal.
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