The foundation of organisational order for any company lies in well-structured corporate governance practices. A central instrument in achieving this is the company constitution, which outlines crucial rules governing the company’s internal affairs and management. Under the repealed Companies Act 1965, all companies in Malaysia were required to file a memorandum and articles of association. Today, under the Companies Act 2016, the memorandum and articles are collectively referred to as the constitution and are no longer a mandatory document for certain companies. This article answers some frequently asked questions concerning a company constitution under the Companies Act 2016.

What is a Company Constitution?

A company constitution is a legal document that sets out the objects of a company and governs the internal affairs and management. It effectively binds the company and its members, including directors, shareholders and officers as provided under Section 33 of the Companies Act 2016:

“33. Effect of constitution

(1) The constitution shall, when adopted, bind the company and the members to the same extent as if the constitution had been signed and sealed by each member and contained covenants on the part of each member to observe all the provisions of the constitution

Section 35(1) of the Companies Act 2016 further states that the constitution of a company may contain provisions relating to:

(a) the objects of the company;

(b) the capacity, rights, powers or privileges of the company if the provision restricts such capacity, rights, powers or privileges;

(c) matters contemplated by the Act to be included in the constitution; and

(d) any other matters as the company wishes to include in its constitution.

Section 35(1), in particular subsection (d), illustrates that a company has great flexibility in drafting the terms of its constitution. It is important to obtain legal expertise to draft a constitution to align with the company’s goals while safeguarding the interests of stakeholders.

Is it Mandatory for all Companies to have a Constitution?

No, it is not mandatory for all companies to have a constitution. Section 31(1) of the Companies Act 2016 provides that a constitution is optional for unlimited companies and companies limited by shares. However, it is mandatory for companies limited by guarantee to have a constitution according to Section 38 of the Companies Act 2016. A company limited by guarantee must lodge a constitution with the Companies Commission of Malaysia (CCM) at the time the company is incorporated.

For companies that opt not to adopt a constitution, the provisions of the Companies Act 2016 will apply to govern the company’s internal affairs and management. Meanwhile, it is important that a constitution adopted by a company does not fall foul of the Companies Act 2016.

For companies that were incorporated before the enactment of the Companies Act 2016 (i.e. incorporated under the Companies Act 1965), the following options are available:

  • Maintain the company’s current memorandum and articles of association. This is permitted under Section 619(3) of the Companies Act 2016;
  • Abolish the current memorandum and articles of association without adopting a new constitution. In this case, the company will be governed by the provisions provided under the Companies Act 2016; or
  • Amend its existing memorandum and articles of association or adopt a new constitution.

What is the Significance of having a constitution?

Without a constitution, a company will be governed exclusively by the broad and generalised provisions of the Companies Act 2016. This lack of specificity can result in confusion, disputes, and other challenges in managing the company’s affairs effectively. For instance, the absence of clearly defined company objects increases the risk of transaction uncertainty and misuse of company resources, while inflexible shares and shareholder rights can hinder business collaborations and growth.

A robust constitution not only provides clarity and structure, but also serves as a safeguard against various structural and legal pitfalls.

Even though a constitution is only mandatory for a company limited by guarantee, it is advisable for all companies to draft and adopt a constitution. Investing some time, effort, and resources to craft a constitution, even though it is not mandatory, is crucial because it significantly supports the company’s unique business goals and objectives:

  • Risk Management: Companies operating in high-risk industries or facing potential legal challenges may include specific clauses in their constitutions to mitigate risks. For example, a company may need specific clauses for outlining decision-making processes, conflict resolution mechanisms and liability limitations.
  • Governance and Management: The constitution defines the roles, responsibilities, and powers of directors, officers and shareholders. The size of the board, voting rights, appointment procedures, and decision-making processes are all influenced by the company’s nature and scale.
  • Compliance Requirements: Industries with specific compliance requirements, such as financial services or healthcare, may consider including additional provisions to align their Constitution with regulatory standards which may include provisions related to reporting, auditing, confidentiality and data protection.
  • Flexibility and Innovation: Companies in dynamic or innovative sectors may design their Constitutions to allow flexibility in adapting to market changes, entering new markets, or pursuing strategic partnerships and alliances.

In essence, the structure of a constitution reflects its unique regulatory, governance and strategic considerations, tailored to support its business objectives while ensuring legal compliance and effective management. Recognising the individuality of each company, a constitution allows for the establishment of consistent rules and preemptively defining processes and protocols to minimise the likelihood of internal disputes.

What should be included in a Constitution?

A well-drafted constitution is paramount for any company seeking to establish a strong governance foundation and protect all stakeholders’ interests. Any omission of essential provisions in the constitution could lead to ambiguities and complications. Hence, a well-drafted constitution will go beyond setting rules and will be able to address uncertainties and potential conflicts. Below are several matters which should be included in a constitution:

1. Appointment and Removal of Directors: The process of appointing and removing directors is crucial for maintaining effective governance within a company. Clear guidelines in the constitution regarding director appointments, nomination procedures, qualifications, and grounds for removal help streamline board composition and ensure the selection of competent and suitable candidates.

“The board of directors shall consist of [insert number] members, who shall be elected by a majority vote of shareholders at the annual general meeting. Any director may be removed from office by a special resolution of shareholders.”

This clause establishes the process for director appointments and removals, emphasising the importance of shareholder involvement in key decisions affecting board composition. This clause may be further tailored to include specific grounds for the removal of directors and the specific procedure a company may want to adopt in the event of any indiscretions by a director.

2. Meeting Protocols: Proper conduct of meetings, whether a meeting of members or the board, is essential for effective decision-making and communication among the members of a company. The constitution should outline rules for meeting frequency, notice requirements, quorum, voting procedures, and record-keeping obligations to promote transparency and accountability at the board level.

“Regular meetings shall be held [state frequency, e.g., monthly], with at least [insert number] days’ notice provided to all directors. Quorum for meetings shall be [insert percentage], and decisions shall be made by a majority vote of members present.”

This clause can be expanded to define the procedures and protocols for conducting board meetings, ensuring that meetings are conducted regularly based on the ability and availability of its members, decisions are correctly made and records are maintained accurately.

3. Reserved Matters: Certain strategic or sensitive matters require special consideration and approval from a higher authority, such as shareholders or a designated board committee. Identifying and delineating these reserved matters in the constitution helps safeguard the company’s interests and prevents unilateral decisions that could impact the company’s direction.

“The following matters shall be considered reserved matters requiring approval by a special resolution of shareholders: .”

This clause identifies key decision areas where additional scrutiny and approval mechanisms are necessary, ensuring that critical decisions align with the company’s strategic goals and stakeholders’ interests.

4. Death of a Member: Planning for contingencies such as the death of a shareholder is essential for continuity and stability within the company. A well-crafted clause on the transmission of shares in the constitution addresses the transfer or disposition of shares, the appointment of successors and procedural steps to manage such events seamlessly.

“In the event of the death of a shareholder, the deceased shareholder’s shares shall be transferred to [insert name of designated beneficiary or executor], subject to approval by the board of directors.”

This clause outlines the process for handling shares in case of a shareholder’s demise, ensuring a smooth transition of ownership and compliance with legal requirements.

5. Right of First Refusal: Protecting existing shareholders’ interests in share transfers or sales is accomplished through a first right of refusal clause, which grants them rights of first refusal or pre-emption. This mechanism allows shareholders to maintain proportional ownership and prevents unwanted third-party ownership changes.

“Before any shareholder may transfer or sell their shares to a third party, they must first offer said shares to existing shareholders in proportion to their current shareholdings, at a price determined in good faith.”

This clause ensures fairness and preserves shareholder control over ownership changes, aligning with principles of equitable treatment and governance.

6. Anti-Dilution: Preserving existing shareholders’ ownership percentages during equity issuances or dilution events is critical for maintaining equity value and investor confidence. An anti-dilution clause in the constitution safeguards against undue dilution and protects shareholders’ investment interests.

“In the event of a new issuance of shares, existing shareholders shall have the right to subscribe to additional shares in proportion to their current shareholdings, to maintain their relative ownership percentages.”

This clause allows shareholders to participate in new share issuances, mitigating dilution effects and ensuring fairness in capital structure adjustments.

Companies can maintain transparency, fairness and stability by incorporating mechanisms to improve governance, defining reserved matters and addressing key events such as death, refusal, and anti-dilution scenarios.

Can a Constitution be Amended once it is Adopted?

Yes, a constitution may be amended once it is adopted. In fact, as part of good governance, it is essential for the company to periodically review its constitution and ensure it accurately aligns with its current objectives and activities. Additionally, verifying that the company’s processes remain responsive to practical requirements is crucial. This approach fosters increased flexibility and certainty in governance, empowering better control as the company evolves or expands over time.

Common reasons for amendments include changes in the company’s structure and governance, addressing specific issues during its business operations, allowing for the issuance of a new class of shares or accommodating to individual members’ intended estate planning (with respect to the transmission of shares), to name a few

A constitution can be amended either by a special resolution passed by the company or by obtaining a court order

  1. Amendment by special resolution: Pursuant to Section 36 of the Companies Act 2016, a company can amend its constitution by passing a special resolution by a majority of not less than 75% of the members. Once it has been passed, the company secretary shall notify and lodge the amended constitution with CCM within thirty (30) days from the special resolution’s date. Upon the date the special resolution was passed or any other specified date mentioned in the resolution, the amendment is binding on the company and all its members.
  2. Amendment by the court: Pursuant to Section 37 of the Companies Act 2016, the court may order the amendment of the constitution if it is satisfied that it is not practicable to amend the constitution by the standard procedures provided under the Companies Act or the constitution. This can be done by an application by a director or a member of the company. Once the court has granted the order, the company secretary must submit and lodge the order with CCM within thirty (30) days from the date of the order.

Failure to observe either of these provisions is a criminal offence. Upon conviction, the company and its officers will be liable to a fine not exceeding RM10,000 and in the case of a continuing offence, to a further fine not exceeding RM500 for each day the offence continues after the conviction.

Is a Constitution the same as a Shareholders’ Agreement?

No, a constitution and a shareholders’ agreement are not the same. Although they may contain similar provisions, they serve distinct purposes and address different stakeholders and issues. The main difference between the two documents is their scope: while a constitution will bind the entire company, including its shareholders and directors, a shareholders agreement binds the shareholders who are parties to the shareholders’ agreement (the company has to be a party to the shareholders’ agreement if it is to be bound by the agreement).

Moreover, while a constitution sets out the fundamental rules governing the company’s internal affairs and management, a shareholders agreement focuses on the rights and obligations of the shareholders in relation to the shares they hold in the company. Further, amendments to the constitution necessitate either a special resolution or a court order. In contrast, modifications to a shareholders’ agreement can be accomplished through mutual consent expressed in writing, typically through either the execution of a supplemental shareholders agreement or the execution of a new shareholders agreement.

It is not uncommon for specific clauses within the shareholders’ agreement to mirror those found in the constitution to ensure consistency. In cases where conflicting provisions arise between the constitution and the shareholders’ agreement, the constitution usually stipulates that its terms take precedence.

The main distinctions between a Constitution and a shareholders agreement are summarised in the table below:

Conclusion

A company constitution serves as a vital document establishing internal governance regulations specific to a company. Although having a constitution is only mandatory for companies limited by guarantee, all other types of companies are strongly advised to adopt a constitution as a guiding document that delineates crucial rules governing internal affairs and management. The importance of having a constitution goes beyond mandated requirements and a well-drafted constitution is critical in fostering a transparent, fair and stable corporate environment for all types of companies. Please contact us for assistance in reviewing or drafting your constitution.

By Anis Mohd Sohaimi and Mira Mashor

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Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each and every case will differ and therefore will require specific legal advice. Feel free to contact us for complimentary legal consultation.