Company Constitution or Replaceable Rules: What’s The Difference?

by Ilyas Omari

November 8, 2022
Blog, SMEs

The internal management of your company is an important matter. Under Australian law, there are two ways you can organise this. Firstly, you can manage your company through an internal company constitution. Alternatively, you can manage it using replaceable rules outlined in the Corporations Act 2001(Cth).

In this article, we’ll discuss what Company Constitutions and Replaceable Rules involve, so you can decide which framework is best for your company.

Read along!

What is a Company Constitution?

A Company Constitution is a document that contains a set of rules governing the operation of a company and the relationship between a company’s shareholders and directors. As a result, they provide the company with methods that can be used to resolve disputes, outline the company’s basic expectations, and they define the rules governing the company’s directors and shareholders regarding the company’s operations.

If you’re a current or future shareholder, you will be bound by the constitution. However, a company constitution doesn’t affect the personal capacity of a shareholder. This is because the rights arising from a company constitution will only be enforceable against shareholders in their capacity as a shareholder.

Furthermore, company shareholders and directors have no enforceable rights. Therefore, the provisions of a company constitution that serve to protect the interests of minority shareholders can’t be enforced by majority shareholders.

How is a Company Constitution modified?

For the modification of a company constitution, there has to be a passing of a special resolution. Through a special resolution, you can either remove or amend provisions of the constitution. You should review your constitution before modifying it to see if the provision you wish to modify or remove can be removed or modified.
You should be aware that 21 days of notice must be provided for a special resolution meeting. However, public companies must give 28 days’ notice. For a special resolution to pass, 75% of the votes need to be in favour to pass the resolution. For more information, read our article about modifying a company constitution.

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What are the advantages of using a company constitution?

When you begin your company, replaceable rules can be easier to use because they’re ready to use and therefore don’t require any time, money or resources to prepare. However, a company constitution has many advantages over replaceable rules. The advantages of using a company constitution include the following:

You can include broader provisions compared to replaceable rules
A constitution allows you to customise rules based on your company’s needs and current situation
Using a constitution will give you greater flexibility in managing your business
The rules contained in replaceable rules are generally stricter than those contained in a company constitution. Therefore, a constitution is beneficial as you can use it to replace the rules
Due to replaceable rules being basic and generalised, they might fail to satisfy your company’s specific needs
Your company constitution can be modified frequently, unlike replaceable rules that are only modified through law reform
Some rules contained in replaceable rules may not suit your company’s needs.
Using a constitution, you will have greater control over share sales. As an example, you can choose to offer shares first to current shareholders
You will be able to create several share classes that have different rights regarding dividends or voting rights
Your company constitution will be easier to refer to than the replaceable rules
Larger companies may find using a company constitution more useful since they can include more detailed rules

Does your company need a company constitution?

You should be aware that the use of a company constitution isn’t mandatory for every proprietary company. However, the use of company constitutions for companies is highly recommended as they are very useful.

The use of company constitutions is particularly important for companies that don’t have ordinary share arrangements.

You should be aware that if you have a ‘special purpose company’ or a ‘no liability ‘ public company, it is mandatory to have a constitution for the company.

What are Replaceable Rules?

Replaceable rules are a general set of rules contained in the Corporations Act 2001(Cth) that can be used to govern a company’s operations and activities. Replaceable rules can be used by a company that chooses not to use a company constitution. In the absence of a constitution, replaceable rules automatically apply to a company.

The table of replaceable rules is set out in section 141 of the Corporations Act. The matters replaceable rules cover include the following:

The appointment of directors by the company
The powers of directors
The regulation of both directors’ and members’ meetings
Inspection of the books
Unusual rights which may attach to special classes of shares
Alternate directors
Voting procedures
The transfer of shares
How director meetings must be called
The appointment of directors by other directors

Every person under a company agrees to follow the replaceable rules. However, they only operate contractually between the following:

Company and members
Company and directors
Company secretary and members

You should be aware that a breach of the replaceable rules doesn’t result in a breach of the Corporations Act. However, due to the existing contractual obligations between members and the company, a breach of the replaceable rules will be considered to be a contract breach.

Furthermore, there’s a right between a shareholder of a company and the other shareholders to require compliance with any replaceable rules that govern a company’s internal activities.

What companies do replaceable rules apply to?

Replaceable rules will automatically apply to your company if it was registered after 1 July 1998 if your company doesn’t have a constitution. Furthermore, if your company was registered before 1 July 1998 and has revoked its constitution since that date, the replaceable rules will apply.

A proprietary company is exempt from the application replaceable rules if the sole shareholder and director are the same person.

What are the differences between a Company Constitution and Replaceable Rules?

There are several key differences between a company constitution and replaceable rules. These include the following:

Unlike company constitutions, replaceable rules allow minority shareholders to protect their interests against decisions that could negatively affect their finances. This is because replaceable rules allow minority shareholders to negotiate the terms of their relationship with other shareholders.
Company constitutions are generally more specific and comprehensive than the replaceable rules of the Corporations Act
Company constitutions are generally clearer than the replaceable rules, as legislation can be difficult to comprehend and due to company constitutions being specifically created for a company
A company constitution can protect a broader range of companies. For example, the replaceable rules cannot govern proprietary companies where a person is a sole director and shareholder, and the replaceable rules are not applicable to special-purpose companies

Can your company use a company constitution and replaceable rules?

The Australian Securities and Investments Commission (ASIC) states that a company’s internal management could be governed in one of the following ways:

Through the use of a company constitution
Through the use of replaceable rules
Through the combination of a company constitution and replaceable rules

Company Constitution or Replaceable Rules: Which one is better?

The answer to this question will depend on the individual company. However, company constitutions are generally better as they’re broader and will cover a wider range of circumstances due to their individualised nature.

Furthermore, replaceable rules also lack coverage of certain business structures such as propriety companies. Due to these reasons and the advantages of using a company constitution, it can be argued that using a constitution is the better way to manage your company’s internal affairs.

Conclusion

If you choose to use a constitution rather than replaceable rules, it is crucial to create an effective constitution for your business as it will govern the activities of your company.

If you’re unsure about what you should include in your constitution, you should hire a lawyer to receive legal advice on how to create an effective company constitution.