What is a Constitution?
It’s something that every organisation likely has and it’s an important, albeit often forgotten, document that governs the relationship between the organisation, its directors and company secretary, and its members/shareholders.
This document is the constitution.
You’re likely familiar with this term (thanks to The Castle) and you probably only have a general idea of what it is and what it’s for (it’s actually more than just ‘the vibe’).
Like a nation’s constitution, an organisation’s constitution is significant and it’s not something to ‘set-and-forget’; even though that’s a trap that many of us fall into.
Well-drafted (and properly adopted) constitutions support the directors to govern the organisation effectively and efficiently. And the contrary is also true. On the extreme end of the spectrum, ignored constitutions can disrupt and distract, leading to poor governance and negative outcomes for the company and, by consequence, its shareholders.
In this article I’m going to ‘open the kimono’ on the corporate constitution – a governing document that nearly every company has. As an important side note, Incorporated Associations and other types of organisations have constitutions too. They’re sometimes referred to as their ‘rules’. In this article we’re containing our analysis to companies operating under the Corporations Act 2001 (if you’re feeling a little lost already, check out this article before proceeding further).
We’re going to nerd out a little here, so hopefully the sub-headings help you to easily scan through and zoom in on the stuff that you’re interested in. (You know, you should be interested in all of it, but I understand most of this stuff can be boring as you-know-what.)
What exactly is a constitution?
A constitution is ‘…a basic set of rules for the internal management of a company (appointments, meetings etc.)’. Some of these rules are mandatory for all companies [and] there are a few special rules for single shareholder/single director companies.
A constitution acts as a contract between:
· the company and each member; and
· between the company and each director and company secretary; and
· between a member and each other member. (section 140)
So, it’s a big deal document and not one to be ignored, flouted, or flippantly disregarded.
A company lodges its constitution (if it has one), or, if it doesn’t have a constitution, adopts the replaceable rules, with ASIC when it registers.
Does a company need a constitution?
A company does not need to create its own constitution and can instead choose to operate under the ‘Replaceable Rules’. The replaceable rules provide companies with a ready-to-go set of standard rules that they can adopt, rather than going through the process of creating their own.
These rules, set out in table form in section 141 of the Corporations Act 2001, cover Officers [this includes directors] and Employees, Director’s Meetings, Meetings of Members, Shares, and Transferring Shares. Coincidentally (or not), all the usual stuff that you’ll find in a corporate constitution.
If a company changes its mind about wanting a constitution instead of using the replaceable rules, it can create and lodge its very own constitution at a future date.
It’s important to note that the replaceable rules do not apply to certain organisations:
· a single shareholder/single director company; or
· a company that had a constitution before the introduction of the replaceable rules regime and has not repealed it.
What does a constitution need to include?
There is certain information that must be included: in general, the constitution will address the items laid out in section 141 the Table of Replaceable Rules.
Let’s call these things the ‘what’. ‘What’ has to happen in an organisation can be done in numerous ways. We’ll call these ways the ‘how’.
For example, a common ‘what’ that needs to occur is the election of directors. ‘How’ that’s done – i.e., the way shareholders vote, how many votes a shareholder/member has, whether voting is by ballot or show of hands, what happens in the event of a tie between director candidates, what happens if someone is running unopposed, etc. – can vary greatly from constitution to constitution. There is no one universal rule for all constitutional items for all organisations.
With all things, there are many differing opinions and how things were done 20 years ago is not necessarily going to be the best way to do it now. Which brings me to my next point…
How often should a company schedule a review of their constitution?
At least every two years.
That’s my straight-up, rule-of-thumb answer.
A more nuanced answer is that it needs to be done when it needs to be done, if not beforehand. So, don’t wait around for that two-year mark if there is an issue with your constitution, or you foresee something becoming an issue, or you know it needs updating to keep pace with contemporary governance practices.
If the constitution is holding back the board/organisation getting done what it needs to get done, or if it has some archaic rules that made sense in 1974 when it was first drafted that really don’t belong in a modern business (rules not allowing female members to vote, I’m looking at you), please change it!
How do you change the constitution?
How a constitution is to be changed is actually set out within the constitution itself. Follow those rules.
A change to the constitution will more than likely require a special resolution; in general, this will require 75% of the voting members to approve the new constitution. It’s meant to be onerous, so the constitution isn’t being changed willy-nilly by a subset of disgruntled members or by a breakaway faction attempting to take control.
This process is different for each constitution, so please refer to your constitution to know how to go about changing it.
Logistically, changing a constitution is tedious, but it should definitely be done when needed (it does not belong in the too-hard basket). My recommendation is to invest in professional (legal) support when drafting or changing a constitution. It’s well worth the cost to have it done right and have it voted in correctly.
Interpersonally (aka, politically), changing a constitution can be a nightmare! It’s always better to change a constitution when the board/organisation and member/shareholder relationship is in a positive state. Sometimes this isn’t possible, so some politicking and trading-off with the voting populous may be necessary.
Where are some areas I would recommend firm rules in the constitution, and where should directors look to build in some flexibility, so they don’t have to keep changing the Constitution too often?
A few key areas where I recommend some flexibility:
You want the ability to start and stop committees as required by the board / organisation from time to time. You probably don’t want to state specific committees that you will have. And you may not want to lock yourself into needing to have committees. You may want to specify how these committees will be populated and that a current board member is always the Chair. You may also want the ability to appoint independent committee members (i.e., non-board members).
Having a size range offers more flexibility for the board to shrink and expand within and to not be panicked into reflexively appointing people because you’re worried about being below the required size (and becoming ‘unconstitutional’). It also may be beneficial to have a vacant seat at most times.
This is usually always stated as a percentage of total current board members, rather than a set number. Often, you’ll see it as ‘half plus one’ of the existing board size. For example, if you have 10 board members, your quorum will be 6 board members required to hold a board meeting (half of 10 is 5, plus 1 is 6).
Anything over 50% is sufficient. If attendance is an issue, it’s an indication of a significant problem with your current board members, and it’s time for a fierce conversation.
Board Member Eligibility
This refers to who is eligible to nominate to be a board member. Please don’t have unnecessary restrictions on who can nominate or be elected as a board member. These types of rules make it challenging for a board to build a diverse group.
The Ability to Pay Directors
You may not NEED to pay directors, it’s nice to be able to if you want to (and if it’s financially prudent to do so). I always like to have the option, where possible.
Holding / Attending Director’s Meeting
We’ve all learned that the ability to meet via technological means (e.g. telephone, online video conferencing, holographically – trust me, it will happen sooner than we think) is required for all organisations to have in their constitutions. Consider extending this to include general meetings being held digitally/electronically as well.
A few areas where I recommend ‘firmer’ rules:
Increased control over Candidates put up for Election
Director positions and the election of them is something that I have seen weaponised by frustrated members. So it’s something that I have started recommending (where possible) for the current board to maintain greater control over, without being too restrictive. Allowing individuals to nominate, yet having a greater ability to only send through the most appropriate candidates to the election is something to consider including in your constitution.
The best example of this that I have found is in the constitution of People’s Choice Credit Union. View clause 10.5 in the PDF constitution regarding their Nominations Committee and how the process of nomination, interview, recommendation, and eventual candidacy is carried out.
This process is still open to negative outcomes and may restrict diversity on the board. However, from my experiences and from what I’ve seen happen in other organisations, I feel like the positives outweigh the potential negatives here.
The ability for the board to appointing a certain number of Directors
It’s nice to have the option for the current board to appoint (rather than elect) certain individuals on to the board as needed. These are generally people who don’t meet the criteria to be elected board members but who add value to the board and organisation due to their expertise. They may be yearly or two-yearly appointments, with the board having the ability to remove them at any time as required.
As an example, check out clause 10.20 in the People’s Choice Credit Union constitution.
Powers of Directors
Some decisions require shareholder voting and are beyond the powers of the directors to exercise. These include changes to the constitution, and the election of directors. The directors cannot have ultimate control of all aspects of the company.
Passing of Director’s Resolutions
Those decisions that are the purview of the board may be better served as being passed by a majority of votes (i.e. 51% + in favour), and some decisions requiring unanimous votes (100% in favour). Setting out what decisions require what type of voting method may help the board members and give the shareholders greater trust in the board.
The Chair having a Casting Vote
I’m a hard ‘no’ on this as I don’t think it’s a modern or practical rule. If a board is that divided on a decision, it’s an indication that more work is likely required before a firm decision can be reached. A Chair making a casting decision in this instance runs the risk of dividing the board – and that has significant, long-lasting ramifications.
Clause 12.4 of the People’s Choice Credit Union constitution lays out both the passing of director’s resolutions and the Chair’s voting.
Within the bounds of what is possible, have clear reasons for removing a Director. Trust me, you’ll want this provision at some point in the future and you’ll want the process to be clear-cut. Some types of organisations are restricted here due to the Corporations Act, so please seek professional help when incorporating this provision into your constitution.
Clause 10.25 of the People’s Choice Credit Union constitution sets out a good example of what constitutes removing a director (cleverly worded as a director ‘vacating’ their office).
How Shareholders Vote
This includes which members can vote, how many votes they have (i.e. one share = one vote OR one shareholder = one vote regardless of the number of shares held), how voting is conducted, etc. and should be clear and specific.
Section 6.3 of the People’s Choice Credit Union constitution lays out their members’ voting rights.
Most constitutions set out organisational objectives. But these days a lot of companies are doing a new mission/vision statement every few years. What is the difference and when would you expect to see the constitution be changed?
Constitutions will stipulate a company’s “Objects”. These are essentially a list of things that the company will do, worded in a very generic sense.
A mission/vision, I feel, sits over the top of these objects. It’s a guiding purpose that brings the objects (i.e., what the organisation delivers as a company) to life. It’s how they’re going to deliver on their objects. It’s what sets the company apart from other similar companies who operate in the same marketplace.
This is better illustrated by a real-life example.
People’s Choice Credit Union has stated their objects in their constitution – check out section 2.1. It’s a pretty basic list of things the company will do and probably looks very similar to all other credit unions’ constitutions.
People’s Choice also have a purpose and vision (copied below).
Working with our members for a better future.
To be the most trusted financial services provider in Australia.
Their purpose and vision give the board and the organisation direction and guidance on how they do the things they have promised the members they will do (remember, the constitution is a contract).
The purpose and vision can change and be whatever it is around a company’s objects, which are more stable and unchanging.
However, I do think that great mission / vision / purpose statements (whatever name you give it) don’t change often either. If a board / organisation feels that they need to update their mission every couple of years, it may be indicating larger issues that may need to be addressed.
The last thing I’d like to add is… if you have specific questions about your constitution, please, please, please get in touch with a legal professional. The internet is a great place to source some knowledge to help you have a conversation with a professional, but it’s not a substitute for specific advice.