All about Entrenchment in Articles Of Association

Articles of Associations of a company lay down the procedures that result in an efficient running of the company. Such procedures include the way of conducting board meetings, the way decisions have to be taken and any other procedure that helps in an effective running of the company. Hence, the Articles of Association of a company are often known as the Constitution of a company.

In an Article of Association company can adopt all or any of the regulations contained in the model articles prescribed in Table F, G, H, I & J of schedule 1 of Companies Act, 2013. Further companies can include additional matters in its articles which are necessary for its management.

What is Entrenchment in Articles of Associations?

The word ‘entrenchment’ in the newly incorporated entrenchment provisions in the Companies Act 2013 has not been defined therein. However, according to the Oxford dictionary, the word ‘entrench’ literally means firmly added, surrounded and a vital part of something that may be in the constitutional document of the company like the Articles of Association.

Therefore, an ‘entrenchment’ means an addition of provision which makes certain amendments either more difficult or cumbersome by way of procedure, checks and safeguards.

An entrenched clause or entrenchment clause of a basic law or constitution is a provision which makes certain amendments either more difficult or impossible, i.e., inadmissible. It may require a form of super majority, a referendum submitted to the people, or the consent of another party.

For e.g. A strategic investor introduced in a company to bring a new technology or investment. Now, such a strategic investor wants to protect its interests in company. The Article may be an entrenchment to protect such interest. In this article may be entrenched to require consent of such investors to pass resolutions.

Types of Entrenchment in Articles of Association (AOA):

There are two types of Entrenchment as follows:

1. Absolute entrenchment: Absolute Entrenchment implies that certain provisions are unalterable and impossible to change unless there is a court/tribunal order. This entrenchment is not provided for in the Companies Act, 2013.

2. Conditional entrenchment: This type of entrenchment on the other hand, implies that certain provisions can be altered, subject to fulfillment of certain conditions or compliance with specific procedures (For example, approval by more than 75% members instead of the usual special majority of 75%.).

Incorporation of Entrenchment in AOA Clause:  

The provisions for Incorporation of Entrenchment can only be included in Articles of Association by way of:

• Incorporation of Entrenchment at the time of Formation of the company itself; or
• If the company is already formed then the entrenchment clause can be incorporated by an amendment to the Articles of Association by all the members in case of private companies and on passing a special resolution in case of public company, if it is already formed.

Notice to the Registrar for Incorporation of Entrenchment clause:

Once the Entrenchment clause has been incorporated in the Articles of Association, the notice must be given to the registrar of companies as follows:

• In the case of a newly formed company, notice is to be given in the Form No. INC.2 for a ‘one person company’ (OPC) or Form No. INC. 7 for companies other than OPCs along with the fees as specified.
• In the case of a company already in existence, Form No. MGT. 14 is to be filed within 30 days from the date the entrenchment articles are incorporated in the AoA along with the fees as specified.

Companies for which the entrenchment provisions are useful:

• Closely-held companies which intend to restrict transfer of shares and maintain the status of “Closely-held”.
• Family-owned companies which intend to ensure that the control and management is kept with the same family.
• Companies in which there is strategic investment by private equity firm/ angel investors which intend to have more control over the management and control (shareholding, investments, borrowings, authority, etc.) over the company
• Joint Venture companies which may include restrictive provisions on the other JV party (e.g. shareholding, investments, borrowings, authority, etc.) or may include provisions which may require unanimous approval of both JV partners (e.g. increase in capital, allotment of shares, convening of general meetings, etc.).

Finally, the term ‘Entrenchment’ and the procedure associated with it is an introduction in the New Act. However the concept of additional safeguards or additional compliance for bringing about amendments to Articles which is constitutional document of Company has always been recognized. It is a shareholders’ document and shareholders are free to agree upon its terms.