It is common practice for parties to a shareholders agreement to assume that if a particular subject matter is dealt with in a shareholders' agreement as well as the company constitution, the inconsistency clause would mean that the shareholders' agreement will prevail. On this basis the constitution is often not exhaustively amended to remove every potential inconsistency with the shareholders' agreement. But does this always achieve what is intended?
The New South Wales Supreme Court's recent opinion has demonstrated the limitations of this approach (Cody v Live Board Holdings Limited  NSWSC 78).
The fact of the matter is…
The board of Live Board Holdings Limited resolved to issue preference shares to Bligh Capital (a new shareholder) and ordinary shares to existing shareholders of Live Board Holdings.
A dispute arose between an existing shareholder and the board as to whether the share issue was valid and the board consequently sought a declaration from the New South Wales Supreme Court that it had the power and authority to issue those shares.
So what was the inconsistency?
Live Board Holding's Constitution provided that the directors could cause the company to issue and allot securities with such preferred, deferred or other special rights as the directors determined. However, if that share issue directly or indirectly varied the rights of a class of shares, the variation would require the approval of at least 75% of holders of shares of that class.
The Shareholders' Agreement provided that the management of the company was under the direction and control of the board. However certain powers of the company were reserved for decision by shareholders. These reserved matters (to be approved by a simple majority of shareholders) included the issue of shares or other securities of the company or the grant of rights over any shares or other securities in the company.
As is standard for agreements of this nature, the Shareholders' Agreement included an inconsistency clause which provided that in the case of any conflict between the provisions of that agreement or the Constitution, the provision in the Shareholders' Agreement would prevail. Further, upon written request, all parties were required to cause the constitution to be amended to remove the conflict. 
The existing shareholders argued that the directors could not issue the preference shares to Bligh Capital without the approval of 75% of ordinary shareholders, as it would vary the existing rights of ordinary shareholders within the meaning of the Constitution.
On the other hand, the directors contended that the 75% majority was not required as the issue of preferences shares was an "issue of shares" within the meaning of the Shareholders' Agreement, and therefore only required a simple majority approval.
Shareholders' Agreement vs Constitution
The parties agreed that, if there was an inconsistency between the Constitution and the Shareholders' Agreement, the Shareholders' Agreement would prevail. The Court was not convinced that this was correct. However, it did not have to decide the point, because it held that there was no inconsistency.
Essentially, even though the relevant provisions in both documents dealt with the same subject matter (being the issue of shares), the court said that the purpose behind the requirements was different. Specifically, the clause in the Constitution was aimed at protecting the interests of the holders of shares, and the rights attached to the ordinary shares "would be varied, at least indirectly, by the issue of preference shares which would… rank ahead of them".
In contrast, the purpose of the provision in the Shareholders' Agreement was to reserve the power to issue shares to the shareholders. As these two provisions were not inconsistent with each other, the court did not find a conflict between them and accordingly both the Constitution and Shareholders' Agreement needed to be complied with.
Although this issue was not mentioned in the judgement, it is possible that the preference share issue was also invalid under section 254A(2) of the Corporations Act 2001 (Cth) which provides that a company can issue preference shares only if the rights attached to those preference shares are set out in the company constitution, or have been otherwise approved by special resolution of the company.
What should companies do?
Typically shareholders and their legal advisers would assume that where there is an inconsistency clause in a shareholders' agreement, a provision in the shareholders' agreement would almost always prevail over a clause in the constitution that dealt with the same subject matter. However, this case is a reminder that this assumption is not always correct.
Parties should review the provisions of the constitution carefully to consider whether, notwithstanding the standard "inconsistency" mechanisms, changes to the constitution and/or the shareholders' agreement are required to ensure that, if they are to be read together, so far as possible, they will achieve the parties' intentions.
Further, when issuing preference shares that in effect vary the rights of existing shareholders, the parties need to look beyond the list of matters reserved to shareholders in a shareholders' agreement and consider the protections afforded to the shareholders:
- in the constitution; and
- in the Corporations Act,
each of which may require a higher voting threshold of 75% to vary existing class rights.
 This is consistent with the position in Russells v Northern Bank Development Corporation Ltd  3 All ER 161;  BCLC 1016;  1 WLR 588, where the House of Lords said that though a company cannot promise not to alter its own constitution, the members of the company may make an effective contract themselves outside the constitution (such as in a shareholders' agreement) as to how they shall exercise their voting rights. [back]