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Sole director companies — be careful as you go it alone

Private companies with sole directors find themselves in a state of uncertainty regarding the authority of their sole director to manage effectively.

In our immediately previous article in our Restructuring series we spoke about the initial points to consider in any restructuring exercise. The first point raised concerned company law issues, and particularly the need to consider any matters raised by a company’s articles of association. It is worthy of pause at this time to mention judgments in 2022 that have called into question whether a sole director of a private company can effectively act if the company in question has adopted the Model Articles (whether in whole or in part).

Not just relevant to restructuring but indeed all spheres of a sole director company’s actions, the High Court judgments in Hashmi v Lorimer-Wing [2022] EWHC 191 (Ch) (also known as Re Fore Fitness Investment Holdings Ltd) and Re Active Wear [2022] EWHC 2340 (Ch) have presented the need for clarity on the power of a sole director. Pending further clarification, companies would be well advised to check their articles of association for the provisions referred to in this article and seek advice on how to address the issues raised.

Background

The Companies Act 2006 (“Act”) allows for private companies to have a single director. 

A company incorporated under the Act is required to have a set of articles of association (being the document which sets out the basic management and administrative structure of the company). Companies may choose to either adopt their own form of articles of association (which may or may not include certain provisions of the Model Articles) or the relevant set of Model Articles prescribed pursuant to sections 19 of the Act and the provisions of the Companies (Model Articles Regulations) 2008 (SI 2008/3229).  The Model Articles are essentially the default position for companies that do not (for whatever reason) adopt their own version. 

Incorporating a private company is reasonably quick and easy to do via Companies House online service.  Many people, not knowing otherwise, simply select to incorporate with the relevant Model Articles without paying much attention to whether the Model Articles reflect the desired management structure. This is usually the default approach: why should an entrepreneur and a director of an owner-managed business do otherwise?

It is important to be aware that those who incorporate with the Model Articles can look to change them at a later stage, by the adoption of specific articles, which may often be undertaken as part of a larger corporate exercise.

Developments

The company whose articles of association were under consideration by the court in Hashmi v Lorimer-Wing had a combination of the Model Articles and tailored provisions, including a bespoke quorum requirement of two directors, whereas the company in Re Active Wear had adopted the Model Articles without amendment.

Both cases involved the interpretation and construction of Articles 7 (Directors to take decisions collectively) and 11 (Quorum for directors’ meetings) of the Model Articles and the interplay between the two provisions.

Article 7 of the Model Articles provides:

“7(1) The general rule about decision making by directors is that any decision of the directors must be either a majority decision at a meeting or a decision taken in accordance with article 8.

(2) If –

  • the company only has one director; and
  • no provision of the articles requires it to have more than one director,

the general rule does not apply and the director may take decisions without regard to any of the provisions of the article relating to directors’ decision-making”

Article 11(2) of the Model Articles provides:

“The quorum for a directors’ meeting may be fixed from time to time by a decision of the directors, but it must never be less than two, and unless otherwise fixed it is two.”

In summary, the court’s interpretation of Article 7(2) in Hashmi v Lorimer-Wing was that Article 7(2) permitted a sole director to manage the company, where no provision of the articles required it to have more than one director.  As the provisions of Article 11(2) provided a minimum quorum requirement of two, the court regarded such provisions to qualify those of Article 7(2).  It is unsurprising that the judgment in this case leaves many somewhat anxious. After all, imagine the potential ramifications of every decision, transaction and act approved by a sole director on behalf of a private company turning out to be invalid!

The court in Re Active Wear disagreed with the reasoning in Hashmi v Lorimer-Wing. In Re Active Wear, the court held that Article 7(2) prevailed over the provisions of Article 11(2) and indicated that the Model Articles “must be read as a whole”, and as such the court did not believe it was the intention that the Model Articles required amendment before the provisions of Article 7(2) could operate at all.

Two may be company, three a crowd, but one may now be untenable.

Prior to the judgment in Hashmi v Lorimer-Wing and Re Active Wear, lawyers and academics recognised that an argument could be made that Article 11(2) requires more than one director. However, general practice was not to interpret Article 11(2) in this way, but rather to interpret it as a provision that addressed the situation where, as a matter of fact there were two or more directors, but did not of itself require there to be more than one director.

Unfortunately, the judgments are both of first instance. Therefore, until there is an appeal or the government amends the Model Articles, the courts are entitled to disagree with the decision in Re Active Wear.

Bearing in mind the original intention of the Act was to modernise and simplify company law and reduce the administrative burden on companies, it is unfortunate that private companies with a sole director find themselves in the present state of uncertainty regarding the authority of their sole director to effectively manage.

As a primary point we are now looking to address the wording of certain company articles of association prior to the implementation of any Restructuring to address the issues raised by Hashmi v Lorimer Wing and to ensure steps taken by a sole director are not open to future question.

Don't hesitate to contact us to discuss your specific needs and how we can help your business. We provide a wide range of corporate and commercial services to businesses of all sizes, from small family businesses to FTSE 100 companies.

For further information any of our authors are more than happy to be contacted directly or if you prefer you can contact your usual contact or a member of our restructuring and insolvency team.

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