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Hands up – who has set up a company with model articles and one director?

Hands up – who has set up a company with model articles and one director?

If this was a real show of hands, it's likely a fair few of the half a million new companies registered each year would admit to this. You may, therefore, believe that choosing the Model Articles (Companies Act 2006) is the safe option, however a recent decision (Hashmi v Lorimer-Wing [2022] EWHC 191 (Ch)) has made practitioners think again as to whether decisions taken by sole directors may be invalid and open to challenge.

What are the articles of a company and why are sole director decisions potentially invalid?

The articles of a company are its rule book (which sits alongside the statutory framework) as to how decisions have to be made by the company - both at director and shareholder level. Article 7 of the Model Articles states:

(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 … [unanimously].

(2) If - (a) the company only has one director, and (b) no provision of the articles requires it to have more than one director, the general rule does not apply, and the director may make decisions without regard to any of the provisions of the articles relating to directors' decision-making.

Article 11 of the Model Articles states:

(1) At a directors' meeting, unless a quorum is participating, no proposal is to be voted on, except a proposal to call another meeting.

(2) The quorum for directors' meetings 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.

(3) If the total number of directors for the time being is less than the quorum required, the directors must not take any decision other than a decision - (a) to appoint further directors, or (b) call a general meeting so as to enable the shareholders to appoint further directors.

There is, therefore, a disconnect between the rule that there is no requirement for there to be more than one director (Article 7) and the rule that there needs to be two directors for there to be a quorum (Article 11). Whilst this was raised as a potential issue back in 2008 (when the Model Articles were first published), the consensus at that time was that Article 7(2) effectively overrode Article 11(2) enabling a sole director to take effective and enforceable decisions.

So, what has changed?

In the Hashmi case, the High Court has determined that there is, under the Model Articles, a requirement to have two directors in order for valid decisions to be taken i.e. Article 7(2) does not effectively override Article 11(2).

We are left in a position where the validity all decisions made by a sole director are called into question (both those made in the past and those to be made in the future). This is likely to cause the most problems where an independent third party gets involved (new investor, mortgage or sale of shares, for example). It is also likely to arise in cases of dispute.

What can be done to resolve the problem?

Whilst there is a view that the Hashmi case may well be overruled in due course, it would be a foolish director who ignored the ramifications now. Any major decisions taken by a sole director, with unedited Model Articles, should be ratified by the shareholders without delay and either (a) a further director should be appointed, or (b) the articles should be amended to remove the requirement as set out at Article 11(2).

What is evident is that, as with so many corporate issues, the articles of a company can catch out the unwary - you should always take specialist legal advice if you are making amendments to the directors, the shareholders, the shares and/or the articles of your company.

How we can help

Need further advice? Our team at Wards has a full service corporate commercial offering, with a focus on SMEs and owner managed businesses.

Contact Marina Maclennan, Head of Corporate Commercial Services, on 0117 929 2811 or email marina.maclennan@wards.uk.com.