26 October 2022

It is incredibly common for single director, single owner companies to use the Model Articles (the standard form constitution provided for by law) as the company’s first constitution. This is because the Model Articles were designed to serve new companies that want to establish an enterprise quickly. The Model Articles should be a ready-made rule book for governing a company that can apply to all situations. However, to the surprise of many, the recent English case of Hashmi v Lorimer-Wing [2022] EWHC 191 (Ch) (02 February 2022) has called into question the legitimacy of sole director decision making if a company uses the Model Articles as its constitution.

What happened in this case?

The question arose about whether the company had validly served notice of a counterclaim. At the time the counterclaim was served, the company had a sole director and had adopted a constitution based on the Model Articles (with some modifications).

Four provisions of the Model Articles were relevant to this decision:

• Model Article 7(1): directors should take decisions either in a board meeting or a “unanimous decision of the eligible directors” (governed by Model Article 8). This is known as “the General Rule”.

• Model Article 7(2): while a company has only one director and its articles do not require it to have more than one director, the General Rule does not apply. Instead, a sole director can take decisions “without regard to any of the provisions of the articles relating to directors’ decision-making”.

• Model Article 11(2): the quorum (minimum number of directors) for board meetings can be fixed from time to time, but it cannot be less than two, and the default position is two. In the Hashmi v Lorimer-Wing, the company had modified this article to require specific directors to be present to constitute a quorum.

• Model Article 11(3): if at any time the total number of directors is less than the quorum, the directors must not take any decision other than to appoint further directors or to convene a general meeting to enable the shareholders to appoint further directors.

The Court ruled that as the company only had a single director, the decision had been made incompetently. The judge said that “a provision in the articles requiring there be at least two directors to constitute a quorum logically is a requirement that the company in question have two directors in order to manage its affairs”.

This decision goes against the generally accepted principle in practice that the exception to the General Rule (Model Article 7(2)) means that a single director can form a quorum and take competent decisions.

What problems does this cause?

Illegitimate decisions could cause the following issues:

• Challenge of decision making – most single director companies also have the same individual as a shareholder but that can change as the company grows. Likewise, a company with multiple directors can move to a single director. In either case, interested parties could challenge decision making.

• Banking - a lender will want to ensure that decisions made by the director are valid and enforceable. If there is any doubt they may enforce a change to the constitution as a condition to lending.

• Legitimacy of contracts – if a contract becomes disputed can the other party to the contract simply say the contract was not entered into validly?

• Company Sale – Can the buyer of the company use this as a reason to question the legitimacy of contracts and use that as a reason to reduce the price payable for acquiring the company.

Re Active Wear Limited (in Administration) – Another change to the position? 

There has since been an unreported English case (Re Active Wear Limited (in Administration)) that has distinguished Hashmi v Lorimer-Wing based on the fact that certain amendments had been made to the Model Articles. The judge applied the ordinary rules of interpretation and noted that, since the provisions relating to quorum are contained in an identifiable Part of the Model Articles (comprising articles 7-16), they are specifically disapplied by Article 7(2). The Court determined that as there was only one director and no other provision requiring more than one director, a competent quorum for taking decisions was indeed a sole director (reaffirming what practitioners understood to be the position). The Court distinguished Hashmi v Lorimer-Wing on the basis that the Model Articles had been amended in the that case, leading to a different interpretation.

Conclusion

Hashmi v Lorimer-Wing called into question the legitimacy of a sole director’s decision making ability in a company that uses the Model Articles. It may be that case is appealed or is continually distinguished on the same basis as Re Active Wear Limited (in Administration) – i.e. the Model Articles had been altered in Hashmi v Lorimer-Wing and not in Re Active Wear Limited (in Administration). However, the case law is not currently settled, which causes some uncertainty. 

Given the uncertainty, the following resolutions can be considered to safeguard a company with one director:

• appoint another director, while being aware that this may alter control of the boardroom;

• change the provision in the Model Articles or adopt new Articles; or

• get retrospective shareholder approval for the sole director’s decisions.

If you require to discuss this matter in further detail, please contact a member of BTO’s Corporate Team for a fuller discussion.

Michael Cox, Senior Associate: mxc@bto.co.uk / 0131 222 2939