Articles of association are a set of rules which determine how a company operates, they regulate the powers, affairs and relationships of the directors, shareholders and the company itself. The Companies Act 2006 (the “Act”) replaced the then well-known, Table A articles with Model Articles. The Model Articles are a generic set of articles of association which are included in Schedule 1 of the Act. Whilst the majority of companies adopt Model Articles as they are fairly suitable in most circumstances, companies are free to amend them or adopt completely bespoke articles.

Hashmi v Lorimer-Wing

However, recent case law has questioned the suitability of Model Articles for companies that have a sole director. The case of Hashmi v Lorimer-Wing (“Hasmi”) questions the authority of a sole director in a company that has Model Articles. Hashmi looked at Model Articles 7 and 11 in particular. The company within Hashmi also had a bespoke article 16; however, regardless of this fact the court determined that the outcome of Hashmi would not have differed if the company only had Model Articles. The relevant articles are set out below:

Model Article 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 (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 take decisions without regard to any of the provisions of the articles relating to directors’ decision-making.

Model Article 11

At a directors’ meeting, unless a quorum is participating, no proposal is to be voted on, except a proposal to call another meeting.

1. 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.

2. 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) to call a general meeting so as to enable the shareholders to appoint further directors.

Bespoke Article 16

“The quorum for meetings of the Board shall be two directors, one of whom must be an investors’ director (if appointed) and one the executive (if appointed as director) unless such investors’ director or executive is unable to attend a Board meeting and has confirmed in writing (which may be by email) that they are satisfied that the Board meeting in question is quorate without them being present”.

In Hashmi a dispute arose where a company had attempted to submit a counterclaim against an unfair prejudice claim brought by a former shareholder. As the sole director of the company filed the counterclaim, it was the argument of the applicant that the decision to file the counterclaim was invalid under the company’s articles. They argued pursuant to Model Article 11, for a meeting to be quorate, there needed to be a minimum of two directors present. In addition to this, the bespoke article 16 further solidified the stance that more than one director was required to be at the meeting where the decision to issue the counterclaim was made. The company argued, (and the vast majority of people for many years were of the understanding) that Model Article 7 overruled Model Article 11 in the circumstances where the company only had one director and therefore for a meeting to be quorate only one director was needed, not two.

In Hashmi the judge did not agree with such a view. They saw Model Article 11 as a clear caveat to the provisions of Model Article 7(2) and that in such circumstances where a sole director company adopts Model Articles, any decision made by the sole director would be outside of their authority due to the provisions of Model Article 11. In the specific circumstances of Hashmi, the judge determined that the bespoke article 16 further added to this position, but would not have affected the outcome if it was not included in the articles.

This created uncertainty for parties that are dealing with sole director companies, those parties who have previously dealt with sole director companies and sole director companies themselves. Whilst many may think that this is not an issue and only a technical legal point, if a decision of a sole director becomes a matter of contention in a dispute, then it is likely the argument that the director acted beyond their powers will arise, questioning the validity of the decision.

Re Active Wear Limited

Since the Hasmi decision, the court in Re Active Wear Limited (in Administration), an unreported case in the High Court, has ruled that the decision of a sole director in a company with unamended model articles was valid notwithstanding the earlier decision in Hashmi.

In Re Active Wear Limited, Deputy Judge Martin QC, adopted the approach that the articles should be interpreted with the ordinary principles of contract as set out in Cosmetic Warriors Ltd & Anor v Gerrie. Consequently, and with note that the Model Articles are organised into specific sections and sub-sections, Martin KC held that, since the provisions relating to quorum are contained in an identifiable section titled “Decision-making by directors” (comprising articles 7-16), they are specifically disapplied by Article 7(2) when there is only one director and no other provision requiring more than one director, as is the case of the Model Articles. On this basis, the unambiguous effect of Article 7 is that a sole director may take their own decisions regarding the conduct of the company. Accordingly, the decision of the sole director in this case was in fact valid and not ultra vires.

It is important to note that Marin KC analysed the decision in Hashmi and attributed much of the reasoning behind the decision to the existence of a bespoke article (Article 16). In doing so, he noted that: “it would, in my judgment, be wrong to read the unamended Model Articles and the existence of the requirement in Article 11(2), as having the effect of ruling out the operation of Article 7(2). It seems to me that to treat the Articles of having that effect would be to deprive Article 7(2) of any practical meaning”. However, this conflicts the judgment in Hashmi, as Deputy Judge Farnhill noted that his decision was not impacted by the presence of the bespoke article.

Conclusion

The fact that the decision in Re Active Wear is unreported, does not detract from the fact that it is still binding and as this case was heard in the High Court, crucially it has the same authority as the earlier decision in Hasmi. Unfortunately, sole directors will continue to review the limits of their authority, but it is likely that the Hasmi decision has been confined and distinguished on the basis of the bespoke article in regard to this case. As there still exists uncertainty due to both cases being decided in the High Court and until we receive judicial clarity on this point through an appeal or through government intervention to implement legislation to amend the position under the Model Articles, the safest course of action is to still amend the provisions of the model articles in order to make it clear that a sole director has clear and unequivocal authority to bind the company. Consequently, following both decisions the two possible solutions are:

• the company appoints a second director to ensure that any meetings of the company meet the requirements of Model Article 11. The shareholders of the company have the authority to do this under Model Article 17(1)(a) by passing an ordinary resolution and the sole director has the authority to do this under Model Article 11(3); or
• the company would amend the Model Articles to caveat the provisions of Model Article 11, so that where there is a sole director, the quorum of a meeting need only be one director. Further, once such changes have been made it is important that the company ratifies any previous decisions. This is done by the passing of sole director and shareholder resolutions to ensure that they are not invalid if circumstances arise in the future where they are challenged. This is a point that should not just be the concern of companies themselves, but also those that have dealt with the relevant company previously.

If you require assistance with amending your articles of association in light of this article, please contact a member of our Corporate team.