A landmark unexpected High Court decision last year in the case of Fore Fitness meant businesses with a single, or ‘sole’ director were left in the extraordinary position of being unable to take any decisions.

In the ruling, the High Court decided that companies operating under the Model Articles cannot operate with a sole director, potentially affecting thousands of small businesses across the UK.

What are Model Articles?

The Model Articles are the default set of rules that directors must follow when running their companies and they, or a slightly modified version, are used by the vast majority of companies that are incorporated. Companies can adopt their own articles, but the ‘Model Articles’ were specifically drafted as a set of basic rules that would be suitable for use by small businesses.

The Model Articles state that to make and sanction decisions a company must hold a directors’ meeting, however there must be two directors present for this to be valid. Currently those articles also have provision to allow for sole directors, stating that where a company only has one director, director meetings are not required for the decision making process.

Since the Model Articles were introduced in 2008, the generally accepted principle has always been that the article about sole directors supersedes the need for two if a company only has one director. The High Court’s decision threw this presumption into doubt and has meant that some businesses have been forced to change their articles in order to continue to do business.

The potential consequences for sole director companies include having contracts contested, loan applications denied and decisions at all made by a sole director being vulnerable to challenges.

Another decision, another view

However fast forward another few months towards the end of last year and we had another decision in the case of Active Wear where a sole director had acted to appoint a liquidator and the High Court was again asked to consider whether this was a valid decision taken by a sole director. This time the High Court ruled that it was acceptable for a company with a sole director and Model Articles to take decisions through a sole director.

So within the space of 12 months we have had two conflicting decisions when the court has been asked to consider almost exactly the same point providing very little certainty for businesses as to what they need to do to make valid decisions. The only difference between the two sets of articles for the two businesses in question was that in Active Wear the company had adopted the Model Articles completely but in Fore Fitness the company had adopted a slightly amended version of the Model Articles.

What impact does this have on businesses?

It feels like common sense has prevailed but companies with one director and anything other than Model Articles should review their articles and ensure they have the articles amended, which will require 75% approval in a shareholder vote.

This may seem like a technical point it has significant business and cost implications and could leave businesses vulnerable. Some small companies with sole directors have been required to change their articles before they can access some funding options and has left some business actions carried out by sole directors open to challenge. The High Court’s decision in Fore Fitness could still end up catching out a lot of small businesses as the decision goes against 14 years of legal precedent and has no benefit for companies. It will cost them money in unnecessary legal fees at a time where inflation is still rising, energy prices are skyrocketing and the economy is in recession.

Appointing a second director is another option, of course, but it is a role has many legal standards that need to be complied with and so is not a decision to be taken lightly or quickly. Amending a company’s articles will generally be a quicker and smoother process.

Some experts feel the Model Articles have never been entirely fit for purpose which is why many companies have adopted a slightly amended version and this is where the risk lies, and now they need to be revisited. There are a number of other standard amendments that can also be made to make a company’s articles more suitable for the way a company operates.”

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Contact: Jody Webb  jody.webb@shma.co.uk

The Economic Crime and Corporate Transparency Bill 2022-23 (the “ECCT Bill”) was first introduced to the House of Commons on 22 September 2022 and is currently at the Report Stage in the House of Commons. This bill is a follow-up of The Economic Crime (Transparency and Enforcement) Act 2022, a previous economic crime measure, which was fast-tracked through Parliament in March 2022 in response to Russia’s invasion of Ukraine and established a new Companies House Register of Overseas Entities (“ROE”) where companies that own qualifying real estate in the UK must register.

What are the new ECCT Bill’s objectives?

• Prevent organised criminals, fraudsters, kleptocrats and terrorists from using companies and other corporate entities to abuse the UK’s open economy;
• Strengthen the UK’s broader response to economic crime; and
• Support enterprise by enabling Companies House to deliver a better service for over four million UK companies, and improving the reliability of its data to inform business transactions and lending decisions across the economy.

How will the Bill achieve this?

The Bill aims to deliver:

• reforms to Companies House including identity verification requirements for all new and existing directors, people with significant control and those filing information with Companies House;
• modifications to stop the exploitation of limited partnerships;
• greater authority to collect and return allegedly illicit cryptoassets
• changes to increase information sharing among firms to combat money laundering and other economic crime
• new law enforcement information collection capabilities and reduction of burdens on business

While the ECCT Bill is currently in its infancy through Parliament, Companies House anticipates, subject to Parliamentary approval, the Bill to receive Royal Assent early 2023. For existing companies, directors, LPs and others affected by the new measures, the legislation’s transitional provisions will set aside periods for observing the new standards.

The Companies House reforms will certainly assist in strengthening the UK business climate and increase openness regarding UK corporations. However, the ability to put these changes into action will depend on having enough resources to ensure that these new powers can be used successfully. Other regulatory bodies such as the ICAEW and The Law Society have already expressed concerns on the challenges in implementing the ROE, particularly the laws that govern the verification process and liability on service providers, making it possible for them to be held accountable for verification even if it was unaware the information being provided was false when it was verified. The ECCT Bill will add another layer of complexity.

What should companies do?

Directors will need to closely monitor the implementation of the ECCT Bill and in-house advisors may want to review current processes especially those in charge of a large number of UK subsidiaries. Corporate service providers will want to ensure that their current systems and processes for verification are robust enough to gain authorisation from Companies House, and once an ACSP, how this process will be managed across their client portfolio.

Buying/Selling

Contact: Jody Webb  jody.webb@shma.co.uk