Corporate Law Update: 1 - 7 October 2022

07 October 2022

In this week’s update: a company with unamended Model Articles was able to operate with a single director, an FRC review of company reporting on business combinations, a QCA report on ESG attitude among small and mid-cap companies, changes to the regulatory threshold for small businesses and an FRC report on navigating barriers to senior leadership for minority ethnic groups.

Model Articles did permit a company to operate with a sole director

The High Court has held that a company which adopted the Model Articles without modification had been able to operate from incorporation with only one director.

What happened?

In the matter of Active Wear Limited [2022] EWHC 2340 (Ch) concerned a company incorporated in 2015 under the Companies Act 2006.

As is common, the company’s constitution was based on the model articles for private companies limited by shares (the Model Articles). The company in this case adopted the Model Articles wholesale and unamended, rather than (as is more common) making modifications to them.

The company at all times had only a single director. In 2022, following a period of unsuccessful trading, the sole director signed documents appointing administrators so as to place the company into administration.

The question for the court was whether that sole director was able to take decisions on behalf of the company, or whether the company’s constitution required it to have more than one director.

To understand the case, it is important to recite four key provisions of the Model Articles, which we have paraphrased below.

  • Model Article 7(1). Directors are to take decisions either in board meeting (which are governed by subsequent articles in the Model Articles) or by a “unanimous decision of the eligible directors” (which are governed by Model Article 8). This is called 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, the general rule does not apply. Instead, the 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 for directors’ meetings can be fixed from time to time, but it cannot be less than two, and the default quorum is two.
  • 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: (i) to appoint further directors; or (ii) to convene a general meeting to enable the shareholders to appoint further directors.

At first glance, Model Articles 11(2) and 11(3) appear to contradict Model Article 7(2). However, the concept that the Model Articles could be internally inconsistent in this way (particularly where they are adopted in unmodified form) is unattractive.

The approach generally taken to date, therefore, has been that Model Article 11(2) and 11(3) form part of the “general rule” and so, at any time when a company has a single director, they do not apply. Instead, Model Article 7(2) allows the sole director to take all decisions.

However, this interpretation was thrown into doubt earlier this year by the decision in Re Fore Fitness Investments Holdings Ltd [2022] EWHC 191 (Ch), in which the High Court held that, by requiring a quorum of at least two for board meetings, Model Article 11(2) effectively set a lower limit of two directors for a company that has adopted the Model Articles.

According to that judgment, if a company wished to be able to operate with only one director, it needed to amend the Model Articles to allow this.

For more information on that case, see our previous Corporate Law Update.

The decision in Fore Fitness took many by surprise. It contradicted what had, until that point, been the general understanding of how the Model Articles functioned and appeared to create contradictions with the intention and details of the legislation (for example, with section 154 of the Companies Act 2006, which specifically allows a private company to have a single director).

What did the court say this time?

In contrast to the decision Fore Fitness, the judge in Active Wear found that the “unambiguous effect” of Model Article 7 is that, under the unamended Model Articles, a sole director of a private company can take any decision relating to the conduct of the affairs of the company on their own.

In particular, the judge endorsed the understanding that prevailed before Fore Fitness, namely that, if a company with Model Articles has a sole director, Model Article 7(2) simply disapplies Model Article 11 – including the quorum requirement in Model Article 11(2). In the judge’s words, to read the Model Articles any other way would “deprive Article 7(2) of any practical meaning”.

This decision appears to run contrary to the decision in Fore Fitness. However, the judge addressed this by noting that, in Fore Fitness, the company in question had modified the Model Articles by introducing a bespoke provision that required two specific individuals to be present for a board meeting to be quorate. That fact alone made the two cases distinct.

To add further confusion, the judge in Active Wear separately suggested that, if a company with unamended Model Articles has more than one director, but the number of directors falls to one, Model Article 11(3) would nonetheless apply and the sole director’s authority would be restricted to appointing a second director (or calling a general meeting to do so).

Where does this leave us?

This decision is naturally useful and will be of comfort to the many companies that have been operating with a sole director under unmodified, or only slightly modified, Model Articles.

However, there is still good reason to remain cautious. The judge here distinguished Active Wear, which concerned a company with unamended Model Articles, from Fore Fitness, which concerned a company with amended Model Articles. Indeed, certain comments by the judge in Active Wear positively support the decision in Fore Fitness in the circumstances of that case.

For a start, therefore, reading the two cases together, the position in Fore Fitness arguably still applies to a company with Model Articles that have been amended to include a specific quorum requirement.

In addition, although the judge in Active Wear strove to distinguish the two cases on this basis, it is still difficult to reconcile the judgment in Active Wear with the comments of the judge in Fore Fitness, which appear to be directed equally to companies with unamended Model Articles.

This problem is compounded by the fact that, although High Court decisions are highly persuasive and the High Court will rarely depart from its own decisions, they do not technically create law in the form of binding precedent. As a result, neither Active Wear nor Fore Fitness can be said to take precedence over the other.

Moreover, Fore Fitness was, in substance, a decision on an application to strike out a claim, and the decision in Active Wear appears to have been made without legal representation or full argument. Despite the judge in each case employing very well-articulated reasoning, these circumstances render both judgments less persuasive than they might otherwise have been.

As a result, the key practical points for shareholders and directors of companies remain similar.

Persons looking to establish a new company should ensure that the company’s articles are drafted properly. If the intention is that the company should be able to operate with only one director, the articles should make this crystal clear.

Established companies should review their articles of association, particularly if they have adopted Model Articles 7 and 11 in unmodified or modified form. A company which has done do should decide whether it needs the flexibility to be able to operate with a sole director and, if it does, consider putting forward amendments to its articles to make it clear that this will be the case.

If the company has historically operated with only one director, it should consider obtaining advice on whether any historic decisions taken by the sole director are or may be void.

FRC publishes review of business combination reporting

The Financial Reporting Council (FRC) has published a thematic review of company accounting and reporting for business combinations.

The review looked at the annual reports of 20 companies, of various sizes across various industries, that had recently completed a business combination. It provides examples of better reporting and highlights areas for improvement.

QCA publishes ESG survey report

The Quoted Companies Alliance (QCA) has published a new report on attitudes towards and knowledge of environmental, social and governance (ESG) issues among small and mid-cap publicly traded companies.

The report follows a survey, to which 57 companies responded, comprising 17 questions relating to attitude and strategies, data collection and reporting, use of external service providers and impact of ESG issues on companies.

Among other things, the QCA found that 70% of respondents had a “very positive” attitude towards ESG and just under two-thirds had a “clear and formal ESG strategy or policy”.

Respondents found the “environmental” aspect of ESG hardest to address and disclose against, with 60% following an environmental framework and 75% measuring their carbon footprint.

Nearly 90% of respondents are addressing the “social” aspect of ESG, with 60% collecting data and using guides/tools/research to help inform this pillar.

Finally, 58% of respondents are using external service providers in connection with ESG, including for consultancy, data collection, reporting, and audit/assurance.

Government raises threshold for regulation of small businesses

The Government has announced that it has raised the threshold for regulation of small businesses.

Currently, businesses with fewer than 50 employees are presumed to be exempt from certain regulations. With effect from 5 October 2022, the Government has raised this threshold to 500 employees. It estimates that this will reduce the regulatory burden on around 40,000 UK businesses.

The new threshold will apply to all new regulations under development or under current and future review and so does not create any automatic legal change. The Government is considering consulting in the future on potentially extending the threshold to businesses with 1,000 employees.

FRC publishes report on barriers to senior leadership for minority ethnic groups

The Financial Reporting Council (FRC) has published a new report focussing on the barriers to senior leadership at FTSE 100 and 250 companies faced by members of minority ethnic groups.

Report is based on interviews with 54 people in a range of senior positions in FTSE 350 companies (including chairs and non-executive directors), as well as separate discussions with executive search consultants.

Challenges the FRC looked at included being overlooked for promotion, overt and covert racism, and having to demonstrate higher standards, compared with colleagues from majority backgrounds, to progress or have the same development opportunities.

The FRC’s view is that, whilst significant challenges remain, companies and their executives across the spectrum have taken the need for change seriously.

The report will be of interest to listed companies, as well as other publicly traded companies, looking to assess and improve access to leadership for minority ethnic groups.