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The unique risks of Sole Director Companies

In business, simplicity is often king. It is no surprise, then, that many limited companies in the UK operate with just a sole director at the helm, instead of opting for a suite of directors on the board.

For some, the rationale is fairly obvious: a desire to retain full control without the dilution or complication of a wider board. For others, particularly where the company serves as a ‘Special Purpose Vehicle’ (SPV), a traditional company setup, designed to operate a business, may seem inappropriate.

However, companies with a sole director are exposed to specific risks which, if not addressed, can and often do lead to significant operational complications. In this article, we explore two of the key pitfalls associated with companies having just a sole director, and how these risks can be appropriately mitigated.

1. Board Decisions

Where a company is incorporated with standard Model Articles of Association, the quorum requirement for board-level decisions is set at two directors.

This raises a now age-old question: “How can a sole director company validly take board-level decisions if, under its articles of association, a minimum of two directors are required?”

While the courts have recognised mechanisms to sidestep this issue, notably through the ‘Duomatic Principle’ (i.e. allowing unanimous informal consent of shareholders to validate company decisions and actions), the legal position still divides practitioners to this day. Indeed, in some cases, the court has disempowered sole directors from acting on the basis that they do not alone form a quorum where that company has Model Articles of Association (see Hashmi v Lorimer-Wing [2022] EWHC 191 (Ch) and Re Active Wear Ltd [2022] EWHC 2340 (Ch)).

It is important to recognise that risk-averse third parties, particularly institutional lenders such as mainstream banks, will not always be satisfied with reliance on case law arguments or the prospect of later ratification.

Many banks and funding institutions will insist that companies either:

• Appoint a second director to satisfy the quorum requirement; or
• Amend their Articles of Association to make clear that a sole director can form a valid quorum and transact business alone.

This issue is particularly prevalent in property investment transactions, where time pressures are tight, and delays caused by corporate governance concerns can materially impact completion deadlines.

For sole director companies seeking to engage with lenders, grant funders, or other such counterparties, it is critical to ensure that the company's constitutional documents permit sole director governance in unequivocal terms. This approach avoids unnecessary remedial steps at critical transactional moments.

2. Death / Incapacity

A more acute, but often overlooked, risk is the vulnerability of sole director companies if the sole director dies or becomes mentally incapable.

For a company with multiple directors, the death or incapacity of one director typically causes minimal disruption. The surviving directors continue to transact business, and (if necessary) appoint a replacement.

However, for a company with only one director, their death or incapacity can paralyse the company, even more so if that person was also a shareholder in the company. There is no one left with authority to manage the company’s affairs, sign contracts, operate bank accounts, or appoint new directors.

The consequences can be severe: critical business operations may cease, property transactions may fall through, and third parties may lose confidence in dealing with the company.

Addressing this risk requires forward planning, such as:

• Amending the Articles of Association to expressly permit shareholders (or in some cases, personal representatives) to appoint new directors in the event of death or incapacity. It will be important to set out the circumstances which this power can trigger (to avoid shareholders abusing this power), and the required voting percentage required from the shareholders before a director can be appointed through this method.
• Wills and Lasting Powers of Attorney. Sole directors should be encouraged to put in place appropriate personal planning measures, particularly where they are also a shareholder in the company; a Will should deal expressly with those shareholdings, as the ability to control the company may pass through their shares, not just through their directorship. A Lasting Power of Attorney for property and financial affairs may also assist if the director becomes incapacitated, although attorneys cannot appoint directors unless explicitly authorised through the company's Articles of Association.

Without these safeguards, the company's fate may depend on time-consuming and costly court applications for the appointment of administrators or to rectify corporate appointments. A wholly avoidable outcome with proper preparation.

Final Remarks

Whilst operating as a sole director can be attractive for reasons of control and simplicity, companies and their owners should be alive to the structural risks it suffers from. In particular, companies should:

• Review their articles of association to ensure that sole director governance is clearly permitted;
• Take proactive steps to safeguard the company's continuity in the event of death or incapacity; and
• Seek advice early to avoid operational paralysis at critical moments.

At Leathes Prior, our Corporate and Commercial Team regularly assists clients with reviewing and amending constitutional documents to support sole director models while minimising risk. If you operate a sole director company and would like to discuss your arrangements, you can contact us at info@leathesprior.co.uk or on 01603 610911.