In the High Court Case, Hahsmi versus Lorimer Wing, a shareholder tried to invalidate a claim made by a company with a sole director on the basis that the articles adopted by the company, which are based on model articles, did not allow a board meeting to be held by only one director.
Model articles are standard articles limited companies adopt, which set out how a company is run and apply by default when a limited company is set up. Limited companies have become increasingly popular amongst buy-to-let investors following tax changes in 2016.
The shareholder argued that the articles required a minimum of two directors for meetings to be held, and that the board decision by the sole director should be overturned.
This is due to two model articles, Articles 7(2) and 11 (2), which were found to be in conflict. The first allows a sole director to make decisions on behalf of the company, but the latter says that the quorum, minimum number of members that must be present to make meeting proceedings valid, for a directors’ meeting must not be less than two unless otherwise stated.
The judge ruled in the shareholders’ favour, who said that one director was not enough for a board meeting to be held and decisions to be made.
Brokers said that consequences could be that some solicitors could insist that limited companies should have two directors, and that if a company has one director then model articles should be changed.
Brokers said that there then could be delays, as legal searches are conducted at the end of mortgage search, and if someone is approaching a mortgage expiry date and lenders are not extending mortgage offers as readily, this could lead to borrowers losing out on a chosen product.
Borrowers may then have to start the process again and could pay more for mortgages due to rising interest rates, and other factors, leading to an increase in mortgage pricing.
Case could raise questions about loan validity and enforcement of security
David Freedman, director in the real estate finance department at Lawrence Stephens, said that in this case the company entered into a transaction with only one director having been appointed, and the non-director shareholder was “unsatisfied with the decision”.
He explained: “Since the meeting was not attended by two directors, the meeting was not quorate. The shareholder, therefore, maintained that the action taken by the sole director was ‘outside of the company’s powers.”
Freedman said that the general implication for lenders after the case was that if a borrower’s limited company was incorporated with unamended model articles, and the sole director and shareholder(s) are not the same people, there could be an issue with validity of the loan and enforcement of security if shareholders do not like the term of the loan.
“This case should put lenders on alert to look perhaps more closely at their borrower’s company constitution,” he said.
Matt Hardman, director of The Buy to Let Broker, said that when it hasn’t been stated that the quorum can be one it could create issues where “lenders insist upon the articles being changed”.
He said: “Advisers and brokerages now need to be careful on both new and existing pipeline cases for sole company directors, which could very well, be impacted by the above.
“Of course, the articles can be amended at a later date, to bring sole director companies into line here, however, with lenders often insisting clients need to choose a new rate should their current offer expire, this new case law shouldn’t be a reason that clients are having to increase their mortgage costs, so brokers should try and stay one step ahead of the game here.”
Hardman said that the company was recently contacted by a client in this situation.
“As we understand, it is possible to make changes yourself by contacting Companies House, but we’d always recommend taking specialist professional advice from a qualified accountant in these instances – as you would if you were undertaking any transaction in a Special Purpose Vehicle,” he added.
Brokers said that to avoid issues, limited companies should match the true company structure and that borrowers should contact solicitors prior to a mortgage offer to make amendments to Companies House if necessary.
Personal guarantees could mitigate problems
Richard Rowntree, managing director for mortgages at Paragon, said that a “substantial proportion” of mortgages the company writes are for letting businesses structured as limited companies.
“We underwrite under the same conditions regardless of whether a limited company has one or multiple directors,” he noted.
Rowntree continued: “To mitigate any risk arising from sole or multiple directors managing a limited company, our underwriting requires personal guarantees from those in control of the company, typically the ‘persons with significant control’.
“In addition to the director/s, this includes the majority shareholders, 80 per cent minimum, helping to ensure all of a limited company’s main parties are subject to our loan conditions.”
