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23 November 2017

When a sole shareholder director dies

A recent case has displayed the risks associated with sole shareholder director companies and the need for clear succession planning when it comes to taking your company forward.

What happens when a sole director shareholder dies? 

In some companies, an individual may act as both a director and a shareholder.  If a company’s power to make decisions relies on that individual, the company risks being left in a vulnerable position should that individual pass away.

Upon the death of a sole shareholder director, personal representatives (PRs) may face the immediate need to appoint a new director to manage the company.  A recent case has highlighted the problems caused when there is no one with legal authority to step into the breach.

The ease with which the problem can be resolved may ultimately come down to the powers granted to the PRs by the company’s main constitutional document, the articles of association.  If a company has not adopted its own bespoke articles of association, there are a default set of governing documents that will apply automatically. The precise set of these “model articles” which apply will depend on when the company was incorporated.

Why is this an issue?

It is a principle of company law that a person is only entitled to be recognised as a shareholder when their name is entered into the company’s register of members; this usually requires the approval of the directors. This means that unless there is express provision in the company’s articles of association, a person cannot exercise any powers, such as appointing a director, until their name is entered into the register of members.

This issue is specifically addressed in the model articles for newer companies set up under the Companies Act 2006.  However, the model articles (called “Table A”) for older companies do not. This creates a problem where a sole director has died, or even resigns and there is no shareholder, or anyone else, with authority to appoint a replacement.

A case in point

In Kings Court Trust v Lancashire Cleaning, Mr P was the sole director and shareholder of a company (“LC Limited”).  Mr P died but left a Will, under which he appointed executors and made a bequest of his shares in LC Limited.

As a result of Mr P’s death, the company was left without a surviving director. Its articles made no provision for his PRs to appoint new members. Therefore, LC Limited was unable to function properly without anyone able to lawfully exercise the management powers of a director, or able to appoint someone who could.

LC Limited’s bank discovered Mr P’s death and froze the company’s accounts, resulting in not only the company being unable to settle outstanding bills but also unable to pay its employees.

The fact that LC Limited had been incorporated under the Companies Act 1985 and had adopted articles based on Table A meant that until the PRs were registered as the shareholders of the company, they could not act to appoint a new director to ensure the continued running of the company. As they could not appoint directors, they could not be formally recognised as shareholders. It was therefore a Catch-22 situation.

To deal with cases such as this, the court does have wide reserve powers to make entries on a register of members and on this occasion, decided to exercise its discretion.  This was mainly due to the urgency required to pay employees, settle outstanding bills and keep the company afloat. As a result, the PRs’ names were entered in the company’s register of members, meaning that they could then exercise their powers, as shareholders, to appoint new directors.

It is important to note that the outcome of this case was atypical and this ruling does not set a precedent.  Indeed, the court made clear that it would only exercise its discretion to rectify the register of members in “exceptional cases”. As a result, there is no guarantee that a court would intervene in all cases where a sole shareholder director dies.

The other consideration is that companies often need their directors to act quickly.  As a result, even where relief might be available, the process of having to make an uncertain court application can prove disruptive to the company’s affairs and can cause further stress at a time of bereavement.

Do my company’s articles contain any protection against this?

As previously mentioned, if you incorporated your company after the introduction of the Companies Act 2006 and used the model articles, then you might take a sigh of relief.  The model articles under the Companies Act 2006 have provisions which allow PRs to appoint a person to be a director before their names are entered into the register of members.  But in some cases these rights only apply once a person has actually been appointed by the courts to act as the PR of the deceased.  This may, unfortunately, mean that there is still a long delay before new directors can be appointed.

Sole shareholders would therefore be well advised to give thought to alternative ways in which the company can be structured, in order to minimise delays and ensure that the company can continue to operate, even if the worst should happen.  Should you need to check or amend your company’s articles, or simply to receive some further advice as to how to protect your company, please contact us.