Companies Act 2006- Introduction to Chapter 4 and 5

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GENERAL INTRODUCTION TO CHAPTERS 4 AND 5

379. These Chapters contains several provisions designed to deal with particular situations in which a director has a conflict of interest. They replace provisions of Part 10 of the 1985 Act, but with a number of changes. The aim of the changes is:

• to improve accessibility and consistency. The Law Commissions commented that Part 10 of the 1985 Act “is widely perceived as being extremely detailed, fragmented, excessive, and in some respects, defective, regulation of directors”; and

• to implement various recommendations of the Law Commissions and the CLR (see in particular section B of the Law Commissions’ joint report Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, annex C of Developing the Framework, chapter 4 of Completing the Structure and chapter 6 of the Final Report).

380. Provisions regulating directors’ conflicts of interest fall into two main categories:

• requirements for disclosure to members;

• requirements for member approval.

381. The four types of transaction requiring the approval of members (long-term service contracts; substantial property transactions; loans, quasi-loans and credit transactions; and payments for loss of office) have been brought together within Chapter 4.

382. Provision for disclosure to members in respect of directors’ service contracts is contained in Chapter 5.

383. On the other hand, the requirements in Part 10 of the 1985 Act to disclose, and maintain a register of, share dealings by directors and their families are repealed (see section 1177).

CHAPTER 4: TRANSACTIONS WITH DIRECTORS REQUIRING APPROVAL OF MEMBERS

Structure

384. This Chapter sets out requirements for member approval in relation to four different types of transaction by a company:

• long-term service contracts;

• substantial property transactions;

• loans, quasi-loans and credit transactions;

• payments for loss of office.

385. The rules relating to each type of transaction tend to adopt the following structure: they begin with the rule requiring member approval, followed by exceptions to that rule and finally the consequences of breaching that rule.

Alignment of provisions

386. The provisions of this Chapter have been aligned wherever appropriate so as to achieve greater consistency of approach. Particular examples of alignment are mentioned below.

Criminal penalties

387. This Chapter no longer imposes any criminal penalties for a failure to comply with its requirements.

Civil remedies

388. The civil consequences of a failure to comply with the requirements for member approval of substantial property transactions and loans, quasi-loans and credit transactions have been aligned.

Approval by holding company

389. This Chapter applies to long-term service contracts, substantial property transactions, loans etc and payments for loss of office entered into by a company and involving either a director of the company or a director of the company’s holding company. In the latter case, the transaction must be approved by both the company and the holding company (unless an exception applies).

Transactions between a company and the director of a fellow subsidiary

390. This Chapter does not normally apply to transactions entered into by a company that is neither the company of which the person is a director nor a subsidiary of the company of which the person is a director. The two exceptions are section 218 (payment for loss of office in connection with transfer of undertaking) and section 219 (payment for loss of office in connection with share transfer), where member approval is required for such a payment by any person to a director.

Exception for wholly-owned subsidiary

391. Approval is never required under this Chapter on the part of the member of a whollyowned subsidiary or on the part of the members of an overseas company.

Shadow directors

392. Section 223 applies all the requirements of this Chapter to shadow directors (with a small modification in the case of payments for loss of office).

Approval required

393. Section 281(3) applies so that the member approval required is an ordinary resolution, but the company’s articles may require a higher majority or even unanimity 394. Where approval for a transaction or arrangement is required under more than one set of rules in Chapter 4, all relevant sets of rules should apply, unless otherwise provided (section 225). For example, if the matter involves both a substantial property transaction and a loan, approval should be required under section 190 and under section 197 unless in each case a relevant exemption applies. Approval may be given for both purposes by a single resolution.

Memorandum with details of the transaction

395. In the case of long-term service contracts, loans etc and payments for loss of office, a memorandum setting out certain particulars about the transaction requiring approval of the members must be made available to the members.

396. If the approval is to be given by way of written resolution, the memorandum must be sent to the members able to vote on the written resolution no later than when the written resolution is sent to them. Section 224 provides that any accidental failure to send the memorandum to one or more members will not invalidate the approval given by the members, unless the company’s articles state otherwise.

Requirement for Charity Commission consent for charitable companies

397. Section 66 of the Charities Act 1993 renders prior authorisation by the members for certain transactions invalid unless the Charity Commissioners have given their prior written consent. This reflects concern that, in some cases, the members of a charitable company are not independent of the directors, and that requiring their approval would not provide sufficient protection for the charity. Section 226 inserts two new sections into the Charities Act 1993 in place of section 66 of that Act to reflect the changes made by this Chapter.

COMMENTARY

Sections 188 and 189: Service contracts

398. These sections replace section 319 of the 1985 Act and require member approval of long-term service contracts. In broad terms, these are contracts under which a director is guaranteed at least two years of employment with the company of which he is a director, or with any subsidiary of that company.

399. A director’s “service contract” is defined in section 227 to include a contract of service, a contract for services and a letter of appointment as director.

400. Failure to obtain approval allows the company to terminate the service contract at any time by giving reasonable notice. The purpose of this section is to limit the duration of directors’ service contracts, as a long-term contract can make it too expensive for the members to remove a director using the procedure in section 168 (ordinary resolution to remove director) while allowing the members to approve longer arrangements if they wish.

401. The length of service contract for which member approval is required has been reduced from those longer than five years to those longer than two years.

Sections 190 to 196: Substantial property transactions

402. These sections require member approval to substantial property transactions. These are transactions where the company buys or sells a non-cash asset (as defined in section 1163) to or from:

• a director of the company;

• a director of its holding company;

• a person connected with a director of the company; or

• a person connected with a director of its holding company.

Approval is only required where the value of the asset exceeds £100,000 or 10% of the company’s net assets (based on its last set of annual accounts or called-up share capital if it has not yet produced any accounts). No approval is required if the value of the asset is less than £5,000.

403. These sections replace sections 320 to 322 of the 1985 Act. The changes include:

• permitting a company to enter into a contract which is conditional on member approval (section 190(1)). This implements a recommendation of the Law Commissions. In cases where the approval of the members of the holding company is also required, the company may enter into arrangements conditional on approval being obtained from the members of the holding company (section 190(2)). The company is not to be liable under the contract if member approval is not forthcoming (section 190(3));

• providing for the aggregation of non-cash assets forming part of an arrangement or series of arrangements for the purpose of determining whether the financial thresholds have been exceeded so that member approval is required (section 190(5));

• excluding payments under directors’ service contracts and payments for loss of office from the requirements of these sections (section 190(6)). This implements a recommendation of the Law Commissions;

• raising the minimum value of what may be regarded as a substantial non-cash asset from £2,000 to £5,000 (section 191);

• expanding the exception for transactions with members to include the acquisition of assets from a person in his character as a member of the company (section 192(a));

• providing an exception for transactions made by companies in administration (section 193). This implements a recommendation of the Law Commissions;

• not requiring approval on the part of the members of a company that is in administration or is being wound up (unless it is a members’ voluntary winding up) (section 193).

Sections 197 to 214: Loans, quasi-loans and credit transactions

404. In the case of a private company which is not associated with a public company, section 197 requires member approval for loans and related guarantees or security made by a company for:

• a director of the company; or

• a director of its holding company.

405. In the case of a public company, or a private company associated with a public company, sections 197, 198, 200 and 201 require member approval for loans, quasi-loans (as defined in section 199), credit transactions (as defined in section 202) and related guarantees or security made by the company for:

• a director of the company; or

• a director of its holding company;

• a person connected with a director of the company; or

• a person connected with a director of its holding company.

406. Section 256 explains what is meant by references to associated companies. A holding company is associated with all its subsidiaries, and a subsidiary is associated with its holding company and all the other subsidiaries of its holding company.

407. Member approval is not required by these sections for:

• loans, quasi-loans, credit transactions and related guarantees or security to meet expenditure on company business. The total value of transactions under this exception made in respect of a director and any person connected to him must not exceed £50,000 (section 204);

• money lent to fund a director’s defence costs for legal proceedings in connection with any alleged negligence, default, breach of duty or breach of trust by him in relation to the company or an associated company (section 205) or in connection with regulatory action or investigation under the same circumstances(section 206);

• small loans and quasi-loans, as long as the total value of such loans and quasi-loans made in respect of a director and any person connected to him does not exceed £10,000 (section 207(1));

• small credit transactions, as long as the total value of such credit transactions made in respect of a director and any person connected to him does not exceed £15,000 (section 207(2));

• credit transactions made in the ordinary course of the company’s business (section 207(3));

• intra-group transactions (section 208); and

• loans and quasi-loans made by a money-lending company in the ordinary course of the company’s business (as long as the requirements of section 209 are met).

408. These sections replace sections 330 to 341 of the 1985 Act. The changes include:

• abolishing the prohibition on loans, quasi-loans etc to directors and replacing it with a requirement for member approval. This implements a recommendation of the CLR;

• abolishing the criminal penalty for breach;

• replacing the concept of relevant company in section 331 of the 1985 Act with associated company, as defined in section 256;

• removing some of the requirements currently imposed by section 337 of the 1985 Act on the exception for expenditure on company business (section 204);

• widening the exception for expenditure on company business to include directors of the company’s holding company and connected persons (section 204);

• creating a new exception specifically for expenditure in connection with regulatory action or investigations (section 206);

• restricting the exceptions for expenditure on defending legal or regulatory proceedings to proceedings in connection with any alleged negligence, default, breach of duty or breach of trust by the director in relation to the company or an associated company (sections 205 and 206);

• widening the exception for small loans to include small quasi-loans (section 207(1)) in place of the current exception for short-term small quasi-loans in section 332 of the 1985 Act;

• widening the exception for small loans and quasi-loans to include transactions with connected persons (section 207(1));

• widening the exception for “home loans” to include those connected persons who are employees (section 209(3));

• raising the maximum amounts permitted under the exception for expenditure on company business (section 204), the exception for small loans and small quasi-loans (section 207(1)) and the exception for small credit transactions (section 207(2));

• widening the exceptions for intra-group transactions (section 208);

• abolishing the maximum amounts permitted under the exception for money-lending companies (section 209); and

• allowing affirmation of loans, quasi-loans and credit transactions entered into by the company in line with the provision in respect of substantial property transactions (section 214).

Sections 215 to 222: Payments for loss of office

409. These sections require member approval for payments for loss of office. These are payments made to a director (or former director) to compensate them for ceasing to be a director, or for losing any other office or employment with the company or with a subsidiary of the company. They also include payments made in connection with retirement. In the case of loss of employment or retirement from employment, the employment must relate to the management of the affairs of the company.

410. Member approval is required under section 217 if a company wishes to make a payment for loss of office to:

• one of its directors;

• a director of its holding company.

411. Member approval is also required if any person (including the company or anyone else) wishes to make a payment for loss of office to a director of the company in connection with the transfer of the whole or any part of the undertaking or the property of the company or of a subsidiary of the company (section 218).

412. In the case of a payment for loss of office to a director in connection with the transfer of shares in the company or in a subsidiary of the company resulting from a takeover bid, approval is required of the holders of the shares to which the bid relates and of any other holders of shares of the same class (section 219).

413. These sections replace sections 312 to 316 of the 1985 Act. The changes include:

• extending the requirements to include payments to connected persons (section 215(3));

• extending the requirements to include payments to directors in respect of the loss of any office, or employment in connection with the management of the affairs of the company, and not merely loss of office as a director as such (section 215). This implements a recommendation of the Law Commissions;

• extending the requirements to include payments by a company to a director of its holding company (section 217(2));

• extending the requirements in connection with the transfer of the undertaking or property of the company to include transfers of the undertaking or property of a subsidiary (section 218(2));

• extending the requirements in connection with share transfers so as to include all transfers of shares in the company or in a subsidiary resulting from a takeover bid (section 219(1));

• excluding the persons making the offer for shares in the company and any associate of them from voting on any resolution to approve a payment for loss of office in connection with a share transfer (section 219(4)). This implements a recommendation of the Law Commissions;

• setting out the exception for payments in discharge of certain legal obligations (section 220);

• creating a new exception for small payments (section 221);

• clarifying the civil consequences of breach of these sections (section 222(1) to (3)); and

• resolving conflicts between the remedies where more than one requirement of these sections is breached (section 222(4) and (5)). For example, if the payment contravenes both section 217 and section 219 because it was a payment by a company to one of its directors and it was a payment in connection with a takeover bid, and none of the required member approvals have been obtained, then the payment is held on trust for the persons who have sold their shares as a result of the offer and not on trust for the company making the payment.

CHAPTER 5: DIRECTORS’ SERVICE CONTRACTS

Section 227: Directors’ service contracts

414. This section is a new provision. It defines what is meant in this Part by references to a director’s service contract. The term is used in sections 177, 182, 188 and 190 and in this Chapter. It includes contracts of employment with the company, or with a subsidiary of the company. It also includes contracts for services and letters of appointment to the office of director. The contract may relate to services as a director or to any other services that a director undertakes personally to perform for the company or a subsidiary.

Section 228: Copy of contract or memorandum of terms to be available for inspection

415. This section requires a company to keep available for inspection copies of every director’s service contract entered into by the company or by a subsidiary of the company. If the contract is not in writing, the company must keep available for inspection a written memorandum of its terms. This section, together with sections 229 and 230, replace section 318 of the 1985 Act.

416. Subsection (3) is new. It requires the service contracts to be retained and kept available for inspection by the company for at least one year after they have expired, but the subsection does not require the copies to be retained thereafter. As a result of the expanded definition of service contract in section 227, this section now applies to contracts for services and letters of appointment, as recommended by the Law Commissions.

417. As recommended by the Law Commissions, the exemption for contracts requiring a director to work outside the UK (section 318(5) of the 1985 Act) and the exemption for contracts with less than 12 months to run (section 318(11) of the 1985 Act) have not been retained.

418. Failure to comply with the requirements of this section is a criminal offence for which every officer of the company who is in default may be held liable on summary conviction to a fine not exceeding level 3 on the standard scale (currently £1,000) or in cases of continued contravention a daily default fine not exceeding one-tenth of that. In a change from the current position under section 318 of the 1985 Act, the company will no longer be liable under the criminal offence.

Section 229: Right of member to inspect and request copy

419. This section gives members a right to inspect without charge the copies of service contracts held by the company in accordance with section 228. Subsection (2) creates a new right for members to request a copy of the service contracts on payment of a fee set by regulations under section 1137.

Section 230: Directors’ service contracts: application of provisions to shadow directors

420. This section applies the requirements of this Chapter to service contracts with shadow directors.