UK: The Companies Act 2006 - Fair Dealing By Directors

Last Updated: 1 November 2007
Article by James Burdett and Nick Thomas

Introduction

The Companies Act 2006 (the "CA 2006") contains new provisions governing the enforcement of fair dealing by directors (including, for this purpose, shadow directors). These provisions are to be found in Chapter 4 of Part 10 CA 2006, with the corresponding provisions in Part X of the Companies Act 1985 (the "CA 1985") being repealed in their entirety, subject to transitional arrangements. The new provisions (which for the most part apply to all companies, public and private) cover four specific situations in which directors face a potential conflict of interest:

  • long-term service contracts;
  • substantial property transactions;
  • loans, quasi-loans and credit transactions; and
  • payments for loss of office.

Generally speaking, the new provisions apply to agreements or transactions entered into on or after 1 October 2007. However, where there is a requirement for the relevant agreement or transaction to be approved by members, a resolution passed before that date will be effective for the purposes of CA 2006 if it complies with the relevant section(s).

In addition, Chapter 5 of Part 10 CA 2006 restates, with some amendments, the provisions relating to the inspection of directors' service contracts.

This client alert focuses primarily on the main differences between the CA 1985 and CA 2006 regimes and assumes a broad understanding of the pre-existing law in this area.

Background and Overview

The Government has stated that the aim of the changes made by CA 2006 to the previous regime in CA 1985 is to "improve accessibility and consistency" and to implement a number of recommendations for reform in this area made by the Law Commission and taken up by the Company Law Review.

Particular efforts have been made to achieve a greater consistency of approach in the drafting and application of the provisions in Chapter 4, including:

  • the imposition of a general requirement for members' approval (in place of outright prohibition), subject to specified exceptions. Where the director is also a director of the company's holding company, approval by the members of that holding company is also generally required. Approval is by ordinary resolution (unless the company’s articles specify a higher majority). Members' approval is not required in any case where the company from whose members approval would otherwise have been sought is not UK-registered or is a wholly-owned subsidiary of another company;
  • the removal of criminal penalties for failure to comply with the statutory requirements; and
  • enhanced harmonisation of the exceptions to the requirement for members' approval and of the civil consequences of a failure to obtain such approval, where required.

Further points of general application to note are:

  • generally speaking, agreements or transactions will require approval when made with or for the benefit of not only directors of the company or of its holding company but also a director's "connected persons". The new definition of "connected persons" is contained in ss252-256 CA 2006 and is somewhat broader than the old definition in s346 CA 1985: in particular, what constitutes a director's "family" for these purposes has been expanded to include his or her parents (but not siblings), children or step-children (of whatever age, not just minors), co-habiting partners (of whatever sex) and minor children of co-habiting partners if living with the director;
  • directors must still have regard to their general duties even where an agreement or arrangement has been approved by members (see s180(2) CA 2006), subject to certain exceptions. So, for example, directors considering a resolution to approve a loan by a company to a director must be satisfied that this is compatible with their general duties to act within their powers, to promote the success of the company and to exercise independent judgment.

Finally, it is worth noting that a number of provisions formerly contained in Part X CA 1985 have been repealed without being replaced by any equivalent provision in CA 2006. The principal examples are the prohibitions on tax-free payments to directors and on directors' dealing in share options (formerly contained in ss311 and 323 CA 1985 respectively) and the provisions relating to the notification of the interests of directors and members of their immediate family in a company's shares and the keeping of a register of such interests (formerly contained in ss324 to 329 CA 1985).

Long-Term Service Contracts (ss188 and 189 CA 2006)

These sections deal with the requirement for members' approval of long-term service contracts of directors and with the civil consequences of a failure to obtain the necessary approval. The main changes from the equivalent provisions in Part X CA 1985 are:

  • the length of the service contract for which members' approval is required is reduced from longer than 5 years to longer than 2 years; and
  • the definition of a "service contract" (in s227 CA 2006) is broadened to include contracts for services and directors' letters of appointment as well as conventional contracts of employment.

While, therefore, a company does not require members' approval before entering into a rolling contract with a director requiring no more than two years' notice of termination, it should be borne in mind that, in the case of listed companies, the Combined Code on Corporate Governance recommends that notice or contract periods should be set at one year or less (see Code Provision B.1.6).

Substantial Property Transactions (ss190 to 196 CA 2006)

These sections require members' approval of substantial property transactions (i.e. those which involve the sale or purchase by the company of substantial non-cash assets to or from directors and their connected persons) and specify the civil consequences of a failure to obtain the necessary approval. In addition to the more extended definition of "connected persons" (see Background and Overview above), the new provisions differ from the equivalent provisions in Part X CA 1985 in the following main respects:

  • transactions may now be entered into conditionally upon the necessary members' approval being obtained (previously it has been necessary to obtain the approval prior to entering into the agreement, which can prove inconvenient);
  • the minimum value of what may be regarded as a "substantial" non-cash asset is raised from £2,000 to £5,000 (subject to this, the test of whether a non-cash asset is "substantial" remains the same, i.e. the lesser of £100,000 and 10% of the company's net assets);
  • there is now provision for the aggregation of more than one non-cash asset and/or a series of arrangements involving non-cash assets in order to determine whether the threshold for requiring members' approval has been reached;
  • payments under directors' service contracts and payments for loss of office are excluded from the scope of the provisions (for the avoidance of doubt);
  • the exception for transactions with members (in their capacity as such) has been extended to include acquisitions from, as well as disposals to, such members; and
  • the requirement for members' approval has been removed where the company is being wound up (unless pursuant to a members' voluntary winding-up) or is in administration (note, however, that the requirement for approval remains where the company is in receivership or administrative receivership).

Loans, Quasi-loans and Credit Transactions (ss197 to 214 CA 2006)

These sections are concerned with loans to directors and certain related transactions. The significant change from the CA 1985 regime is that it is no longer unlawful for a private company to make a loan to a director of the company or of its holding company, or for a public company (or a private company "associated" with a public company - see the revised definition in s256 CA 2006) to make a loan or quasi-loan to, or enter into a credit transaction with, a director of the company or of its holding company or persons connected with such a director. Instead, such transactions will be lawful provided that specified information concerning the proposed transaction is supplied to members in advance and their approval is obtained. There are no longer any criminal sanctions for breach of these provisions. Other changes from the previous law include:

  • widening a number of the exceptions to the requirement for members' approval (formerly the prohibition) and raising (or removing altogether) the financial limits for the application of certain of the exceptions; and
  • permitting affirmation of loans, quasi-loans and credit transactions entered into without the necessary approval (in line with the equivalent provisions in respect of substantial property transactions).

Payments for Loss of Office (ss215 to 222 CA 2006)

These sections are concerned with the requirement for members' approval for payments for loss of office (including where the payment is in connection with the transfer of an undertaking or a takeover) and the civil consequences of a failure to obtain the approval, where required. They re-enact provisions formerly contained in ss312 to 316 CA 1985, but with a number of important differences, including:

  • the definition of a payment for loss of office has been expanded. It now includes compensation for loss of (or in connection with retirement from) all offices or employments (not just the office of director) and also for loss of or retirement from office or employment in subsidiaries. Non-cash benefits are now included, as are payments made to persons connected with or at the direction of the director. Payments to past directors are also explicitly caught;
  • prescribed information must be made available to members in advance of their approval being sought;
  • where the proposed payment is in connection with a takeover, the offeror and its associates are prevented from voting on the resolution to approve the payment;
  • the old exception (in s316(3) CA 1985) for "bona fide payments by way of damages for breach of contract" is retained, but in a restated form (see s220 CA 2006); and
  • there is a new exception for small payments (not exceeding £200 in aggregate).

Inspection of Directors' Service Contracts (ss227 to 230 CA 2006)

These sections contain provisions requiring a company to keep available for inspection copies of every director's service contract (having the extended meaning in s227 CA 2006 discussed in Long-Term Service Contracts above) with the company or any of its subsidiaries and giving members rights to inspect and request copies of such contracts. There are a number of changes from the equivalent requirements in Part X CA 1985, including:

  • copies of contracts (or written memoranda of their terms, where the contracts themselves are not in writing) must now be retained and made available for inspection for at least one year following their termination or expiry;
  • the former exemptions for directors working outside the UK, and for contracts with less than 12 months to run, have been abolished; and
  • members are now entitled to request copies of the contract or memorandum on payment of the prescribed fee.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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