Formation of a Company and Director's Duties

Question 1

What is the memorandum?

Answer 1

Under the Companies Act 1985 (CA 1985) the memorandum formed part of the company’s constitution. Companies were required to include an objects clause setting out the purposes for which the company has been formed. Acting outside of this purpose was described as acting ‘ultra vires’ or outside the company’s capacity.

Companies formed under CA 2006 have unrestricted objects (s 31 CA 2006) unless the objects are specifically restricted in the company’s Articles. The ultra vires rule is not applicable to a 2006 Act company unless it has chosen to insert an objects clause into its Articles.

For older companies that were incorporated under the CA 1985, s 28 CA 2006 provides that any provisions in a memorandum must be treated as provisions of the company’s Articles. This includes the objects clauses included in the memoranda of all CA 1985-incorporated companies. Under CA 2006, therefore, the objects clause of an older company continues in force, operating as a limitation on that company’s capacity unless and until the Articles of that company are amended to remove its objects clause.

Question 2

What are the articles of association?

Answer 2

All companies must have articles of association (Articles) (s 18 CA 2006). Under CA 2006, the Articles form the main constitutional document of a company. The purpose of the Articles is to regulate the relationship between the shareholders, the directors and the company. Examples of the types of provisions which are included in the Articles of a company are:

• the number of directors required to transact business (both to form a quorum at board meetings and to take decisions at board meetings);
• the method of appointment of directors;
• the powers of directors;
• how board meetings are to be conducted;
• any special rights attaching to shares;
• how shareholder meetings are to be conducted; and
• how and to whom shareholders may transfer their shares.

Question 3

Relationship between CA 2006 and the Articles

Answer 3

A company’s Articles must be interpreted in the light of relevant legislation. There is considerable scope for overlap between the procedures set out in CA 2006 and those that may also be contained in the company’s Articles.

The Articles must comply with the minimum provisions of CA 2006 (this is known as the Legality Test).

A company may in certain circumstances provide a procedure in its Articles which is more onerous than that contained in CA 2006 eg s 154(1) CA 2006 provides that a private company must have a minimum of one director. A company may provide in its Articles that it requires three directors.

However, there are some CA 2006 provisions which override anything in a company’s Articles eg s 321 the right to demand a poll vote at a GM – this cannot be removed or varied.

There are also powers available to companies by default under the provisions of CA 2006 unless the Articles provide otherwise eg the power of a private company to issue redeemable shares.

It is important to always check the procedures set out both in the relevant legislation and in your client’s Articles.

Question 4

How can a company form its Articles?

Answer 4

1. Model Articles (MA) / Table A

There are prescribed MA for different types of company. If a new company does not register Articles at Companies House, s 20(1) CA 2006 provides that the relevant MA will constitute the company’s Articles in default. Note that there was a similar provision under the CA 1985. For companies incorporated under the CA 1985 the default Articles were known as Table A (which you may encounter in practice).

2. Amended MA

Not all of the provisions contained in the MA are suitable for all companies. Many companies therefore choose to adopt the MA as their Articles, but elect to exclude, or modify the effect of, some of its provisions in so far as the CA 2006 allows them to do so.

3. Tailor made Articles

A client may wish their solicitors to draft Articles which are tailor-made for the particular company concerned. This is a very time-consuming process and therefore costly. Most small companies will prefer to adopt MA, subject to certain amendments.

Question 5

Amending the Articles

Answer 5

Once a company has adopted Articles, it is able to alter them at any future date by special resolution (s 21(1) CA 2006).

There is quite a lot of case law relating to altering the Articles however, the basic rule is that, to be valid, any alteration must be made bona fide in the interests of the company as a whole.

Section 22 CA 2006 permits the entrenchment of specific provisions within a company’s Articles, though this occurs relatively rarely in practice.

An entrenched provision of a company’s Articles is one which can only be amended or repealed if specific conditions are met, or if procedures more restrictive than a special resolution are complied with. Entrenched Articles can nevertheless always be amended by the agreement of all of the members, or by a court order (s 22(3) CA 2006).

Question 6

Legal effect of the Articles

Answer 6

The nature of the contract established by the Articles of a company is set out in s 33(1) CA 2006, which provides that the provisions in the company’s Articles bind the company and its members to the same extent as if there were covenants on the part of the company and each member to observe those provisions.

Whatever form the company’s Articles take, therefore, they will be binding on both the company and its members and enforceable.

The generally established rule is that the Articles evidence a contract between the company and its members in their capacity as members and with respect to their rights and obligations as members.

Question 7

Are articles a contract?

Answer 7

Articles as a contract between the members themselves

Generally, the courts appear to be of the opinion that members will only be able to enforce provisions contained in Articles through the company itself.

If a member is likely to wish to enforce rights against other members, he/she should be advised to enter into a shareholders’ agreement. A shareholders’ agreement is a private agreement between the shareholders which is enforceable as a contract between the members. You will consider shareholders’ agreements later in this module.

Articles as a contract between the company and its members

Courts have been willing to prevent a company from infringing its members’ rights in breach of the Articles by granting an injunction. Each member, acting in his capacity as a member, is similarly obliged to the company to comply with the Articles. However, a member may not enforce any rights contained in the Articles against the company that are not relevant to his capacity as a member.

Rights contained in the Articles that would be enforceable by members under s 33 CA 2006 would be the right to vote or the right to receive a final dividend once it has been declared (ie approved by a resolution of the shareholders).

Question 8

Formation of a company

Answer 8

A client wishing to start a business through the medium of a company can either incorporate a new company from scratch or purchase and then convert an existing shelf company to conduct its business.

Incorporation from scratch - By submitting relevant information to Companies House / online

Shelf company conversion - Purchase of shelf company followed by formalities to enable necessary changes

Question 9

Incorporation from scratch

Answer 9

In order to incorporate a new company from scratch, the following must be delivered to Companies House (s9):

• a copy of the company’s memorandum;
• Articles (if the company does not intend to use the Model Articles (MA));
• the fee (the applicant may pay a higher fee for a same-day incorporation); and
• an application for registration (Form IN01) containing:
• The company’s proposed name and registered office;
• Whether the company is to be private or public;
• Whether the company is to be limited by shares (or guarantee);
• A statement of capital and initial shareholdings (s 10) (or if it is to be limited by guarantee, details must be given of the guarantee (s 11));
• A statement of the company’s proposed officers (s 12) and persons with significant control (s 790); and
• A statement of compliance (s 13).

Once the Registrar of Companies has approved the application for incorporation of the company, the company is sent a certificate of incorporation authenticated by the Registrar’s official seal.

The certificate of incorporation sets out:

• the name of the company. This may be changed at a later date;
• the company’s registered number. The company’s registered number will never change and must therefore be used when drafting any legal agreements to which the company is a party to ensure that the company can be correctly identified following future changes to its name; and
• the date of incorporation.

The company becomes a legal entity (s 16(3)) from the date on which the certificate of incorporation is issued by Companies House. The date of incorporation is set out in the certificate of incorporation (s 15 CA 2006).

Question 10

Incorporation by converting a shelf company

Answer 10

It has been more common traditionally for a solicitor to purchase a shelf company on behalf of the client and then make the necessary changes rather than to incorporate a new company from scratch. This position however is changing as a result of online incorporation services.

A shelf company is one that has been set up in advance by a company registration agent or law stationer. Many firms of solicitors also operate an in-house service that sets up shelf companies for sale to clients.

It is likely that the client will have to make some, or all, of the following changes (amongst others) to the shelf company to meet their requirements:

*Name – most shelf companies will have a name that has no connection with the client or its business (eg ABC 123 Ltd). It will therefore need to be changed to a name selected by the client. Under s 77(1) CA 2006 a company’s name can be changed by a special resolution of the shareholders or by any other means provided by the company’s Articles (eg a decision of the directors by way of board resolution). Form NM01 is required to be filed at Companies House with the special resolution passed to change the name and the fee;

*Registered office - the client’s chosen address will need to be substituted for the first registered office in accordance with s 87(1) CA 2006. Form AD01 is required to be filed at Companies House.

*Articles – it is common for a shelf company to have been incorporated with MA (though some firms and registration agents incorporate their shelf companies with a different form of Articles drafted in-house). You will need to consider whether the company’s existing Articles need to be amended, in accordance with s 21(1) CA 2006, to meet the specific requirements of your client. A company may alter its Articles by special resolution (SR). The amended Articles and SR need to be filed at Companies House.

*Members, directors and the company secretary – representatives of the company registration agent or law firm will have become the first member(s) (subscriber(s)), director(s) and company secretary (if the company has one) of the company. It is therefore essential that:

*the share(s) held by the subscriber(s) (the first members) is/are transferred using a stock transfer form. The client becomes the shareholder once it is entered on the register of members;

*the client’s representatives are appointed as director(s) and the company secretary (if there is to be one). Forms AP01 (directors) and AP03 (secretary) are required to be filed at Companies House, and

*the first director(s) and company secretary (if there was one) resign. Forms TM01 (directors) and TM02 (secretary) are required to be filed at Companies House. The order that appointments and resignations are made is very important; the company will always need at least one director to be CA 2006 compliant.

Question 11

Company Name: Considerations

Answer 11

A preliminary consideration for a business, whether incorporated from scratch or via a shelf company conversion, will be choosing a company name. There are various commercial and legal considerations regarding a company name. The name:

• Must not be offensive (s 53(b) CA 2006);
• Must end in limited/ltd (for a private limited company - s 59 CA 2006);
• Must not be the ‘same as’ another on the index of company names (s 66 CA 2006);
• Must obtain approval if it suggests a ‘connection with government or public authority’ (s 54 CA 2006) or contains other ‘sensitive words’ (s 55 CA 2006). Companies House publishes guidance on these names from time to time, so it is advisable to refer to these each time you advise a client.

Once a company has chosen its name and had it registered, it has an obligation to display it in certain prescribed locations (s 82 CA 2006).

A new company name becomes effective from the date on which the new certificate of incorporation on change of name is issued by the Registrar of Companies (s 81(1) CA 2006).

Question 12

Post-incorporation steps

Answer 12

Once the new company has been formed, there are a number of practical issues that the directors will need to attend to as follows:

*Chairperson – The Board needs to decide whether to elect a chair and whether the Chairperson should have a casting vote in the event of a tied board resolution. MA 13 provides for this, but they may wish to amend the MA by special resolution (s21). The SR and amended Articles need to be filed at Companies House.

*Accounting reference date – s 391(4) provides that the default accounting reference date will be the last day of the month in which the company was incorporated. Often companies will change this to align with their financial year. Form AA01 is required to be filed at Companies House.

*Auditor – all companies must prepare annual accounts (s 394) and will usually therefore need to appoint an auditor usually by Board resolution if company has MA.

*Tax registrations – the company will need to register for corporation tax, VAT and PAYE and National Insurance (if it has employees).

*Shareholder agreement – this is a private contract between the shareholders. It is not required and not all companies have a shareholder agreement, but it may be useful. We will consider shareholder agreements in more detail later in this module.

Question 13

Pre incorporation contracts

Answer 13

Section 51 CA 2006 seeks to protect third parties who believe they are entering into a contract with a company which is incorporated and registered by making pre-incorporation contracts enforceable as personal contracts against the persons purporting to act on the company’s behalf (known as ‘promoters’).

Section 51 Pre-incorporation contracts, deeds and obligations

(1) A contract that purports to be made by or on behalf of a company at a time when the company has not been incorporated has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly.’

Example: If one of the directors of a company purports to enter into a contract on behalf of the company before the company has been properly incorporated, it is the director themselves who will be personally liable under the contract. The company, once incorporated, will have no rights or obligations under the contract (unless the parties take steps to novate the contract). Note that it is also not possible for a company to ratify a contract made before it came into existence.

Question 14

Company decision making

Answer 14

*As the company is inanimate, much of the standard day-to-day business of a company is carried out by the directors. Unless the power to take a particular decision has been delegated by the board of directors (the board) to a particular director or committee of directors, a decision of the board of directors of a company must be taken in accordance with the procedure set out in the company’s Articles.

*From time to time however, it will be necessary for specific authority to be given to a director (perhaps in connection with the execution of documentation on behalf of the company in respect of an especially important transaction).

• Alternatively, a matter may need to be referred to the company’s shareholders. For example, where:
• a matter is outside the powers of the directors and must be effected by a resolution of the shareholders (eg amending the company’s Articles); or
• a matter is within the powers of the directors but requires the prior approval of the shareholders before the directors can be authorised to act (eg making a loan to a director of the company).

Question 15

Board resolutions

Answer 15

Decisions of the directors are taken by passing Board Resolutions at Board Meetings (BMs).

Board Resolutions – each director has one vote.

Board resolutions are passed by simple majority (MA 7) unless the directors have agreed that a particular decision requires unanimity (MA 8).

Question 16

Shareholder resolutions

Answer 16

Decisions of the shareholders are taken by passing Shareholder Resolutions.

Shareholder resolutions may be passed either:

• At a meeting of the shareholders (referred to as a General Meeting (GM)), or
• In writing (for private companies only under s 288 CA 2006).

There are two different types of shareholder resolution:

• Ordinary Resolutions which are passed by a simple majority – so over 50% of the votes, and
• Special Resolutions which are passed by a majority of 75% or more of the votes.

Either CA 2006 or the Articles will stipulate what type of resolution is required.

Note that a written resolution is a method of voting, not a different type of vote.

Shareholder voting – show of hands and poll votes at General Meetings

Ata GM it is possible for shareholders to vote on a show of hands or on a poll. The votes are counted out of all the eligible shareholders who are present and voting at the meeting. Note that shareholders are entitled to appoint another person as their proxy to exercise all or any of their rights to attend and to speak and vote at any GM (s 324).

When the shareholders vote on a show of hands, each shareholder who is present at the meeting will be entitled to one vote, regardless of the number of shares held by that shareholder (provided the share has voting rights under the Articles) (s 284(2)).

When the shareholders vote on a poll, every shareholder has one vote in respect of each share held by them (s 284(3)).

The right to demand a poll vote is very important and will make a significant difference when the shareholders are not in agreement over a resolution. Section 321CA 2006 sets out the conditions that must be met in order for a shareholder to be entitled to demand a poll although these conditions may be relaxed by a provision in the Articles and in fact they are relaxed in the MA (see Art 44 MA).

Question 17

Voting on a Written Resolution

Answer 17

Under s 281 CA 2006 only private companies may pass a shareholders’ resolution by way of a written resolution.

Section 284(1) CA 2006 states that, where a company has a share capital, every member has one vote in respect of each share held by them when voting on a written resolution.

There are two types of written resolution:

• written ordinary resolution - passed by a simple majority of the total voting rights of eligible members (s 282(2) CA 2006).
• written special resolution:
• must state it is a special resolution, and
• passed by a majority of members representing not less than 75% of the total voting rights of eligible members (ss 283(2) and (3) CA 2006).

Note that there are two decisions that may not be passed as written resolutions (s 288(2), which are removal of a director under s 168, and removal of an auditor under s 510.

Question 18

Board Meetings

Answer 18

Board resolutions can be passed, without great formality, at a BM.

Who calls a BM?: MA 9provides that any director may call a BM or require the company secretary (if the company has one) to do so at any time. Therefore, the process is fairly informal and, when acting for a company, it is important to consider what the usual practice is for its directors.

Notice: In Browne v La Trinidad, the court held that reasonable notice of the BM was necessary, and that this would be whatever notice is usual for the directors to give. For example, if all the directors are in the same building, the meeting could be called almost immediately, if such notice is customary for the directors.

Quorum: Directors may not validly consider business unless a minimum number of directors entitled to vote are present at the time the meeting takes place. MA 11(2)requires a minimum of two directors to be present for the meeting to be quorate (unless the articles provide otherwise).

Voting: Board resolutions are passed by majority vote on a show of hands (MA 7(1)). Each director has one vote. The chair may have a casting vote to prevent deadlock (MA13 provides for this but it is possible for the company to amend this).

Question 19

General Meetings

Answer 19

Who calls a GM?: The Board will usually convene (ie call) a GM.

Notice: For private companies, 14 clear days’ notice is required (s307(1) CA 2006)(subject to a shorter notice period – see later). In this context, the word ‘notice’ refers to a period of time (between the board’s act of convening a GM and its actually taking place).

• Section 360(1) CA 2006 states that the clear-day rule applies to s 307(1) CA 2006, and in counting the days of the notice period, the day of the meeting and the day the notice is given are both excluded. Note: s 1147 CA 2006 provides that if the notice is posted or e-mailed, it is deemed to be served 48 hours after sending.
• In order to convene the GM, the board must inform the shareholders of when (and where) it is taking place, by giving notice to the shareholders. In this context, the word ‘notice’ refers to a document inviting shareholders to attend the GM.
• The directors must approve the form of the notice of the GM and then they must authorise its circulation to the shareholders.

Quorum: the quorum for a GM is generally two shareholders (s 318(2) CA 2006), although it is one shareholder for single member companies (s 318(1) CA 2006).

Question 20

Company meetings – the ‘GM sandwich’

Answer 20

You saw above that it is generally the Board who will call a GM (note that it is possible in limited circumstances for shareholders to do this and we will explore this later in this module). Where a shareholder vote is required for a certain transaction, it is therefore necessary for the company to hold a series of meetings (depicted below):

• A BM is first required in order to call the GM;
• A GM is then required for the shareholders to vote on the resolution;
• A further BM is then required to put into effect the outcome of the shareholder vote, and
• There may be post meeting matters (PMM) to attend to such as filings at Companies House.

We will now look at this process in more detail, starting by looking at the procedure where the GM is held on full notice.

BM – GM – BM – PMMs

Question 21

Sequence of Meetings – full notice GM

Answer 21

Board Meeting 1 - A BM is held to decide on the issues to be considered at the GM, to resolve to convene the GM, to approve the form of notice for the GM and to authorise its circulation. The notice of the GM will set out the wording of the resolutions to be put before the shareholders. The notice of the GM is then circulated to the shareholders by the company secretary (if the company has one) or by the directors.

General Meeting - The GM will take place and the shareholders will vote on the resolutions set out in the notice.

Board Meeting 2 - A further BM will be held and the directors will be informed as to how the shareholders voted at the GM and whether the resolutions were passed. The directors will then authorise the company secretary, or a director, to deal with the post-meeting matters.

Post-Meeting Matters (PMMs) - The PMMs will then be carried out by the company secretary (if the company has one) or a director (if not). This means that copies of the relevant documents will be filed at Companies House, and the company’s internal records (minute books and registers) will be brought up-to-date. We will consider the PMMs further below.

Question 22

Shortening the notice for a GM

Answer 22

You have seen previously in this element that the Board is required to give the shareholders at least 14 clear days’ notice of the GM. However, you can appreciate that for some companies (eg those where the same persons are the directors and shareholders) this notice period might hold up the decision-making process of a company unnecessarily.

The CA 2006 allows for GMs to be called on less than the usual amount of short notice if sufficient members agree. Section 307(5) CA 2006 provides that, for a private company, a GM may be called on short notice if this is agreed to by:

• a majority in number of the members who,
• together hold shares with a nominal value of not less than 90% of the total nominal value of the shares which give the right to attend and vote at the GM.

This percentage may be increased to up to 95% by a provision in the company’s articles of association but there is no such provision in the MA.

Therefore, where companies have few shareholders, it is often possible for meetings to be held at short notice.

Question 23

Sequence of meetings – short notice GM

Answer 23

equence of meetings – short notice GM

If all the shareholders are available at the time the directors decide to convene a GM, the following sequence of events may be possible. All this can be dealt with in under an hour.

• A BM is held to resolve to convene the GM, to approve the form of notice for the GM and the form of consent to short notice, and to authorise their circulation to the shareholders. The notice of the GM and the form of consent to short notice are then given to the shareholders who indicate their agreement for the GM to be held on short notice by signing the form of consent to short notice. The BM is then adjourned to enable the GM to take place.
• The GM takes place immediately following the adjournment of the BM and the shareholders vote on the resolutions set out in the notice.
• The BM is then reconvened. The directors are informed as to how the shareholders voted and they authorise one of their number to take the relevant action and deal with the post-meeting matters.
• The PMMs will then be carried out.

Question 24

Written Resolutions – Procedure

Answer 24

Sections 288 - 300 CA 2006 contain the general provisions applying to written resolutions.

• A written resolution is passed when the required majority of those eligible members signify their agreement to it. If the company does not receive a sufficient number of responses to pass the resolution, it will lapse. For a company with MA, the lapse date is 28 days beginning with the circulation date. A company can choose another period of time in its Articles.
• Section 288(2) CA 2006 provides that resolutions to remove a director or auditor from office may not be passed by way of written resolutions (essentially to allow the director or auditor time and opportunity to mount a defence).
• Auditorsare entitled to copies of written resolutions.
• Written resolutions must be recorded in the minute books in the same way as minutes of a GM.

Sequence of meetings – Written Resolution

• A BM is held to resolve to propose the use of the WR procedure and to approve the form of wording of the WR. The WR is then circulated to the shareholders.
• There are two options to proceed:
• If the shareholders are present (as if there had been a meeting), the BM is adjourned. The approval of the WR takes place immediately following the adjournment of the BM and the shareholders vote on the resolutions set out in the WR by signing to signify their approval or not signing or abstaining (both of which constitute votes against the resolution); OR
• If the shareholders are not present (eg they are in different parts of the country/world), the BM is closed. The WR is circulated to the shareholders. The WR is passed once it receives the requisite level of support or it will deem to lapse after 28 days (for a MA company).
• The BM is then reconvened OR a second BM is called. The directors are informed as to how the shareholders voted and they authorise one of their number to take the relevant action and deal with the post-meeting matters. The PMMs will then be carried out.

Question 25

Post-Meeting Matters

Answer 25

Essentially the PMMs break down into three categories:

• Internal
• Minutes of all meetings need to be kept for 10 years
• Updating of statutory books eg register of members, directors, PSC register
• Filing at Companies House
• All special resolutions must be filed. Generally ordinary resolutions do not need to be filed (but you will encounter some exceptions).
• Amended Articles must be filed, along with any forms that the Companies House requires eg Change of Name form.
• Record Keeping
• You will come across various documents that need to be kept at the registered office, eg directors service contracts.

Question 26

The role of directors

Answer 26

One key point to remember when considering the role of directors is that, as a company is inanimate, it is the directors who on a day to day basis are responsible for managing the company through an agency relationship. The directors are accountable to the company itself rather than to the shareholders directly. The shareholders own the company yet have input only into certain key decisions. It is therefore important to remember the relationship between directors and shareholders:

Directors

• Manage the company on a day to day basis – on an agency basis
• Certain actions can only be taken by directors if the shareholders have given authority
• Owe duties to the company

Question 27

Shareholders

Answer 27

• Own the company
• Are able to control key decisions through shareholder resolutions eg to give directors authority to change the name of the company

It is common for directors and shareholders to be the same people in a company.

Directors’ authority to manage the company

CA 2006 reserves certain important decisions for shareholder approval, such as changing the company’s name (unless the articles provide otherwise), amending the articles of association, removing directors and so on.

The board of a company with MA is usually free under a company’s articles to make decisions on behalf of the company on all other matters (MA 3).

The directors can therefore act on behalf of the company to employ individuals (other than directors on long term service contracts) and decide what they will be paid, enter into contracts with customers and suppliers, buy and sell company property, raise funds by borrowing from banks and authorise the company’s assets to be used as security. The directors are also responsible for putting together company accounts and for supplying information to auditors. These are just a few examples of the decisions that directors are free to make without shareholder approval.

MA 5 allows the Board of Directors to delegate a particular decision to one of the directors or a committee. For example, a HR Director might be delegated decision-making with regards to the HR decisions of a company.

Question 28

Directors’ accountability

Answer 28

The power delegated to the directors is therefore extremely wide and, if this power were left unchecked and unregulated, the less ethically minded might start using companies as a medium for a variety of corrupt practices. Certain directors may, for example, decide to lend themselves company funds on very favourable terms or even give false or misleading statements in the accounts to make the company look more attractive to investors or banks.

In order to prevent such practices and to ensure companies are run for the benefit of, amongst others, their shareholders and for the protection of the company’s creditors, directors’ actions and powers are restricted and regulated by statute. The key provisions are included in Part 10 of CA 2006, which includes directors’ general duties. We will look at directors’ duties in detail later in this topic.

Directors can be made to account for wrongs done through civil and criminal actions taken against them for breaching the Companies Acts. They may also be found guilty of criminal actions and sentenced under other legislation eg fraud under the Fraud Act 2006, and/or offences under the Theft Act 1968; insider dealing under the Criminal Justice Act 1993; money laundering under the Proceeds of Crime Act 2002.

Question 29

De jure directors and de facto directors

Answer 29

A de jure director is a director who has been validly appointed at law.

Under s 154 CA 2006:

• a private limited company must have at least one director and
• a public limited company must have at least two directors.

Although a company can be appointed as a director, every company must have at least one director who is a natural person (s 155(1) CA 2006) to ensure that for all companies, there will always be one individual in place to aid accountability.

The CA 2006 does not prescribe a maximum number of directors and neither do the MA, but a company can put a maximum number of directors into its own articles.

Under s 157 CA 2006 a person may not be appointed as a director unless they are at least 16 years old.

A de facto director is someone who assumes to act as a director but has in fact not been validly appointed. The fiduciary duties and liabilities apply to de facto directors as they do to de jure directors.

Question 30

Shadow directors

Answer 30

Sometimes a person (usually a shareholder) may try to exert influence over the board but without being appointed as a director, in an effort to avoid the duties imposed on directors under CA 2006 and the common law.

Section 251(1) CA 2006 defines a shadow director as ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act’. Section 251(2) makes it clear that professional advisers are not to be regarded as shadow directors eg an accountant providing professional advice on the company’s finances will not usually be a shadow director, even if the directors follow the advice of the accountant exactly.

This legislation is designed to ensure that anyone who acts as a director, even if they are not technically appointed as one, is subject to the duties and restrictions which apply to all directors. For example, a friend of a director who gives advice from ‘behind the scenes’, which the directors follow, would be seen as a shadow director. Most of the provisions in the CA 2006 and the Insolvency Act 1986 imposing duties, obligations or restrictions on directors therefore apply equally to shadow directors.

(See for example, s 162(6) in respect of the keeping of registers of directors, s 223 in respect of transactions with directors requiring shareholder approval, and ss 230 - 231 CA 2006 concerning the keeping of copies of service contracts and the wrongful trading provisions under s 214 IA 1986.)

Question 31

Executive and non-executive directors

Answer 31

The CA 2006 does not differentiate between executive and non-executive directors, but in practice there is a distinction. However, note that the duties, obligations and restrictions placed on directors under CA 2006apply to all directors, executive and non-executive.

Executive directors

An executive director is a director who has been appointed to executive office. Such a director will generally spend the majority, if not all, of their working time on the business of the company and will be both an officer and an employee of his company. Examples include a Finance Director, Managing Director, Marketing Director.

Non-executive directors

A non-executive director is also an officer of the company but will not be an employee of the company. Non-executive directors do not take part in the day-to-day running of the company. Their role is generally to provide independent guidance and advice to the board and to protect the interests of shareholders.

Question 32

Alternate directors

Answer 32

The office of director is a personal responsibility. However, some companies in their articles provide for alternate directors to take the place of a director where one or more directors are absent.

An alternate director is usually either a fellow director of the company or someone who has been approved by a resolution of the board of directors. The alternate director has the voting powers of the absent director.

The MA do not provide for the appointment of alternate directors and, since it is now possible to hold board meetings over the telephone and to pass board resolutions by means of written resolutions, the use of alternate directors is becoming quite rare.

Whether or not the provisions of CA 2006 apply to alternate directors is a matter of construction, but it is thought that the duties of directors will apply equally to alternate directors.

Question 33

Company secretary

Answer 33

A company secretary’s main duties are to keep the company books up-to-date, produce minutes of board and general meetings, and make sure that all necessary filings are made at Companies House. It is not a part of their role to take decisions on behalf of the company, which is the domain of either the directors or the shareholders.

In the past all companies were required to have a company secretary. But under CA 2006:

• a private company is not required to have a company secretary (s 270(1) CA 2006) unless the articles require it to have one. If a private company does not have a company secretary, the directors (or any person the directors authorise) may do anything that the secretary was required or authorised to do (s 270(3)(b) CA 2006).
• a public company must have a company secretary (s 271 CA 2006).

Part 12 of the CA 2006 applies to all companies with a company secretary. A public company secretary must have the requisite knowledge and experience, and one of the qualifications set out in s 273(2) CA 2006 (for example, the secretary may be a solicitor or a chartered accountant). The directors appoint the secretary and are required to check that the secretary qualifies under these provisions.

Question 34

Appointment of directors

Answer 34

CA 2006 does not stipulate a procedure for the appointment of directors, so this is something that will be governed by the Articles of the company.

The MA deal with the matter simply. Companies with MA may appoint a director:

By an ordinary resolution of the shareholders - MA 17(1)(a)

By a decision of the directors - MA 17(1)(b)

It is usual for the board of directors to appoint new directors under MA17(1)(b) because is easier to put into effect. Unless there is a particular reason for using the ordinary resolution procedure, a director will be appointed by the majority of the other directors.

Of course, companies may instead have custom Articles setting out an alternative procedure for the appointment of directors, therefore you must always check the Articles of a company before advising on the appointment of directors.

Question 35

Service contracts

Answer 35

An executive director will be an employee of the company. As an employee, they should be given a written contract of employment (otherwise known as a service contract), setting out the terms and conditions of employment including duties, remuneration package, notice provisions etc. There is no automatic entitlement for directors to be paid for their services – this is something that the board can determine, subject to the provisions of the company’s articles.

The Company has an obligation to keep its directors’ service contracts at its registered office for inspection by the members (s 228 CA 2006).

The effect of Art 19 MA is that the terms of an individual director’s service contract, including remuneration, are for the board to determine. As a general rule, a director’s service agreement will only require the approval of a resolution of the board of directors. However, shareholder approval is required to enter into long-term service contracts under s 188 CA 2006. You will look at this in the next element.

It is worth noting that one individual can be a director, a shareholder and an employee of a company. These are three separate roles.

Question 36

Disclosure of identity of directors and secretary

Answer 36

The CA 2006 requires certain details about a company’s directors to be disclosed either publicly or to the members.

Every company must maintain a register of its directors (s 162(1) CA 2006) and secretary (s 275(1) CA 2006) and should keep these registers at its registered office.

Each company must also notify the Registrar of Companies (ie Companies House) of changes relating to its directors (s 167 CA 2006) or secretary (s 276 CA 2006) using forms published by Companies House (eg AP01 for Appointment of Director).

The particulars which must be registeredin relation to directors are specified in ss 163(1) and 164 CA 2006 (and those for secretaries in ss 277(1) and 278(1) CA 2006).

The information kept at Companies House is available for inspection by the public (s1085(1) CA 2006) and, in addition, the register kept at a company’s registered office must be open for inspection by any member of the company without charge and by any other person on payment of a fee (ss 162(5) and 275(5) CA 2006 for the register of directors and secretaries respectively).

Question 37

Privacy for Officers of the Company

Answer 37

The provisions of CA 2006 allow the directors and secretary more confidentiality than had previously been the case.

Section 163(1) CA 2006 specifies that only a service address for a director needs to be included on the company’s register of directors (s 277(5) CA 2006 contains the same provision in relation to the address to be included on the company’s register of secretaries). This service address can either be the director’s residential address (if they are not concerned with the need for privacy) or could simply be the company’s registered office and will be the only address available to the public generally. Residential addresses that are already on the public register will not be removed automatically.

Individual directors (but not secretaries) will still have to provide their residential address under s 165 CA 2006, but this information will be kept on a separate, secure register. This register is not open to public inspection.

Question 38

Disclosure required: annual accounts

Answer 38

Section 412 CA 2006 relates to information about directors’ (and past directors’) remuneration and what information will need to be included in the company’s annual accounts. Two SIs currently set out in detail the information which needs to be included in the notes to a company’s annual accounts. This includes information relating to:

• the directors’ salaries, bonus payments and pension entitlements; and
• compensation paid to directors and past directors for loss of office.

Section 412 CA 2006 also requires details to be disclosed of any payments made to, or receivable by, a person connected to such a director or a body corporate controlled by a director.

Section 413 CA 2006 relates to the disclosure of information on advances and credits given by a company to its directors and guarantees entered into by a company on behalf of its directors. Section 413 CA 2006 applies to a person who was a director at any time during the applicable financial year.

Question 39

Removal of a director by the shareholders

Answer 39

The ability to remove a director from office is the ultimate sanction that shareholders have against a director. The director may not be performing well in their role or there may be a personality clash or a difference of opinion about company strategy and the best way to expand the business of the company.

Under s 168(1) CA 2006, a company (ie the shareholders) may by ordinary resolution remove a director before the expiration of their period of office.

Under s 168(2) CA 2006 special notice (28 days) is required of a removal resolution.

It is not possible for the Board to remove a director (unless the Articles specifically provide for this).

Directors who are also shareholders are allowed to vote in their capacity as a shareholder on the ordinary resolution to remove them.

You will learn about the process by which shareholders may remove a director in detail in ‘The rights and remedies of shareholders’ topic (‘Removal of a Director’ element).

Question 40

Vacation from office

Answer 40

Resignation by notice

A director may simply take the decision to resign from the board by tendering a letter of resignation. This procedure is provided for in MA 18(f). It is usual, although not obligatory, in these circumstances for the board to pass a board resolution accepting the letter of resignation.

Automatic termination

Under MA 18 a person ceases to be a director as soon as:

• the director becomes disqualified from being a director;
• the director becomes the subject of an individual voluntary arrangement (or similar);
• the director becomes bankrupt, or
• a registered medical practitioner who is treating the director states in writing to the company that the director has become physically or mentally incapable of acting as a director and will remain so for more than three months.
• Disqualification - Company Directors Disqualification Act 1986 (‘CDDA’)
• The CDDA is the key piece of legislation regarding disqualification of directors. Under this Act, the court may make a disqualification order against a person preventing them, unless they obtain leave of the court, to be a director, liquidator, receiver or in any other way directly or indirectly involved in the promotion, formation or management of a company. The purpose of such an order is to protect the public against the activities of such a director. Grounds for disqualification include fraudulent or wrongful trading or persistent breaches of company law.
• The period of disqualification is for a maximum of 15 years. If a director has been disqualified under the CDDA, it is a criminal offence to participate directly or indirectly in corporate management without leave of the court.
• Retirement by rotation
• The model articles for public companies require retirement and reappointment of directors by the members every three years. In addition, all directors of listed companies are subject to annual re-election.
• Companies House filing requirements
• When a director leaves office, the company must both update the company’s register of directors and also give notice to Companies House by filing form TM01 (Termination of appointment of director).

Question 41

What are the general duties of directors?

Answer 41

The general duties of directors are owed by a director to the company (and not to the shareholders directly). Any breach of duty by a director is therefore a wrong done to the company and it is the company who would therefore be the claimant in proceedings in respect of a breach of duty by a director. Note though that when a company is in financial difficulty, the position changes and the directors’ duties shift to the protection of the creditors. We will look at this in more detail in the insolvency topics.

The statutory duties apply to all types of directors.

The general duties of directors ss 170 – 177 CA 2006

The general duties are set out in sections 171-177 CA 2006 and are as follows:

• Duty to act within powers (s 171 CA 2006);
• Duty to promote the success of the company for the benefit of the members as a whole (s 172 CA 2006);
• Duty to exercise independent judgment (s 173 CA 2006);
• Duty to exercise reasonable care, skill and diligence (s 174 CA 2006);
• Duty to avoid conflicts of interest (s 175 CA 2006);
• Duty not to accept benefits from third parties (s 176 CA 2006); and
• Duty to declare any interest in a proposed transaction (s 177 CA 2006).

Question 42

Section 171 CA 2006: Duty to act within powers

Answer 42

1. Duty to act within the company’s constitution

The company’s constitution is defined in s 257 CA 2006 and includes everything set out in the company’s articles of association and decisions taken in accordance with the articles (ie shareholder resolutions). A director is in breach of this duty if they act without authority, eg commit the company to borrow more than the articles allow without prior shareholder approval.

2. Duty to exercise powers for the purposes for which they are conferred

Directors must not use their powers for improper purposes (eg for personal gain).

Section 172 CA 2006: Duty to promote the success of the company

This duty has been the subject of much debate. It is seen as codifying the previous common law duty requiring directors to act in the ‘best interests’ of the company. It forms the central duty under the new regime.

Section 172 CA 2006 stipulates that a director must act in a way which they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.

The Government has stated that ‘success’ should normally mean, for commercial companies, a ‘long-term increase in value’.

The list of matters to be considered is not exhaustive. It is clear that the list is secondary to the duty to shareholders under s 172 CA 2006, and that the duty is owed to the company and not to the third party.

In exercising this duty, a director is required to have regard to a range of non-exhaustive matters which are set out in s 172(1) CA 2006, including:

the likely long-term consequences of any decision

employees’ interests

the need to foster relationships with suppliers, customers and others

the impact of the company’s operations on the community and the environment

the desirability of the company’s maintaining a reputation for high standards of business conduct

the need to act fairly as between the members of a company

Although many of these matters were not specifically provided for under the common law, many companies would routinely consider such matters, as a necessary part of good business practice following the concept of ‘enlightened shareholder value’. This is a term used to describe the ‘middle way’ between, on the one hand, running the company purely to maximise shareholders’ interests/profits and, on the other hand, a pluralist approach which involves acting in the interests of a wider group of stakeholders.

Question 43

Compliance with s 172 CA 2006

Answer 43

Since the introduction of the statutory duties there has been some uncertainty as to how to balance the various matters in the list, which will inevitably conflict from time to time.

One fear was that companies may feel the need to respond by having more detailed board minutes to document how they have considered each area for every decision made. Another was that the new duty under s 172 CA 2006 may lead to increased litigation. Neither fear has yet come to pass.

Many companies are taking the common-sense approach of ensuring board minutes clearly note that consideration has been given to the s 172 CA 2006 duty when taking board decisions particularly, with regard to significant commercial decisions, there will have been the requisite amount of research, discussion and briefing of the board to amply demonstrate consideration of the matters in s 172(1) CA 2006 should the company be challenged.

The courts appear to be backing this approach given the lack of significant case law on the point since these provisions came into force.

From January 2019 there is a requirement for certain companies (including all public listed companies) to make a s 172 statement in their accounts about how they have considered and met the duty over the year.

Question 44

Section 173 CA 2006: Duty to exercise independent judgment

Answer 44

This duty codifies the principle that directors must exercise their powers independently, and not fetter their discretion other than in accordance with s 173(2) which states the duty is not infringed by a director acting:

(a) in accordance with an agreement entered into by the company that restricts the future exercise of discreation by its directors; or

(b) in a way authorised by its constitution.

They can rely on advice from others but must make their own judgments. Directors must be mindful of the individual nature of this duty when acting.

They cannot blindly follow others’ views without considering the interests of the company.

Question 45

Section 174 CA 2006: Duty to exercise reasonable care, skill and diligence

Answer 45

The level of care, skill and diligence which a director must exercise is assessed objectively and subjectively.

The required level is the level of skill, care and diligence which would be exercised by a reasonably diligent person with:

• the general knowledge, skill and experience that may reasonably be expected of someone in their role; and
• the general knowledge, skill and experience of that director.

The minimum standard expected of a director is that objectively expected of a director in that position. This standard may then be subjectively raised if the particular director has any special knowledge, skill and experience.

Question 46

Section 175 CA 2006: Duty to avoid conflicts of interest

Answer 46

This duty is the first of three duties aimed at dealing with conflicts of interest which directors might experience.

This duty requires a director to ‘avoid a situation in which they have, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.’

This is quite widely drafted and is said to apply ‘in particular to the exploitation of any property, information or opportunity’. It is no excuse for the director to say that the opportunity is not one which the company could have exploited itself.

The duty is not infringed ‘if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest_’_ or if the conflict arises:

• in relation to a transaction with the company (eg a transaction between the director and the company) (s 175(3) CA 2006); or
• in relation to a matter which has been authorised by the directors (s 175(4)(b) CA 2006).

Question 47

Section 176 CA 2006: Duty not to accept benefits from third parties

Answer 47

This is the second of the three duties aimed at conflicts of interest. Under this section, a director must not accept a benefit from a third party which is conferred by reason of them being a director, or by reason of them doing (or not doing) anything as a director.

However, note that the duty is not breached if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest (s 176(4) CA 2006).

Note that, unlike the duty in s 175 CA 2006, the other directors cannot authorise an arrangement under this section. There is no provision allowing them to do so. It would be possible for the shareholders to approve a director’s proposed action in advance or for ratification under s 239.

Question 48

Section 177 CA 2006: Duty to declare an interest in a proposed transaction

Answer 48

This is the third of the three duties aimed at conflicts of interest. Any director who is interested in a proposed transaction with the company must declare the nature and extent of their interest to the other directors. This covers indirect interests, as well as direct interests.

In addition to the duty under s 177 CA 2006 to disclose interests in proposed transactions entered into by the company, directors are also required to disclose interests in existing transactions or arrangements entered into by the company (s 182 CA 2006.

Question 49

Procedural Matters relating to s 177 CA 2006

Answer 49

• Note that s 177 CA 2006 applies equally to ‘indirect interests’. An indirect interest is not always easy to identify. Where a director has some interest whether through a spouse or another relative or through a company in which they are a member, the director is likely to be deemed to have an indirect interest. The director does not have to be party to the transaction for s 177 CA 2006 to apply.
• A director must declare their interest in a proposed transaction before the transaction is entered (s 177(4) CA 2006, subject to anything different expressed in the articles).
• The declaration can be at a Board Meeting (s 177(2)(a) CA 2006) or in writing in advance of the Board Meeting (s 177(2)(b)(i) CA 2006). It is also possible for directors to give a one-off general notice of their interest (s 177(2)(b)(ii) CA 2006). Best practice suggests that an interested director will declare that interest at BM1.
• If a director discloses an interest to the other directors by way of written notice rather than in a meeting of the directors, then the notice must be sent to all directors either electronically (if agreed) or in paper form (s 184 CA 2006).
• Under s 185, a director can give general notice to the effect that they are always to be considered interested in any transaction or arrangement with a specified party. This will be if a director has an interest in a specified body corporate or firm (s 185(2)(a) CA 2006) or is connected to a specified person (s 185(2)(b) CA 2006).

Question 50

When does a director NOT need to make a declaration pursuant to s 177 CA 2006?

Answer 50

Sections 177(5) and (6) CA 2006 set out when a director is not required to make a declaration; namely when:

• the director is not aware of the interest or transaction or arrangement in question (a director is treated as being aware of the interest or transaction/arrangement if it is a matter of which they ought reasonably to have been aware);
• the interest cannot reasonably be regarded as likely to give rise to a conflict of interest or the other directors know about or ought to have known about the conflict of interest; or
• if the conflict arises because it concerns their service contract and their service contract has been or will be considered by the board, or a committee of the board, of directors.

In practice, directors are likely to continue to declare their interests even if the other directors know or ought to have known about any conflict. This can easily be documented in the board minutes and avoids the need to rely on an exception that may or may not apply.

Question 51

Section 177 CA 2006 and MA 14

Answer 51

MA 14 specifies that a director who is interested in a transaction or arrangement with the company cannot vote on or count in the quorum for board resolutions in respect of that transaction or arrangement.

This could cause difficulties in small companies. However, MA 14(2) and (3) allow the conflicted director to count in the quorum and vote if:

• the company disapplies MA 14(1) by ordinary resolution;
• the director’s interest cannot reasonably be regarded as likely to give rise to a conflict of interest; or
• the director’s conflict arises from a permitted cause (defined in MA 14(4)).

An alternative, and more permanent, measure would be to remove MA 14 under s 21 CA 2006 and replace it with an article expressly permitting a director interested in a transaction or arrangement with the company to vote and count in a quorum on board resolutions to approve the transaction or arrangement.

Question 52

Remedies for breach of directors’ duties

Answer 52

Directors owe their duties to the company, rather than to individual shareholders. If directors breach their duties, the company has a claim against them personally in law.

Under s 178 CA 2006, the consequences of a breach of directors’ duties are the same as for breach of the corresponding common law or equitable principles. With the exception of the duty to exercise reasonable care, skill and diligence (s 174 CA 2006), the statutory duties are enforceable in the same way as fiduciary duties owed by directors to their company.

Section 174

The remedy for a breach of the duty of care, skill and diligence (s 174) is damages.

Sections 171 – 173 and 175 – 177

Remedies for breaches of general duties other than s 174 include:

• injunction;
• setting aside of the transaction;
• restitution and account of profits;
• restoration of company property;
• damages.

Question 53

Shareholder approval in advance

Answer 53

Shareholders may support a director’s proposed action, and be prepared to approve it in advance, even though it would otherwise represent a breach of the general duties set out in ss 171-177 CA 2006. Note however that shareholders cannot approve unlawful acts in this way.

The statutory duties under CA 2006 are said to ‘have effect subject to any rule of law enabling the company to give authority, specifically or generally, for anything to be done (or omitted) by the directors … that would otherwise be a breach of duty’ (s 180(4) CA 2006).

This represents a continuation of the common law approach.

Authorisation is only effective provided there has been full disclosure by the directors so that the shareholders are properly aware of the details of the action and can make an informed decision.

Question 54

Ratification for breach of duty

Answer 54

The shareholders can, by ordinary resolution, subject to anything in the company’s articles requiring a higher majority or unanimity, under s 239(2) CA 2006, ratify (ie approve after the breach) the following conduct of directors:

• negligence;
• default;
• breach of duty; and
• breach of trust.

If a director holds shares in the company, then any votes to ratify their breach which attach to shares held by them or any person connected with them (eg their spouse, children, parents or a company which they control – see ss 252 and 253 CA 2006) will be disregarded under s 239(4) CA 2006.

Unlawful acts can never be ratified (eg declaring a dividend when no distributable profits are available) and shareholders cannot ratify a director’s breach of fiduciary duty in insolvency situations since directors owe their duties to creditors, not shareholders, once the company is insolvent.

Question 55

Transactions with Directors

Answer 55

On this module you will learn about three types of transaction between the company and its directors (or people connected to them) which are regulated by CA 2006 and which require the approval of the company’s shareholders, in order for the transaction to be valid. The particular types of transaction are:

Directors’ long-term service contracts (ss 188 – 189 CA 2006)

Substantial property transactions (ss 190 – 196 CA 2006)

Loans, quasi-loans and credit transactions (ss 197 – 214 CA 2006)

In these transactions there is a real risk of conflict between the interests of the directors and the shareholders. If the directors proceeded with any of these transactions without obtaining shareholder approval, then they would be in breach of their general duties under s 171 – 177 CA 2006, as well as in breach of the requirements above.

Question 56

Directors’ long-term service contracts (s 188 CA 2006)

Answer 56

Under s 188(2)(a) CA 2006 (combined with s 281(3) CA 2006)), shareholder approval by ordinary resolution is required for any director’s service contract which is, or may be, for a guaranteed period in excess of two years (referred to as the ‘guaranteed term’). The guaranteed term applies to either:

• a period during which the contract is to continue other than at the instance of the company (ie a contractual term of more than two years or where the director is in control of how long the contract continues) (s 188(3)(a)(i) CA 2006), and
• during this time the company either cannot terminate the contract or can only terminate in specific circumstances (s 188(3)(a)(ii) CA 2006).
• OR the period of notice to be given by the company (s 188(3)(b) CA 2006).

It will also apply to an aggregate of any periods covered by either s 188(3)(a) or (b).

Note that s 188(2)(b) CA 2006 also makes it clear that if the director is also a director of any holding company, the shareholders of the holding company will also need to give approval.

Question 57

Consequences of non-compliance: s 189 CA 2006

Answer 57

If a company agrees to a provision in a service contract in contravention of s 188 CA 2006, the consequences are as follows:

• the provision will be void to the extent of the contravention under s 189 CA 2006, and
• the contract will be deemed to contain a term entitling the company to terminate it at any time by the giving of reasonable notice.

Question 58

Disclosure of Interest – s 177 CA 2006

Answer 58

Under s 177(6)(c) CA 2006, a director is not required to disclose their interest in the service contract. However, it is likely to remain the practice that directors will continue to make the declaration of interest under s 177(1) CA 2006 so that it is documented in the board minutes.

In addition, the director will not be permitted to vote or count in the quorum on any board resolution relating to the contract (MA 14(1)).

Question 59

Members’ inspection rights of all directors’ service contracts - s 228 CA 2006

Answer 59

A company must keep a copy of all directors’ service contracts (or, where the contracts are not in writing, memoranda of their terms) at the company’s registered office or a place specified in regulations made under s 1136 CA 2006 for a period of at least one year from the date of termination or expiry of the contract for members to inspect. This obligation applies regardless of the length of any service contract and whether or not it is terminable within 12 months. Under s 229 CA 2006 members have the right to inspect without charge or to request a copy on payment of a fee.

Question 60

Section 188 CA 2006: Procedural Issues

Answer 60

Where the ordinary resolution is to be passed at a General Meeting, s188(5)(b) CA 2006 sets out that a memorandum setting out the proposed contract must be made available for inspection by members of the company both:

a) at the company’s registered office for not less than 15 days ending with the date of the meeting; and

b) at the meeting itself.

A minimum of 15 days’ notice of the GM held to approve the contract will therefore have to be given to shareholders (even if the short notice procedure is followed) unless the written resolution procedure is used. You can see that this will impact on the speed with which the decision to approve the service contract or not can be made. There is no such 15-day requirement for a written resolution.

Where the written resolution procedure is being followed pursuant to s 188(5)(a) CA 2006, the memorandum setting out the proposed contract must be sent or submitted to every eligible member at or before the time at which the proposed resolution is sent or submitted to the member.

Question 61

Substantial property transactions (s 190 – 196 CA 2006)

Answer 61

Section 190 CA 2006 governs an acquisition or disposal by a director/holding company director (or connected person) of a substantial non-cash asset to or from the company.

These types of transaction are permitted but again require shareholder approval by ordinary resolution.

Shareholder approval must be given either before the transaction is entered into, or after, provided that the transaction is made conditional on approval being obtained.

Question 62

Section 190 CA 2006: Substantial Non-Cash Asset

Answer 62

‘Non-Cash Asset’ means any property other than cash (s 1163 CA 2006).

‘Substantial’ is defined in s 191 CA 2006 as follows:

• An asset worth £5,000 or less is not a substantial asset.
• An asset worth more than £100,000 is a substantial asset.
• An asset worth more than £5,000, but not more than £100,000 is a substantial asset only if it is worth more than 10% of the company’s net asset value. A company’s net asset value is that shown in its most recent statutory accounts.

If the company is only recently incorporated and no accounts have yet been prepared, then the net asset value is taken to be the amount of the company’s called up share capital.

Question 63

Connected persons – s 252 – 254 CA 2006

Answer 63

The definition of ‘persons connected with a director’ is set out in ss 252–254 CA 2006. The definition is complex and where you suspect that a connected person may be involved, you should always check the details of the legislation. However, in summary, the key categories of connected persons are:

Members of the director’s family: spouse or civil partner, parents, children or step-children (s 253(2)). Note that brothers, sisters, grandparents, grandchildren, uncles and aunts are NOT connected persons under CA 2006.

Bodies corporate ie companies in which the director (and others connected with them) holds 20% or more of the shares (s 254).

A business partner of the director or those connected with them (s 252(2)(d)).

Trustees of a trust the beneficiaries of which include the director or those connected with them (s 252(2)(c)).

Question 64

Holding company

Answer 64

Section 190(2) CA 2006 states that if the transaction is between a company and a director of the company’s holding company or a person connected to a director of the holding company, the holding company will also need to approve the transaction by OR.

Exceptions

Under s 190(4)(b), approval is not required by the members of any company which is a wholly-owned subsidiary of another company. This is exactly the same rule that you saw in relation to a director’s long-term service contract (s 188).

In addition, there are a list of limited exceptions in s 192 CA 2006. If the arrangement falls within the list of transactions within this section, it will not require shareholder approval. For example, if a director who is also a shareholder sells their shares back to the company, this transaction will not be a SPT because it falls under s 192(a) as a transaction between a company and a person in their capacity as a shareholder.

Remedies (s 195 CA 2006)

Where a SPT is entered into without shareholder approval, under s 195(2) CA 2006 the transaction is voidable at the instance of the company unless:

(a) restitution is no longer possible,

(b) the company has been indemnified for the loss or damage suffered by it, or

(c) rights acquired in good faith by third party would be affected by the avoidance.

The directors involved (and those so connected under s 195(4) CA 2006) are liable to account to the company for any profits made and to indemnify the company for any loss incurred s 195(3) CA 2006.

Section 196 CA 2006 allows for the arrangement to be affirmed by the shareholders of the company and the holding company (where relevant) by ordinary resolution within a reasonable period. If the transaction is affirmed, the arrangement may no longer be avoided under s 195 CA 2006.

Defences (s 195 CA 2006)

If the SPT is between a company and a person connected with a director, and the director concerned shows that they took all reasonable steps to ensure the company’s compliance with s 190 CA 2006, the director will not be liable under s 195(6) CA 2006.

There is also a defence under s 195(7) CA 2006 for any connected person (if relevant) and any director who authorised the transaction who can show they had no knowledge of the circumstances constituting the contravention.

Question 65

Sections 190 & 177 CA 2006

Answer 65

Under s 177(1) CA 2006 a director would need to disclose the nature and extent of their interest to the board.

Under the exception in s177(6)(b) CA 2006, it is arguable that an interested director need not formally to declare an interest if the other directors are already aware of it. However, it is likely to remain the practice that directors will continue to make the declaration so that it is documented in the board minutes.

Under MA 14(1), any interested directors will not be permitted to vote on the board resolutions to approve the contract and authorise a signatory. They cannot count in the quorum for board resolutions regarding the contract either.

Question 66

Loans and related transactions with directors

Answer 66

Company loans to directors, holding company directors and connected persons, although permitted, may also be subject to the requirement of shareholder approval by ordinary resolution.

The restrictions set out in this part of CA 2006 apply to four different types of transaction:

Loans – where the company lends money to a director (197 CA 2006);

Quasi-loans – as defined in s 199 CA 2006. An example of a quasi-loan would be where a company agreed to pay off an outstanding account owed by a director to a third party on the understanding that the director would later reimburse the company;

Credit Transactions – as defined in s 202 CA 2006. A credit transaction includes any transaction entered into between the company and the director where the company provides goods or services on a credit basis which will be paid for at a later date. Only the company and the director will be parties to this arrangement; and

Guarantees or the provision of security for any of the above – eg where a director obtains a loan from a bank and their company stands as guarantor for the repayment of the loan or the company provides the bank with security over its assets.

Question 67

Which companies are restricted?

Answer 67

For these restrictions, it is important to distinguish between private companies on the one hand, and public companies and private companies that are associated with public companies on the other. Under s 256 CA 2006, companies are associated if one is a subsidiary of the other or both are subsidiaries of the same body corporate.

So, for example, a private company that is a subsidiary of a public company will be associated with the public company for these purposes.

You will see that private companies (not associated with a Plc) are subject to much less regulation than Plcs (or companies associated with Plcs).

All companies (s 197): Loans, guarantees or security for directors

No company may make loans to its directors or to directors of its holding company or give guarantees or enter into security in connection with loans to such directors, without the transaction first being approved by the shareholders by ordinary resolution. If the company in question is a private company that is not associated with a public company, these are the only transactions for which shareholder approval is required under the CA 2006 loan provisions.

Public companies and private companies associated with public companies (s 198 – 202): Quasi loans, credit transactions and connected persons

These companies also require shareholder approval for:

• Loans to a person connected to a director of the company or a director of its holding company (s 200);
• Quasi-loans (s 198) to, or credit transactions (s 201) with their directors and directors of a holding company or persons connected with such directors; and
• Guarantees or security in respect of any such loans, quasi-loans or credit transactions with their directors and directors of a holding company or persons connected with such directors (s 197, 198, 200, 201).

Question 68

Exceptions (s 204 – 209 CA 2006)

Answer 68

There are a number of exceptions to the requirement for shareholder approval, the details of which are set out in s 204 – 209 CA 2006. These are as follows:

• Section 204: Expenditure on company business (up to a maximum of £50,000);
• Section 205: Loans for defending proceedings brought against a director;
• Section 206: Loans for defending regulatory actions or investigations;
• Section 207: Minor and business transactions – loans or quasi-loans of up to £10,000 and credit transactions up to £15,000 do not require shareholder approval;
• Section 208: Intra group transactions, and
• Section 209: Money lending companies (where the loan is made in the ordinary course of the business of the company).

Question 69

Remedies (s 213 CA 2006)

Answer 69

If shareholder approval is not obtained and no exceptions apply, the consequences are set out in s 213 CA 2006. These are very similar to the consequences for breach of s 190 CA 2006, set out earlier. In relation to the transaction, the consequences are set out in s 213(2) CA 2006: the arrangement is voidable at the instance of the company unless:

(a) restitution is no longer possible,

(b) the company has been indemnified for the loss or damage suffered by it, or

(c) rights acquired in good faith by a third party would be affected by the avoidance.

The directors involved (and those so connected under s 213(4) CA 2006) are liable to account to the company for any profits made and to indemnify the company for any loss incurred (s 213(3) CA 2006).

Section 214 CA 2006 allows for the arrangement to be affirmed by the shareholders of the company and the holding company (where relevant) by ordinary resolution within a reasonable period. If it is affirmed, the arrangement may no longer be avoided under s 213 CA 2006.

Question 70

Defences?

Answer 70

If a transaction contravenes ss 200, 201 or 203 CA 2006 and is entered into with a person connected with a director, that director will not be liable if they took all reasonable steps to ensure the company complied with those sections (s 213(6) CA 2006).

There is also a defence under s 213(7) CA 2006 for any connected person (if relevant) and any director that authorised the transaction who can show they had no knowledge of the circumstances constituting the contravention.

Question 71

Holding Company

Answer 71

As with s 190 CA 2006, if the transaction is between a company and a director of the company’s holding company or a person connected to a director of the holding company, the holding company will also need to approve the transaction by OR.

Wholly-owned subsidiary Exemption

As with both ss 188 and 190 CA 2006 approval is not required by the members of any company which is a wholly-owned subsidiary of another company.

Question 72

Disclosures under s 177 CA 2006

Answer 72

Again, under s 177(1) a director would need to disclose the nature and extent of their interest to the board if they were interested in any of the transactions caught by ss 197-202 CA 2006.

Pursuant to s 177(6)(b) CA 2006, it is arguable that an interested director need not formally declare an interest if the other directors are already aware of it. However, it is likely to remain the practice that directors will continue to make the declaration so that it is documented in the board minutes. In addition, it will not always be obvious to the rest of the Board if the director has an indirect interest in a transaction, so directors should be advised to act cautiously.

Under MA14(1), any interested directors will not permitted to vote on the board resolutions to approve the transaction and authorise a signatory because it is “a… transaction…with the company in which [they] are interested”. They cannot count in the quorum for board resolutions regarding the contract either.

Question 73

Sections 197 - 201: Procedural issues

Answer 73

Where the ordinary resolution is to be passed at a General Meeting, a memorandum setting out the proposed transaction must be made available for inspection by members of the company both:

a) at the company’s registered office for not less than 15 days ending with the date of the meeting; and

b) at the meeting itself.

A minimum of 15 days’ notice of the general meeting held to approve the transaction will therefore have to be given to shareholders (even if the short notice procedure is followed) unless the written resolution procedure is used. You can see that this will impact on the speed with which the decision to approve the transaction or not can be made.

Where the written resolution procedure is being followed, a memorandum setting out the proposed transaction must be sent or submitted to every eligible member at or before the time at which the proposed resolution is sent or submitted to the member.

You will find these rules within the relevant statutory authority for each transaction.