'Substantial Property Transaction' Trend Grows

Relevant Legislation
Compliance Procedure
Effects of Non-Compliance
Comment

A recent Irish Independent survey(1) showed that the latest trend for entrepreneurs in Irish-quoted technology companies is to become the landlords for their own companies. Perhaps the best example of this operation is when the former Esat chairman and chief executive, Denis O' Brien, purchased a major development property from Esat in 1998 and then completed its development and leased it back to Esat. According to the article, for Denis O' Brien this will mean a total potential rental income of £1.47 million.

This update explains the law which is in place in relation to such 'substantial property transactions' and the procedures which are to be followed in order to enable them to happen.

Relevant Legislation

Since 1990 there has been legislation in place which aims to minimize the risk to creditors of directors or shadow directors abusing their status and causing the company to enter into an arrangement on less favourable terms that they would have received from a third party. Section 29 of the Companies Act 1990(2) is concerned with such 'substantial property transactions' and came into operation on February 1 1991. (Similar legislation exists in England and the corresponding provision is Section 320 of the UK Companies Act 1985.)

As a result of this provision, a company may not enter into an arrangement with the following persons unless the arrangement is first approved by a resolution of the company in general meeting:

• a director of the company;
  
  
• a director of its holding company; or
  
  
• a person connected with such director.

Further, Subsection (1) provides that a company shall not enter into an arrangement (i) whereby a director of the company or its holding company, or a person connected with such a director, acquires or is to acquire one or more non-cash assets of the requisite value from the company, or (ii) whereby the company acquires or is to acquire one or more non-cash assets(3) of the requisite value from such a director or a person so connected, unless the arrangement is first approved by a resolution of the company in general meeting. If the director or connected person is a director of a holding company or a person connected with such a director, a prior resolution in general meeting of the holding company is also required.

An 'arrangement' for the purposes of the section is an agreement whereby one or more non-cash assets are acquired by:

• the company from a director;
  
  
• the company from a person connected with its director or a director of its holding company; or
  
  
• a director or a person connected with him from the company or its holding company.

'Connected persons' are defined in Section 26 of the act as:

• the directors and their spouses, parents, siblings and children;
  
  
• a person acting in his capacity as the trustee of a trust whose principal beneficiaries are the director, his spouse or any of his children, or any body corporate which he controls; or
  
  
• a partner of that director.

'Requisite value' is defined by Section 29(2), which provides that for the purposes of Section 29 a non-cash asset is of the requisite value "if at the time the arrangement in question is entered into its value is not less than £1,000 but, subject to that, exceeds £50,000 or 10% of the amount of the company's relevant assets".

Compliance Procedure

Section 29 requires the members to pass an ordinary resolution to sanction a substantial property transaction between a director (or shadow director) and the company. Section 29(3)(c) allows for retrospective validation of such an arrangement.

From the conveyancer's perspective it is important to understand the implication of Section 29. In December 1991(4) the Conveyancing Committee of the Law Society of Ireland issued a practice note which provided that in transactions between natural persons and bodies corporate, and in transactions between bodies corporate, a certificate should be included in the purchase deed showing either that the parties are not connected or that they are connected and the requisite resolution has been passed by the appropriate company. The Law Society also states that a resolution which is signed by all the members entitled to attend and vote on such resolution at a general meeting is as valid and effective for all purposes as if the resolution had been passed at a general meeting of the company duly convened and held.

Effects of Non-Compliance

Section 29(3)(c) allows for retrospective validation of arrangements within a reasonable period.(5) Where a company acts in contravention of this section, the arrangement and any transaction entered into pursuant to the arrangement (whether by the company or any other person, including a liquidator) are deemed to be voidable at the instance of the company. Any director of the company is obliged to account for the arrangement and to indemnify the company for any resulting loss or damage it suffered.

Practitioners should be mindful of the outcome of the 1996 case of British Racing Drivers Club Ltd v Hextall Erskine & Co(6). This case was based on the corresponding legislative provision in the United Kingdom, namely Section 320 of the Companies Act 1985. In this case the chairman of the company, which was considering diversifying, suggested a joint venture with another company of which he was a substantial shareholder. The company sought legal advice and was told that all that was needed was that the director declare his interest to the board of directors. It was necessary to obtain the approval of the members of the group's holding company. The deal was being kept secret from the company's shareholders. The joint venture went ahead and the company invested £5.3 million. Subsequently, when the deal provided less than the company expected, the chairman acquired the company's interest for £3.2 million. In an action for negligence against the company's solicitors, it was held that the solicitors were liable for the loss as had the company been given proper advice and had the matter been referred to the shareholders for approval, the deal would not have gone ahead.

Comment

The provisions of Section 29 of the Companies Act 1990 are as important to commercial practitioners as they are to conveyancers. While commercial practitioners are concerned with the workings of the arrangement and the procedure to be followed, conveyancers are concerned with the necessary certificates, which must be inserted into the purchase deed in order to comply with the recommended practice of the Law Society.

For further information on this topic please contact Paul Eustace at Dillon Eustace by telephone (+353 1 6670022) or by fax (+353 1 6670042) or by e-mail ([email protected]).

Endnotes

(1) Irish Independent June 7 2001, page 7.

(2) Companies Act 1990 (33 of 1990).

(3) Non-cash assets includes shares in the company - British Racing Drivers Club Ltd v Hextall Erskine & Co [1996] 3 AER 667.

(4) Practice Note (1991) Gazette ILSI 419.

(5) What is meant by a "reasonable period" was discussed in Re Duckwari plc [1997] 2 WLR 48 at 54.

(6) [1996] 3 AER 667.