This briefing note should be read in conjunction with our earlier briefing, ‘Companies Act 2006: Introduction and background’. In this briefing, we consider some of the main changes the 2006 Act will make in relation to company directors and company secretaries.
For information on this key topic, see our earlier briefing note ‘The Companies Act 2006: Directors’ Duties (and first commencement order)’. In brief, the 2006 Act will lay down a statement of the general duties applicable to all directors, namely:
- to act within the terms of the company’s constitution and to exercise powers for the purposes for which they are conferred;
- to promote the success of the company;
- to exercise independent judgment;
- to exercise reasonable care, skill and diligence;
- to avoid conflicts of interest;
- not to accept benefits from third parties; and
- to declare interests in existing and proposed transactions or arrangements.
Derivative actions are proceedings brought by one or more members of the company in the name of the company. Members will be able to bring these actions wherever there is any actual, or proposed, act or omission involving negligence, default, breach of duty or breach of trust by a director. Actions will be possible for breach of any of the general statutory duties, including the duty to exercise reasonable skill and care. Unlike the current position, actions may be brought for breach of the duty to exercise reasonable care and skill regardless of whether or not:
- the director concerned has benefited personally; and
- the wrongdoing directors control the majority of the company’s shares (ie there is alleged to be a “fraud on the minority”).
The existing rules would not permit an action for straightforward negligence without any additional element of bad faith or gain. According to some commentators, actions will be possible for breach of the conflict of interest rules, even without bad faith or gain on the part of the director concerned. Actions will be possible against shadow directors and against third parties, eg anyone who dishonestly assists a breach of duty or knowingly receives company property transferred in breach of duty. Some concern has been expressed that the widely worded provisions allowing claims against third parties could permit claims against auditors. The DTI guidance notes suggest, however, that claims against third parties would only be allowed in a very narrow range of circumstances, where there was some element of deliberate “aiding and abetting”.
Members will only be able to continue derivative actions with the approval of the Court. Spurious claims or claims with no practical chance of success will therefore be weeded out at a relatively early stage. Many column inches have been filled in speculation over the extent to which litigation will be used for example to challenge proposed takeovers or as a tactic to deter directors from particular actions, along lines more familiar in the USA. We will have to wait and see.
Directors interests and conflicts
Directors of private companies who have an actual or potential conflict of interest with the company will be able to seek authorisation for the conflict from a quorum of independent - ie, non-conflicted - directors. If the conflict is authorised, there will be no breach of duty. The same provisions will apply to a public company only if expressly permitted by its constitution. Transitional provisions will require existing companies to amend their articles if they wish to apply these provisions (unless those articles already provide for the same relaxation). However, the acceptance by a director of a material benefit from a third party will in all cases require the approval of the members.
Companies will be able to ratify conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company. Where members ratify acts of directors, the votes of members with personal interests in the ratification will be disregarded. This is not the case under the existing common law rules.
Directors will be obliged to declare both the nature and - for the first time - the extent of their interests in both new and existing arrangements entered into by the company. Failure to notify an existing interest (eg on appointment as a director) will be a criminal offence. Directors’ interests will include those of connected persons, who will for the first time include civil partners, parents, children over 18 and some minor children of an unmarried partner. However, from 6 April 2007 companies will no longer need to disclose and retain records of shareholdings of, or share dealings by, directors and their families. Other notable features of the duty to disclose are as follows:
- Declarations of interest may be made at a board meeting, by a written notice specifying a particular interest or by a general notice, eg that a director will be interested in any contract made with a particular party. Written notices must be sent to every other director and may be sent electronically if the recipient has agreed to this. Written notices will be deemed to form part of the business of the next board meeting and should be minuted accordingly.
- Sole directors will no longer be required to declare interests to themselves, as strictly required by the current law, unless the relevant company is required to have more than one director. In that case, the interest will have to be recorded in writing and minuted, so as to be evident to an incoming director. Where a single member company enters into a contract, other than in the ordinary course of business, with the sole member who is also a director (or shadow director) of the company, then unless the contract is in writing, the terms of the contract must be set out in a written memorandum or in the minutes of the first board meeting following the transaction.
Fettering discretion and delegation
Directors will be able to fetter future exercise of their discretion in accordance with an agreement duly entered into by the company or in accordance with the company’s constitution. This clarifies the legal position of directors who might, for example, agree to vote in the future in favour of a particular property development in order to induce the developer to incur expenses in preliminary steps, such as planning, design and so on. However, any such agreement would still be subject to all the general duties of directors listed above, eg the directors must be satisfied that it will promote the success of the company.
Directors will not be prohibited from delegating the performance of their functions so long as the company’s constitution allows this. This reflects the common practice under many existing company articles of association of allowing delegation to committees and to managing or other executive directors. Widely drafted provisions will appear in the new model forms of articles for private companies, permitting delegation to anyone approved by the directors with only a few stated exceptions (eg in relation to dismissing a director or declaring a dividend).
Identity and age of directors
For the first time, every company will have to have at least one natural person as a director. The stated intention of this change is so that there will always be someone who may be held to account for the acts or failures of a company. Public companies will still have to have at least two directors in total.
Directors aged less than 16 years will not be permitted to hold office, but directors will be able to continue in office beyond 70 years (the existing restriction on directors continuing in office beyond the age of 70 will be repealed with effect from 6 April 2007).
Private companies will no longer need to have a secretary. However, any provisions in the articles of an existing company that require or assume the appointment of a secretary will continue to have effect unless and until duly amended. Private companies that choose to have a secretary will still need to maintain a register of secretaries and notify Companies House of any changes in secretary. A director may also be the secretary - something frowned on by institutional shareholders of quoted companies.
A firm or corporate entity can act as secretary.
Thankfully, company secretaries will still be authorised signatories for the purposes of deeds executed on behalf of companies, where a director also signs the relevant documents. This late amendment reversed proposals in the original Bill.
The provisions relating to secretaries of public companies are restated but are substantially unchanged. A person will no longer qualify as a public company secretary merely by having held office on 22 December 1980.
If the office of secretary is vacant, a deputy or assistant secretary (if any) will be able to carry out the duties of the secretary. If there is no deputy or assistant, those duties may be carried out by any person authorised by the directors. Currently, only an officer of the company - such as a director - can be authorised for this purpose. Practically, this is only likely to apply to public companies, since private companies will not need to have a secretary unless their articles require one.
Directors’ addresses and other details
Directors will no longer need to disclose their private residential addresses on the public register. However, the company will still need to keep a register of those private addresses, in case these are required by a regulatory authority. Service addresses - which may be the company’s registered office - may be given on the public record. The same will apply to company secretaries. Note, however, that addresses already provided to the Registrar of Companies will not be removed from the public record. There is already a procedure whereby persons at risk of violence may be able to have their addresses removed.
Registers of directors and particulars provided by directors will no longer need to state the names of other companies of which the director is or has been a director. Directors will need to declare former names if used at any time for “business purposes” within the previous 20 years, including where a name has changed on marriage.
Substantial property transactions and indemnities
The rules on substantial property transactions between companies and directors will be amended, including permitting contracts to be entered into conditional on members’ approval. The level below which transactions may be disregarded is increased from £2,000 to £5,000. It will be made clear that payments under service contracts or for loss of office are excluded from the category of prohibited transactions. It is also made clear that a company indemnity to a director of a pension trustee company in relation to trustee liabilities to third parties will be permitted. Indemnities for liabilities to third parties incurred in the capacity of director have been possible since April 2005.
Loans, quasi-loans and credit transactions
A private company which is not “associated with” a public company (ie broadly not in the same group as a public company) will be able to make loans to its directors, or directors of its holding company, with member approval. The same will apply to related guarantees or security. There will be no such requirement for approval of arrangements involving connected persons of those directors, subject to the overriding duties of directors. Loans, together with quasi-loans and credit transactions (which are broadly indirect arrangements equivalent in effect to loans), will be possible to or with:
- directors of public companies;
- directors of private companies which are “associated with” a public company; or
- persons connected with those directors,
subject in each case to members’ approval. These, together with any other arrangements in which directors have material interests, will have to be disclosed in company accounts. There will be no restriction on quasi-loans or credit transactions to or with directors of private companies which are not “associated with” a public company or their connected persons again, subject to the overriding duties of directors. At present, all these arrangements are - with some minor exceptions - unlawful, regardless of member approval. Note that even if member approval is obtained, these transactions may have adverse tax consequences, eg under the rules regarding benefits in kind. They may also be prohibited by the terms of bank lending or other investment or shareholder agreements.
It is made clear that if a single transaction represents both a substantial property transaction and a loan or other relevant transaction, it will have to be approved for the purposes of each relevant section of the Act. A single resolution may, however cover all of them.
Directors’ service contracts will require member approval if they have a guaranteed term which is, or may be, longer than two years. For these purposes, service contracts will include contracts for services and letters of appointment. Any longer term will be void to the extent of the contravention and the contract will be deemed to contain a provision allowing the company to terminate it at any time by reasonable notice. The current maximum is five years, although market practice, has long been to cut the maximum term to one or two years at most, especially in private equitybacked and listed companies.
Directors’ service contracts will have to be retained by the company for at least 12 months following expiry. This will apply to all service contracts, regardless of duration, and includes contracts of directors working abroad. Members will be entitled to inspect contracts (free of charge) and request copies (on payment of a fee). Similar provisions will apply in relation to qualifying third party or pension trustee indemnities provided for directors.
Payments for loss of office
There will be extensive provisions limiting payments for loss of office or employment. The restrictions will apply to payments made by a company or by any other person. Any payment to directors or connected persons will require the approval of members. These restrictions extend to non-cash benefits and also expressly refer to vendor directors being paid more for their shares than other shareholders. There is a de minimis provision, but this is only £200. It appears that care will therefore be needed, for example, in connection with arrangements for resigning directors to acquire company cars and similar deals. The provisions will catch arrangements which result in a benefit to the relevant director without reference to the effect, if any, on the assets of the company. Thus even transfers at, or above, book value may be in breach. Payments made in contravention of the provisions will be held on trust by the recipient, but there will be no criminal offence. The main changes to the existing provisions include the extension of the prohibition to cover:
- payments to persons connected with directors;
- payments for loss of employment in connection with the management of the company as well as for loss of office;
- payments by companies to directors of their holding companies; and
- payments made by a company in connection with transfers of the undertaking or property of a subsidiary.
Minutes of directors’ meetings will be required to be retained for at least ten years.
Directors will have powers to make provision for the benefit of employees of the company or subsidiaries on cessation or transfer of all or part of their undertaking. This will require members’ approval unless the company’s constitution excludes that requirement. Payments will only be permitted out of distributable profits. Unlike the equivalent provisions in the 1985 Act, if the company’s articles permit such payments to be approved by the directors, a board resolution will not be enough to permit payments to employees who are also current or former directors, or shadow directors, as these will always require member approval.
The prohibition on companies paying remuneration to directors free of income tax will be repealed with effect from 6 April 2007. The prohibition on directors and relatives buying put or call options over listed shares or debentures in their company or another group company will also be repealed with effect from 6 April 2007.
Companies will no longer need to disclose in their accounts transactions with officers other than directors.
The various provisions of the existing law which require statutory declarations by directors or others will be amended so that only statements of compliance are required. These statements could be in electronic form and need not be witnessed.
The maximum penalty for fraudulent trading will be increased to ten years’ imprisonment.
The Secretary of State will be empowered to make regulations disqualifying from directorship of a UK company anyone disqualified from so acting in another state. This will close an existing loophole.
For the Companies Act 2006, see: http://www.opsi.gov.uk/acts/acts2006/ukpga_20060046_en.pdf
Or perhaps more useful, the related DTI guidance notes (which do not have legal effect):
Please note that except as indicated in this note, the amendments covered above are not in force as at 28 February 2007 and it is not yet known when they will come into effect. The government has indicated that it will make announcements in February 2007 as to when it proposes to bring the amendments into effect (no later than October 2008)