On 1 October 2007, modifications to the rules governing loans and related dealings between a company and its directors or those of its holding company were brought into force. The new provisions make significant and welcome amendments to the previous rules set out in sections 330 to 342 of the 1985 Act.

1985 Act

Before October 2007, section 330(2) of the 1985 Act, prevented all private and public companies from making loans to their directors or to the directors of their holding companies (Directors).

Public companies and their subsidiaries, including companies in a group of companies, one of which is a public company (Relevant Companies) were additionally prohibited from extending certain quasi-loans (a transaction where a Director’s liability to a third party is satisfied by the company and the Director subsequently reimburses the company) to their Directors and connected persons. Relevant Companies were also prohibited from entering into credit transactions (where goods, land or services are supplied on some kind of deferred or periodical payment terms) as creditor for their Directors and connected persons.

Guarantees or the provision of security in connection with a prohibited loan, quasi-loan or credit transaction made by any person to a Director or connected persons also fell foul of this legislation.

There were some limited exceptions to these rules – small loans of £5,000 or less were not outlawed; nor was the provision of funds to a Director to meet expenditure incurred in his role as an officer of the company (though in the case of Relevant Companies this was subject to a £20,000 limit) or to defend criminal or civil proceedings brought against him as a director of the company. Similarly, Relevant Companies could grant short-term quasi-loans not exceeding £5,000 and enter into credit transactions for a director in respect of sums not exceeding £10,000.

There were a few other specific exceptions as well, but generally the rules were highly restrictive in operation; transactions in breach were voidable and criminal sanctions applied where certain breaches of the rules had been committed.

Post-October 2007

Last Autumn, sections 197 to 214 of the 2006 Act replaced the 1985 Act provisions. Most notably, the general prohibition on loans to Directors has been abolished and replaced by a requirement for shareholder consent to be obtained prior to a company entering into such transactions. The distinction between loans, quasiloans and credit transactions made under the 1985 Act still applies. For consistency with the rest of the 2006 Act the concept of ‘Relevant Company’ has been abolished, but the 2006 Act rules on quasi-loans and credit transactions apply to public companies and private companies associated with public companies (companies being ‘associated’ with each other under the 2006 Act if one is a subsidiary of the other or both are subsidiaries of the same parent company). Again though, such transactions are now permissible if prior shareholder approval is obtained. For private companies not associated with a public company there remain no restrictions on loans to persons ‘connected’ with directors, but shareholder approval is required for this type of loan by a public company or a private company which is associated with a public company. In this context it is worth noting that the 2006 Act definition of ‘connected’ is broader than that under the 1985 Act.

To obtain shareholder approval, a memorandum setting out details of the transaction and its value has to be circulated with the shareholder meeting notice (or written resolution text if there is no meeting). No shareholder approval is required if the company in question is not UK-registered or if it is a wholly-owned subsidiary of another body corporate.

The thresholds for de minimis expenditure have also been raised: small transactions involving expenditure on company business not exceeding £50,000, minor and business transactions not exceeding £15,000, and quasiloans not exceeding £10,000 are now permissible before the requirement to obtain shareholder consent is triggered.

The old law which permitted a company to fund director expenditure on criminal and civil proceedings has been restricted under the 2006 Act to expenditure in defending criminal or civil proceedings in connection with certain allegations of negligence, default and breaches of trust or duty. However, for the first time, the 2006 Act permits a company to fund expenditure for a Director to meet the costs of or to avoid a regulatory investigation.

The criminal penalties for breaches of the rules have been abolished, though transactions in breach are still voidable (just as they were under the 1985 Act unless indemnities have been given to the company, bona fide third party rights would be adversely affected or restitution is no longer possible). If shareholders affirm the transaction in question within a reasonable period, the transaction also ceases to be voidable.

This is a brief overview of the new rules. Anyone thinking of making use of them might like to contact us for advice. Generally though, they represent a welcome relaxation of what was formerly quite an awkward area of law.