Companies Act 2006

After the early implementation of the first parts of the Companies Act 2006 (Act), principally those dealing with the bringing into force of the provisions of the Transparency Directive [Part 43 which came into force in January 2007] and the Takeover Directive [Part 28 which comes into force in April 2007], the government announced at the end of February the implementation timetable for the whole of the Act.

There are two main things to note about the implementation timetable. First, the Act will come into force in three main stages, on 1 October 2007, 6 April 2008 and 1 October 2008. Second, some of the most controversial parts of the Act will be in the first tranche. This autumn will see most of the provisions of the Act relating to directors, the so-called derivative action rights of shareholders and the extended business review becoming law, alongside the new rights of beneficial shareholder interests and the revised provisions for meetings and resolutions. This first major implementation stage gives companies plenty to grapple with over the next few months, possibly more than was first anticipated when the Act was published at the end of 2006.

¦ A company’s directors [Part 10]

This is one of the most controversial parts of the Act and introduces a number of significant changes for companies and their directors. This Part is not being brought into force in its entirety on 1 October 2007: the provisions relating to natural directors [s 155], underage directors [s 159], directors’ residential addresses [s 165 and s 240 – 246] and a director’s duty to avoid conflicts of interests [s175] will NOT come into force until 1 October 2008.

Perhaps the most discussed feature of the Act is the codification of directors’ duties. With the exception of the duty to avoid conflicts of interest, directors will have to discharge these statutory duties with effect from this October. These duties are based on the existing common law and equitable principles that directors will be familiar with and, as is currently the case, the duties will be owed to the company. To that extent there is no change. In outline, the duties coming into force are: to act within the powers granted to the director by the company’s constitution and for the purposes they are granted; to promote the success of the company; to exercise independent judgment; to exercise reasonable care, skill and judgment; to not accept benefits from third parties and to declare an interest in a proposed transaction or arrangement as well as to declare an interest in any existing transaction or arrangement. The Act requires that a director, when acting in good faith to promote the success of the company for the benefit of the members as a whole [s 172], must have regard to a non-exhaustive statutory list of factors: the long-term consequences of the decision; the interests of the employees; the need to foster business relations with suppliers and customers; the impact of the company’s operations on the environment and community; the desirability of maintaining a reputation for high business standards and the need to act fairly between members of the company. The duties are not exclusive so directors will need to have regard to every duty that applies in any case. Some of the duties will continue to bind a director even after he has vacated office and all will apply to shadow directors. There is continued debate as to how best discharge the new duties without increasing company bureaucracy or exposing directors to unnecessary liability. It is an area that will require careful consideration and some adjustment by companies to ensure satisfactory compliance.

Other noteworthy changes contained in this Part include the relaxation of the prohibitions against a company entering into substantial property transactions with directors or the directors of its holding company and against the company making loans or providing security in respect of loans to its directors or the directors of its holding company. These transactions will be permissible subject to their approval by the members of the company, which must be obtained in accordance with the provisions of the Act. There are some minor changes to the provisions relating to directorsf service contracts: any service contract for more than two years must be approved by membersf resolution.

¡ Derivative claims and proceedings by members [Part 11]

The duties of directors are owed to the company and only the company can bring an action against a director in respect of a breach. The duties are mainly fiduciary therefore the remedies available are generally damages, restitution, accounting for profits or injunctive relief. Directors are most likely to be at risk of an action against them where the company has suffered a financial loss. Part 11 contains an enhanced right for any shareholder (regardless of size of shareholding or membership at the time of an alleged breach) to bring an action on behalf of the company in respect of negligence, default, breach of duty or breach of trust by a director of the company. This is wider than the current position, which is limited to where there has been a breach of duty from which the director has made a personal gain. When first announced there was concern that, coupled with the statutory duties and in particular the list of factors a director is required to consider in the decision making process, this right could lead to companies being held hostage by single issue campaigners as an action can be brought in respect of proposed as well as actual acts and also omissions to act.

To address this concern, the Act provides that a member must first obtain the courtfs permission to continue a claim based on a prima facie statement of the case. The Act specifies a number of circumstances where the court must refuse permission, including: if a director seeking to promote the success of the business would discontinue the claim or if the act or omission has been authorised or ratified by the company. In determining whether to permit the continuation of the claim, the court must have regard to a number of factors: the importance a director would attach to continuing the claim; whether the act or omission is likely to be authorised by the company in advance or subsequently ratified; the good faith of the member bringing the action; whether the company has decided not to pursue the claim and the views of any members who do not have a personal interest in the claim.

¡ Directorsf report and business review [section 417 Part 15]

Only one section of the Part of the Act dealing with reports and accounts comes into force in October 2007, but it is another of the more controversial changes: the expanded business review [s 417].

Neither the directorfs report nor the business review is entirely new. All companies must produce a directorfs report, and all companies (other than those that meet the statutory definition of esmall companyf [s 382]) must include a business review. One change is the statutory statement of the purpose of the business review, namely to inform members and help them assess how the directors have performed their duty to promote the success of the company. This raises again the possible problems for directors in adequately discharging this complex duty and the concerns over exposure to derivative actions for alleged breaches. Consideration will need to be given to the presentation of the business review in order to achieve the statutory purpose.

Many of the requirements for the content of the business review is a restatement of the provisions of the Companies Act 1985 that have been in place for a couple of years. However, one amendment that attracted a lot of comment when it appeared is the additional information that must be included in the business review of quoted companies. The area of difficulty is that in addition to information about the main trends and factors likely to effect the future performance and development of the business, information about environmental matters, the impact of the business on the environment, employees and social and community issues, a quoted company must also supply information about persons with whom it has contractual or other arrangements that are essential to its business. Directors have been given discretion to withhold this information where matters are in the course of development or negotiation and disclosure would be seriously prejudicial to the interests of the company or where in the directorsf opinion disclosure of information about a person would be seriously prejudicial to that person or contrary to public interest.

The liability of directors for false or misleading statements in reports, including the directorsf report [s 463], came into force in January 2007. This liability is owed by a director to the company in respect of loss it suffers from untrue or misleading statements in financial reports or any omission from the report of anything required to be included in it, where the director knew or was reckless as to whether the statement was untrue or misleading or knew the omission was a dishonest concealment of fact.

¡ Exercise of membersf rights [Part 9]

This Part introduces a right for the registered holder of shares in a listed company to nominate a third party, i.e. the beneficial shareholder, to receive information about the company including reports and accounts, notices of meetings and details of information placed on the companyfs website. In addition, where the companyfs articles provide for it, these beneficial shareholders can exercise full voting and other membership rights. It is intended that the commencement provisions for this Part will enable nominee investment organisations to send the nominations in respect of indirect shareholders with effect from 1 October 2007 with a view to the information rights being fully operational by the end of the year. The rights conferred on a beneficial shareholder will have the same status as those afforded a member by the companyfs articles.

¡ Resolutions and meetings [Part 13]

The provisions in this Part relating to using electronic means to send documents relating to meetings [s 333] and the sending of notice of meetings by electronic means [s 308-309] came into force with the ‘company communication provisions’ in January 2007. These permit, where the company has obtained the requisite consents, the sending of notices of general meetings of the company by electronic means or by use of the website, prescribe the details for the effective giving of notice via the company’s website and deem that where a company distributes documents relating to a meeting in electronic form, and supplied an electronic address, the company has given its consent for responses to those documents to be sent to it by electronic means.

In October 2007 the remainder of this Part will come into force introducing a number of changes to the holding of general meetings and the passing of members’ resolutions. It will no longer be compulsory for private companies to hold annual general meetings. The notice period for general meetings will be reduced to 14 days. The majority of private company members required to agree to short notice is to be reduced. Public companies will have to hold their annual general meetings within 6 months of their financial year-end.

The Act anticipates the greater use of written resolutions (which can be in electronic form) by members to replace general meetings almost entirely for private companies and contains detailed provisions for their use. The requirement for unanimity of written resolutions is removed. A simple majority will be sufficient to pass an ordinary resolution, a special resolution will require a 75% majority. Unless expressly stated otherwise, an ordinary resolution will be sufficient to sanction an act of the company. There are a number of new provisions relating to voting at general meetings, for example, new voting powers are given to proxies, and the Act imposes new obligations on quoted companies to disclose certain voting information on its website.

Companies may wish to consider possible amendments to their articles of association and internal administration to take advantage of some of these de-regulating and modernising provisions.

The DTI is currently consulting on the policy issues surrounding the secondary legislation that is yet to be drafted to give full effect to the Act, the transitional arrangements to be put in place for existing companies and also on the draft Model Articles that have been published recently. This process will not be completed until the end of May, after which we can expect to see the missing detail that will need to be considered before companies can make the necessary adjustments to their articles of association, internal processes and administration to conduct their business in the new corporate environment. We will be keeping you fully informed as the full information becomes available. 1 October 2007 will also see the provisions relating to control of political donations and expenditure [Part 14], fraudulent trading [Part 29], protection of members against unfair prejudice [Part 30] and company investigations [Part 32] coming into force.

Changes to Business Stationery Rules

Following the implementation to the First Company Law Directive on 1 January 2007 by The Companies (Registrar, Languages and Trading Disclosures) Regulations 2006, changes have been made to the information a company must make available on its business stationery. The scope of business stationery also been expanded to include electronic communications and any website of the company where the content of such website is controlled by the company and relates to the company’s business or operations.

All companies (which includes limited liability partnerships) must state their name legibly on all business letters, notices and other publications and all bills of exchange, promissory notes, endorsements, cheques and orders for money or goods purporting to be signed by the company it or on its behalf, whether such documents are in hard copy, electronic or any other form.

In addition, all companies and limited liability partnerships must show in legible lettering on all business letters, invoices, order forms or orders for goods and on any of its websites: its place of registration, registered number, registered office address and if it is being wound up, a statement of that fact. The statement that a company is in liquidation will apply to those liquidations commenced before 1 January 2007. Business letters in electronic form will include emails sent from the company or LLP.

Fraud Act 2006

The Fraud Act 2006 came into force on 15 January 2007. It creates a general offence of fraud that can be committed in one of three ways:

¦ Fraud by false representation [section 2]

The representation may be as to law or fact (including state of mind) and either expressed in words (including a statement on a website) or implied by conduct. It will be false if it is untrue or misleading and the person making the representation knows that it is, or might be, untrue or misleading.

¦ Fraud by failing to disclose information [section 3]

This applies where there is a legal duty to disclose information either under statute, a contract, custom or a fiduciary duty.

¦ Fraud by abuse of position [section 4]

This may occur where the position is one of privilege or where the person is expected to safeguard the financial interests of another or not to act against those interests, for example a company director, professional adviser, employer or trustee. “Abuse” is not defined and is intended to cover a wide range of conduct or omission. For the offence to be committed there are two key elements that must be present in each case. The act or omission must be:

1) Dishonest. This is a two-stage test. Would the defendant’s behaviour be regarded as dishonest by the standards of reasonable and honest people? If yes, was the defendant aware that his conduct was dishonest and would be regarded as dishonest by reasonable and honest people? AND

(2) Committed with the intention of making a gain or causing a loss or risk of loss (of either money or property) to another. There is no requirement for the accused to have made a gain or for actual loss to have been suffered by the victim of the fraud.

Company officers, including company secretaries or anyone with a managerial role (which could include a member involved in the management of the company) who is party to an offence committed by a company may also be charge with the offence. The maximum custodial sentence is 10 years.

A number of other new offences are created by the act, including:

¦ “Phishing”, where emails are sent purportedly from a financial institution to prompt the recipient to disclose credit card or bank details.

¦ Participating in a fraudulent business carried on by a sole trader. A person must knowingly be party to the carrying on of a business with the intent to defraud creditors or for any other fraudulent purposes. This offence can only be committed by a person exercising a managerial or controlling function in the business; the dishonesty test set out in the act applies. In addition, the Companies Act 1985 offence of fraudulent trading (restated in Companies Act 2006 with effect from October 2007) has been extended to non-corporate traders.

¦ Obtaining services dishonestly. This offence cannot be committed by omission. The services must be obtained and there must be an intention not to pay for them.

New Construction Industry Scheme By Tax Strategies

The New Construction Industry Scheme (“New CIS”) is due to come into force on 6 April 2007. It introduces significant changes for construction contractors and the way that they pay their subcontractors.

New CIS replaces the existing scheme of registration cards (CIS4) and tax certificates (CIS 5 and CIS6) for subcontractors which currently permits payments in respect of labour in construction operations to be made without deduction of income tax and national insurance or net of income tax and national insurance at a reduced rate of 18%. Under New CIS a subcontractor will be:

¦ Registered for gross payment, subject to certain tests: the business test, turnover test and compliance test; or

¦ Registered for payment under deduction. This is a default registration for subcontractors who do not meet the tests for gross payment. A deduction in respect of tax must be made from contract payments at a rate of 20%; or

¦ Not registered at all. Contract payments can be made to an unregistered subcontractor, unlike the existing scheme, but subject to a deduction of 30%.

One of the major changes under New CIS is the requirement for the contractor to verify the registration status of the subcontractor directly with HMRC, rather than have the subcontractor present a tax certificate to the contractor. The subcontractor must supply the contractor with his name, national insurance number and taxpayer reference in order that the contractor may conduct the verification. In the first year of the new system some relaxations in the verification system will apply to subcontractors already working for a contractor. New CIS creates a new administrative burden for contractors. They are required to submit a return to HMRC, within 14 days of the end of each tax month, containing information about each subcontractor and all payments and deductions made. Nil returns will be required where no payments are made. The return must confirm the verification requirements have been complied with in every case and that the information is complete and correct. In addition the contractor must prepare a separate monthly statement of payments for each subcontractor paid net of tax and indicate if verification has not been possible, since in these cases the higher rate of deduction for tax will have to be made. The contractor must also confirm to HMRC the employment status of each subcontractor.

For financiers there is a concern that the change from the existing tax certificates, which include photograph ID, to a reliance on information supplied by the subcontractor could lead to an increase in identity fraud. In addition, confirmation of a subcontractor’s tax status will be more difficult. There will no longer be the tax certificates that could be produced to the financier as evidence, so a financier may have to make more detailed enquiries to satisfy itself on the point. The alternative system is not as easy for a financier to rely on. A financier will not have access to the HMRC online verification system; it will only be able to obtain the information in writing. However there will be a delay in obtaining the results from HMRC and whilst there is provision for contractors to be notified by HMRC of changes to a subcontractor’s registration status, this notification will not be sent to financiers. In some cases it may be possible for the financier to obtain confirmation of a subcontractor’s registration status from the contractor, but this may not be appropriate in every situation.

There are also some payment risks for a financier under New CIS. The requirement for monthly returns and regular verifications with HMRC means that at any time the information submitted by the contractor is incomplete, inaccurate or otherwise does not match that held by HMRC, the contractor will be required to make deductions from the contract payment at the highest (30%) rate. This could mean a recovery gap for the financier if it has assumed that the subcontractor is registered for gross payments or payments under deduction (where the rate is 20%). Maintaining up to date information about the subcontractor’s registration status and the rate of any deductions from contract payments will be essential for a financier to minimise this gap, as will seeing the monthly statements of payments from the contractor (if possible) before making any balancing payments to the subcontractor.

Another risk to full recovery of payments made by a financier arises where HMRC determines that the subcontractor is not eligible for gross payments or the reduced rate of deduction whilst the financier has made advances on the assumption of a certain level of payment from the contractor. For example, full compliance with its tax and reporting obligations is one of the criteria for a subcontractor’s eligibility for registration for a gross payment. HMRC may withhold gross payment status (even if previously awarded) from subcontractors with a poor tax compliance record. A prudent financier should not make assumptions about a subcontractor’s compliance with its obligations to HMRC and may wish to make satisfaction of this requirement a condition of funding.

Additionally, financiers will need to concern themselves more with the terms of engagement of any subcontractor with a contractor. Like its predecessor, New CIS is only available to self-employed contractors, and to improve compliance in future HMRC is imposing a requirement on contractors to declare in each monthly return that none of the individuals included is an employee, with stiff penalties on the contractor for any breach. The assessment of employment status is to be made by the contractor having regard to a number of criteria relating to the manner of performance of the contract (including length of engagement, whether the individual is obliged to undertake the work himself or can supply a substitute, whether he is required to work set hours, whether he receives holiday and sick pay and whether he is required to provide tools and materials) rather than merely rely on any declaration of his employment status by the subcontractor.

The risk of a financierfs exposure to a recovery gap here could be reduced by the financier carefully checking the subcontractorfs employment status on every contract against HMRCfs published employment status indicator or only making advances on the basis that the full 30% deduction may be made from the contract payment.

A detailed manual for the scheme is now available on the HMRC website: cisrmanual/index.htm

Consumer Credit Act 2006

The Consumer Credit Act 2006 aims to extend the protection for consumers and improve the regulation of credit businesses.

On 6 April 2007, the first substantive provisions of the Consumer Credit Act 2006 will come into force under the Consumer Credit Act 2006 (Commencement No 2 and Transitional Provisions and Savings) Order 2007.

The first change is a new definition of gindividualh [section

1], to include a partnership of two or three persons not consisting entirely of bodies corporate. Larger partnerships are to be treated in the same way as body corporates.

The most important change under the new act that comes into force in April 2007 is the replacement of the provisions relating to an extortionate credit bargain with the concept of the eunfair relationshipf [sections 19-22]. The new regime will allow the court to consider whether the relationship between creditor and debtor is unfair to the debtor because of:

  •  The terms of the agreement or any related agreement;
  • The way it is being operated or the way the creditor has exercised or enforced any of its rights under the agreement: or
  •  Any other act or omission on the part of the creditor or on its behalf before or after the making of the agreement.

The court has substantial discretion to take into account all matters it thinks are relevant to the situation and has a broad range of remedies. The court will have the power, on the application of the debtor or a surety, or on the instance of the debtor or a surety in proceedings for enforcement of the agreement or in other proceedings where the amount payable under the agreement is relevant, to:

  •  Require repayment by the creditor of all sums paid by the debtor or a surety; 
  • Reduce or discharge any sum payable by the creditor or the surety under the agreement or related agreement; 
  • Return to the surety any property provided as security; 
  • Set aside any obligations imposed on the debtor or the surety; or
  • Otherwise vary any terms of the agreement.

The burden of proof in any allegation by the debtor or surety that the agreement is unfair is on the creditor to prove the contrary.

For the purposes of the eunfair relationshipf provisions, a credit agreement is an agreement between any individual debtor and the creditor (and any assignee or transferee of either party) for the provision of credit in any amount. This definition of credit agreement anticipates a further amendment yet to be implemented in the act, which is to remove the upper limit of ’25,000 for agreements regulated by the act. The provisions will apply to any credit agreement, any linked transaction to such credit agreements or any security provided in respect of any credit agreement or linked transaction.

It should be noted that whilst consumer credit or hire arrangements in excess of ’25,000 entered into wholly or predominantly for the business purposes of the debtor are not to be regulated by the act in general, the provisions relating to unfair relationships will apply to these business agreements. The only exception from the application of the unfair relationship provisions are consumer credit agreements secured by land that are regulated by the FSA under the Financial Markets and Services Act 2000.

Consolidation of Secondary Insolvency Legislation

The Insolvency Service has reported on its progress with the consolidation of the Insolvency Rules. The draft of the new rules are being published for limited consultation now and a further draft is expected in the summer of 2007 with a view to them coming into force in April 2008.

One of the features of the consolidation will be a ecommon partsf section containing the rules common to administration, administrative receivership, liquidation and bankruptcy, for example all rules on remuneration, committees, notices for meetings, etc. are to be consolidated and made consistent. This will remove any unintentional discrepancies between these procedural rules where they are repeated in the separate sections of the existing rules. The Part dealing with liquidations is to be restructured to be more accessible: there will be separate sections for each of membersf voluntary liquidations, creditorsf voluntary liquidations and compulsory liquidations with the rules relating to each procedure in its own section.

There will be an opt-in for creditors who want to receive all of the notices with respect to administrations/ liquidations. Those creditors who do not elect to receive every notice will not hear again from the insolvency practitioner until dividends are proposed. The new rules will also make provision for use of electronic communications, including meetings that can either be held electronically or telephonically and various communications simply being put on a website. It is also proposed to reduce the number of filings at court to be replaced by more online filings at Companies House. Also included are proposals to provide more certainty on liquidators’ and administrators’ fees: if the fees are not set at an early stage (because they are not agreed with the Committee or approved by the creditors in meeting) the relevant officeholder will have to go court to have his fees fixed at the end of the appointment.

The rules relating to Individual Voluntary Arrangements are not included in this review as they are the subject of a separate review.

Documentary Credits: UCP 600

The International Chamber of Commerce has published the latest revision of the Uniform Customs and Practice for Documentary Credits (UCP 600). Some of the changes include:

¦ New definitions (for example, “complying presentation”, “honour” (payment, acceptance or deferred payment) and “negotiation” (purchase of drafts or documents or an agreement to advance funds prior to the actual date of payment by the issuer)) and interpretation clauses (for example, dealing with the running of time), which should provide helpful clarity. For the first time all credits are stated to be irrevocable.

¦ The replacement of the “reasonable time” for acceptance and refusal of documents with a fixed period of FIVE banking days. A bank will have five banking days following presentation of the documents to examine them and must give any notice of rejection in that period. Once a bank decides a presentation is a complying one, it must honour the presentation.

¦ New provisions allowing for the discounting of deferred payment credits. A bank may be nominated to accept a draft or incur a deferred payment obligation and by doing so the issuing bank is authorising that nominated bank to prepay or purchase the draft.

¦ The requirement that banks apply “reasonable care” in examining documents has been replaced with the need for them to determine on the basis of the documents alone whether or not they appear on their face to be a complying presentation. There is no requirement for documents to be identical with the credit, but they should not conflict with any other document or term of the credit. This wider language may cause problems for suppliers waiting for payment.

¦ The content of discrepancy notices has been specified in more detail. When sending a discrepancy notice a bank must state what it is doing with the documents. A new provision is that a bank may hold the documents until it receives a waiver or other instruction from the presenter.

¦ There have been a number of clarifying amendments to the provisions dealing with transport documents. UCP 600 come into force on 1 July 2007, which should give trade financiers time to familiarise themselves with the detail of the new provisions and incorporate them into standard documentation.

Expenses in administration: non-domestic rates

In the matter of Trident Fashions Plc: Exeter City Council v Bairstow Ch D March 2007

The changes to the administration regime made by the Enterprise Act 2002 introduced a new rule 2.67 to the Insolvency Rules 1986, for the first time making express provision for the payment of certain expenses incurred by an administrator before discharging his remuneration for the administration. However rule 2.67 uses general language rather than providing an exhaustive list, so inevitably there has been some uncertainty as to what exactly an administrator is required to pay. Rates in respect of business premises occupied or used by a company in administration have been the latest item to be considered for payment under this rule by the court.

In this case the High Court has held that rates in respect of business premises occupied by a company for the purposes of continuing its trade whilst in administration rank as a “necessary disbursement” under rule 2.67(f) Insolvency Rules 1986. In addition, although it was not argued, the judge indicated that he would have reached the same conclusion even if the premises had been unoccupied during the administration.

The decision has a number of important consequences for administrators:

¦ It removes the option previously available to administrators to decide whether or not to pay rates, taking into account the possible impact of the payment on the overall success of the administration.

¦ It treats rates in administrations the same way as they have been treated previously in liquidations; they are liabilities imposed on the company. However, unlike in liquidations, an administrator cannot disclaim a lease nor is there any statutory exemption from liability for rates in respect of unoccupied premises as there is in a liquidation.

¦ It introduces a potentially significant sum into the calculation of expenses to be paid, which may not only impact on the payment of the administrator’s remuneration, but also on the amount of distributions to floating charge holders and unsecured creditors.

¦ It may threaten the use of administrations as a rescue remedy for distressed companies, with the consequential loss of viable businesses and employment opportunities.