Summary

A number of further provisions in the Companies Act 2006 (CA 2006) come into effect on 1 October 2008. This briefing outlines the principal changes being introduced and highlights actions to be taken in preparation for these changes. We also include a brief reminder of key provisions already in force and those which remain to be introduced in October 2009.

Provisions coming into effect in October 2008

Changes coming into effect on 1 October 2008 include:

  • the introduction of new statutory duties for directors in relation to conflicts of interest
  • the abolition of the financial assistance prohibition for private companies
  • the introduction of a new capital reduction procedure for private companies.

Additional statutory duties for directors

October 2007 saw the introduction of four of the seven codified directors’ duties. On 1 October 2008, the final three, which deal with conflicts of interest, will be implemented. These largely codify or reflect the existing law, but with some important differences. In summary:

  • there is a new duty to avoid unauthorised conflicts of interest in situations other than transactions/arrangements to which the company is or will be a party (the section 175 Duty). The section 175 Duty will not be infringed if the matter has been authorised by the directors in accordance with CA 2006
  • existing requirements of the Companies Act 1985 (CA 1985) are largely restated so that a director has to declare any interest in a proposed or existing transaction or arrangement with the company
  • a director must not accept benefits from third parties given because he is a director or by reason of his doing (or not doing) anything as a director.

In each case:

  • interests include “indirect interests” such as the interests of family members and others with a connection to the director concerned
  • there is an exception where the situation cannot reasonably be regarded as likely to give rise to a conflict of interest.

The new duties, and some practical steps which should be taken in consequence of their implementation, are described below.

Duty to avoid conflicts of interest – section 175 CA 2006

Section 175 CA 2006 requires a director to “avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”. This applies in particular to the “exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity)”.

Section 175 does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. Conflicts arising in these circumstances are covered elsewhere in CA 2006 and are described below.

The section 175 Duty represents a change in emphasis from the existing common law, imposing on directors a positive duty to avoid conflicts rather than disabling directors from acting in such situations. The section 175 Duty will not be breached in two situations. The first is a situation which “cannot reasonably be regarded as likely to give rise to a conflict of interest”. The second is where the situation has been authorised by the board. The introduction of a mechanism for board sanction of conflicts in CA 2006 was a response to the view that the current requirement for shareholder approval for such conflicts is “unduly strict”. In practice, most companies address the need for shareholder sanction by including a provision in their articles entitling directors to continue to act in certain conflict situations subject to making disclosure of any material interest to the other directors. In addition, existing practice is often for conflicts of interest to be managed by a director absenting himself from deliberations in which he has a conflict. In future such “sitting-out”, of itself, will not be sufficient and prior board or shareholder authorisation will be required to ensure that the section 175 Duty is not breached. Whilst the introduction of the board authorisation mechanism for authorising conflicts arising on or after 1 October 2008 does not limit the application of already existing disclosure and sanction mechanisms in articles, many conflict situations are unlikely to be covered explicitly by those mechanisms. Accordingly, it would be prudent to follow the board authorisation route for all situations within section 175.

For a public company, board authorisation is only possible if its articles contain an express provision to this effect. Indeed, one of the reasons why the implementation of this duty was deferred was to give public companies the opportunity to make the necessary changes to their articles to permit such authorisation. We recommend that other changes be made to articles at the same time to bring them into line with the new conflicts of interest rules. Such changes include the insertion of provisions relating to confidential information, attendance at board meetings and availability of board papers to protect a director from being in breach of duty if a conflict of interest or potential conflict of interest arises. Many listed companies have already made these changes to their articles at their 2008 AGM.

Whilst it is not necessary for private companies to change their articles to enable board authorisation (provided their articles do not actually prevent the board from authorising conflicts which, typically, they would not), many of the changes that we are recommending be made to public company articles are equally applicable to private company articles. In addition, a private company incorporated before 1 October 2008 will need its shareholders to pass an ordinary resolution to give the board the right to authorise conflicts. For private companies incorporated on or after 1 October 2008, the board will be able to authorise conflicts without shareholder approval unless the articles provide otherwise.

In the case of both public and private companies, effective board authorisation means authorisation by the board of directors (not by a committee of the board) prior to the conflict or possible conflict situation arising and requires any directors who have an interest in the matter not to be counted in the quorum and to be excluded from voting on the matter being authorised. If there are no independent directors for these purposes, shareholder authorisation will be required.

Duty to declare interest in proposed transactions or arrangements, or existing transactions or arrangements, with the company – sections 177 and 182 CA 2006

“If a director of a company is in any way, directly or indirectly interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors.” The rules for existing transactions are similar to those for proposed transactions and together they broadly replicate the existing disclosure provisions in CA 1985. It should be noted that additional specific rules requiring shareholder approval continue to apply where directors propose to enter into “substantial property transactions” (involving non-cash assets) or to receive a loan or credit from the company.

The main differences of substance between the existing and the new disclosure requirements are:

  • For proposed transactions or arrangements, the declaration must be made before the transaction or arrangement is entered into (under CA 1985 the declaration must be made at the first board meeting at which the proposed contract is first considered or (if he was not then interested) at the first board meeting following the director becoming interested in the proposed contract). For existing transactions, the declaration of interest must be made as soon as reasonably practicable after the interest comes into existence.
  • The extent as well as the nature of the interest needs to be declared (under CA 1985 only the nature of the interest needs to be declared).
  • The declaration needs to be updated if it becomes inaccurate or incomplete. This requirement also applies to declarations made before 1 October 2008 (ie, under CA 1985) that become inaccurate or incomplete.

As with the section 175 Duty referred to above, the duty to declare interests does not apply to those interests which cannot reasonably be regarded as likely to give rise to a conflict of interest. In addition, in the case of interests in proposed or existing transactions or arrangements with the company, the duty does not apply to interests that the other directors are already aware of (or ought reasonably to be aware of) or to an interest that concerns the director’s service contract.

The current ability to make a declaration at a board meeting or by way of a general notice (for example, that the director is a shareholder of Company B and therefore should be regarded as interested in any future contract between the company and Company B) is repeated in the new rules in CA 2006. However, the extent of that interest will also now need to be declared. In addition, directors will now be able to declare the interest in a written notice sent to all the other directors.

Duty not to accept benefits from third parties – section 176 CA 2006

“A director must not accept a benefit from a third party conferred by reason of

(a) his being a director, or

(b) his doing (or not doing) anything as a director.”

This duty does not represent a substantive change to the law. As with the other conflicts duties, there is a defence if the acceptance of the benefit “cannot reasonably be regarded as likely to give rise to a conflict of interest”. However, there is no provision for board authorisation of the receipt of such benefits.

In summary, we recommend the following actions in response to these changes:

Check the company’s articles: public companies wishing to empower their directors to authorise conflicts need to change their articles to permit this (and it is recommended that they include other relevant provisions). Private companies need to check that their articles do not prohibit authorisation. In addition, private companies incorporated before 1 October 2008 will require their shareholders to pass an ordinary resolution to permit board authorisation of conflicts. Private companies should also consider making certain changes to their articles in consequence of the introduction of the new duties.

Identify all conflicts or potential conflicts: directors should be briefed on the new duties and be asked to consider other positions (including directorships) they hold and any other conflict situations they think may require authorisation, including any indirect interests (for example, interests of their families). In addition, directors should be asked to review any declarations of interest they have already made in respect of existing or proposed transactions or arrangements with the company, and to update those declarations if they become incomplete or inaccurate after 1 October 2008.

Authorisation: convene a meeting of the board to consider whether to authorise any conflicts of interest of directors that have been identified and, if so, on what terms (for example, debarring the interested director from attending meetings or from receiving certain information relating to the situation in respect of which he or she has a conflict). It may also be appropriate for the independent directors on the board to set out the circumstances in which the authorisation should be reviewed or withdrawn. Those independent directors will need to take account of their other duties to the company (including their duty to promote the success of the company) in deciding whether and on what terms to authorise a conflict. The new rules allowing boards to authorise conflicts apply to conflict situations which arise on or after 1 October 2008. Strictly, boards do not need to authorise conflicts that existed before then (unless circumstances change and a new conflict situation arises). However, given the reporting expectations of investor bodies such as the Association of British Insurers (ABI) (see below), it may be considered prudent for listed companies with institutional shareholders to obtain independent director authorisation for conflicts which arose before, but which continue to exist on, 1 October 2008.

Review authorisation and compliance procedures: continuing procedures should be adopted to identify and deal in advance with all conflicts or possible conflicts arising on or after 1 October 2008. It will also be important for companies to keep appropriate records of conflicts and authorisations on a continuing basis. For listed companies, and other companies whose shareholders expect compliance with ABI recommendations, it should be noted that the ABI will be looking for annual disclosure of how conflicts are being dealt with and confirmation that systems are in place which are operating effectively. Review policy on gifts and corporate hospitality: whilst the codification of the duty not to accept benefits from third parties does not represent a substantive change to the law, companies which already have internal policies on gifts or corporate hospitality should review these in the light of the new statutory rules. Companies that do not have such policies in place should consider introducing them in order to provide guidance to directors on acceptable levels of benefits or circumstances in which no benefits should be accepted. Records of benefits received should be kept.

How might the new conflicts regime impact on directors?

The following examples indicate how important it will be for directors to keep situations under review so that they do not breach any of the new statutory duties.

If a director of Company A is asked to become a director of Company B which operates in a different sector to that of Company A, then the director will need to consider whether he has a section 175 Duty that needs to be authorised before he accepts the appointment (as well as considering any existing corporate policies of the two companies in respect of multiple directorships). As the two businesses operate in different market sectors, the director may be able to take the view that the situation is one which cannot reasonably be regarded as likely to give rise to a conflict of interest and so does not require board authorisation under section 175. However, if six months later Company B buys a company which is a competitor of Company A, then the position will have changed and at that point the director is likely to need board authorisation of the situation from both companies. There may then be confidentiality issues which impact on the timing of when the director is able to seek such authorisations.

A director of Company X is also a minority shareholder in Company Y which is on a list of preferred suppliers of Company X. This general relationship may give rise to a section 175 Duty on the part of the director if it can “reasonably be regarded as likely to give rise to a conflict of interest” between the director’s interests as a director of Company X and as a shareholder of Company Y. If it can, then this will need board authorisation under section 175. However, if Company X and Company Y then agree to enter into a supply contract with one another, this will become a situation which is caught by section 177 (as the director may then be indirectly interested in a proposed transaction with Company X) and the director will have a duty to declare the nature and extent of his interest to the other directors of Company X before the supply contract is entered into. However, under section 177 a director does not need to declare an interest “if, or to the extent that, the other directors are already aware of it (and for this purpose the other directors are treated as aware of anything of which they ought reasonably to be aware)”. Since the director has already disclosed the situation and had it authorised under section 175, he will be able to rely on this exception in section 177 and not make a further declaration unless the terms of the authorisation he was given require disclosure to be made in the circumstances or if the facts on which the authorisation was given have now changed. This underlines the need for companies to keep appropriate records of conflicts and authorisations on a continuing basis as such records will provide evidence of interests of which the directors of the company are aware.

Abolition of prohibition on financial assistance for most private companies

The long-awaited removal of the financial assistance prohibition comes into effect on 1 October 2008. From that date, private companies will no longer be prohibited from giving financial assistance for the purpose of the acquisition of their shares, or the shares of their private holding company, and the “whitewash” procedure (involving statutory declarations of solvency by each director, an auditors’ report and sometimes a special resolution of shareholders) will also be abolished from that date. The restrictions will continue to apply to public companies and to private companies giving financial assistance for the purpose of the acquisition of the shares of their public holding company.

The repeal of these provisions for private companies applies in relation to financial assistance given on or after 1 October 2008 even if the shares in question were acquired and/or the liability in question incurred before that date. This means, for example, that a refinancing after 1 October 2008 of financial assistance given by a private company before 1 October 2008, will not need to be whitewashed.

When CA 2006 was first passed, there was a concern that the abolition of the financial assistance prohibition on private companies could revive certain common law rules so as to continue to prevent a private company from giving financial assistance (without the possibility of sanctioning it by a “whitewash”). The Government was of the view that the effect of the repeal would not be to resurrect the common law but it has, in any event, expressly addressed this point in the Commencement Order which brings this change into effect.

The immediate practical effect of this repeal will be to remove from directors the threat of criminal sanction for a breach of the prohibition on giving financial assistance. It will also remove the cost and timetabling implications of following the whitewash procedure. However, directors will still need to consider whether the transaction concerned:

  • is “likely to promote the success of the company for the benefit of its members”
  • will involve an unlawful reduction of the company’s capital
  • is otherwise vulnerable to challenge as a transaction at an undervalue under insolvency legislation.

By way of example, a target company, prior to its sale, transfers an asset to a member of the seller’s retained group. If this is done at less than the asset’s market value, this will no longer be unlawful financial assistance. However, the directors of the target company concerned may be in breach of their duties as directors and, if the consideration is at or below the book value of the asset and the target company does not have sufficient distributable reserves to cover the shortfall, in breach of other provisions of CA 2006.

Reduction of capital for private companies: new solvency statement procedure

From 1 October 2008 a private company will have a new means of reducing its share capital. There are various reasons why a company might wish to reduce its share capital. A company’s share capital may no longer properly reflect its actual financial position. For example, a company may have a large accumulated loss either as a result of poor historic performance or perhaps a reorganisation of the business. Although the business may be expected to be profitable in future, the company would be prevented from paying dividends to shareholders because of a lack of distributable profits. In these circumstances, the company may want to reduce or cancel its share capital or share premium account so as to be able to set off the reserve arising on such reduction or cancellation against the accumulated loss, thereby enabling it to pay dividends out of future profits. Alternatively, a company may want to make a large distribution to shareholders (for example, in the case of a demerger or share buy-back) and need to create sufficient distributable profits to do this. Again, such reserves can be created by a reduction or cancellation of share capital or share premium.

The new procedure is a quicker and cheaper alternative for private companies to the court approved procedure for a share capital reduction (although this will remain in place). Other means by which the company may lawfully reduce its capital, for example by repurchase or redemption of its shares, or by conversion to an unlimited company are retained, largely unchanged.

The new procedure will require a special resolution of shareholders and a solvency statement given by all the directors, which is similar to the current CA 1985 “whitewash” statutory declaration for financial assistance. However, unlike the “whitewash” procedure, no auditors’ report is required (although directors may consider it prudent to consult with or obtain comfort from the company’s auditors before giving the solvency statement). In addition, whilst a reduction of capital confirmed by the court provides an opportunity for certain creditors to object to the reduction, creditors have no right to object to a reduction of capital supported by a solvency statement. It will be a criminal offence if the directors make a solvency statement without having reasonable grounds for the opinions expressed in it.

Subject to anything to the contrary in the shareholder resolution relating to the reduction or anything in the company’s articles, if a private company reduces its share capital supported by a solvency statement, then, according to draft secondary legislation published by the Government, the reserve will be treated for the purposes of CA 2006 as a realised profit.

Other changes taking effect on 1 October 2008

Requirement for every company to have at least one natural person as a director

Every company will be required to have at least one director who is a natural person, ie, an individual. The legislative intent is to ensure that there is at least one individual who can be accountable for the actions of the company.

Those companies which did not have a natural person as a director on 8 November 2006 (the date on which CA 2006 received Royal Assent) will have until 1 October 2010 to make any necessary changes.

Minimum age for the appointment of a director

No person may act or be appointed as a director of a company unless he or she is at least 16 years old.

Any person under the age of 16 who purports to act as a director or acts as a shadow director, could be liable to prosecution for civil and criminal offences under CA 2006 even though their appointment is void.

Political donations and expenditure to independent election candidates

Small additional changes to Part 14 CA 2006 (which came into effect in October 2007) will come into effect and will extend those provisions which concern the control of political donations and expenditure to independent political candidates.

Accordingly, from 1 October 2008, a company may wish to pass a resolution authorising a political donation to or political expenditure in connection with an independent election candidate. If a political donation is made to, or political expenditure is incurred in connection with, an independent election candidate and no such resolution has been passed then the directors of the company and the directors of any relevant holding company may be civilly liable to the company under CA 2006.

Objection to company names 

There will be a new right for a person to object to a company’s name on the grounds that the name was chosen with the principal intention of seeking money from the objector or preventing the objector registering the name himself where it is one in which the objector has previously acquired reputation or goodwill. The intention is to deter the opportunistic registration of company names.

CA 2006 implementation timetable – a quick guide to the key changes

Already in force

January 2007

  • Electronic and website communications between company and shareholders
  • Information about interests in a company’s shares
  • Liability for false or misleading statements in reports

April 2007

  • Provisions relating to takeovers
  • Repeal of provisions concerning disclosure of directors’ interests in shares in CA 1985
  • Repeal of directors’ retirement provisions

October 2007

  • Codification of directors’ duties (other than in relation to conflicts of interest)
  • Shareholder actions against directors (new statutory derivative action)
  • New rules on resolutions and meetings, including new written resolution procedures and optional AGM for private companies, shorter notice periods for special resolutions if permitted by articles, and new AGM and meeting requirements for public companies and quoted companies
  • New “information rights” for indirect investors in traded companies
  • Contents of director’s report: expanded business review requirements for financial years beginning on or after 1 October 2007

April 2008

  • Appointment of company secretary optional for private companies (subject to articles)
  • Auditor liability limitation agreements permitted
  • New rules on execution of documents by companies
  • New accounting rules for financial years beginning on or after 6 April 2008

Coming into force

October 2008

  • Codification of directors’ conflict of interest duties
  • Abolition of financial assistance prohibition for private companies
  • New capital reduction route for private companies

To come into force

October 2009

  • New model articles for public and private companies
  • Abolition of authorised share capital
  • New rules on public filing of directors’ home addresses
  • All remaining sections of CA 2006 in force