House of Commons - Explanatory Note
Company Law Reform Bill [HL] - continued          House of Commons

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COMMENTARY

Clauses 174 and 175: Service contracts

379.     These clauses require member approval of long-term service contracts. In broad terms, these are contracts under which a director is guaranteed at least 2 years of employment with the company of which he is a director, or with any subsidiary of that company.

380.     Directors service contract is defined in clause 211 as including contracts of service, contracts for service and letter of appointment as director.

381.     Failure to obtain approval allows the company to terminate the service contract at any time by giving reasonable notice. The purpose of this clause is to limit the duration of directors' service contracts, as a long-term contract can make it too expensive for the members to remove a director using the procedure in clause 154 (ordinary resolution to remove director) while allowing the members to approve longer arrangements if they wish.

382.     These clauses replace section 319 of the 1985 Act. The length of service contract for which member approval is required has been reduced from those longer than 5 years to those longer than 2 years.

Clauses 176 to 182: Substantial property transactions

383.     These clauses require member approval to substantial property transactions. These are transactions where the company buys or sells a non-cash asset (as defined in section 739(1) of the 1985 Act) to or from:

  • a director of the company;

  • a director of its holding company;

  • a person connected with a director of the company; or

  • a person connected with a director of its holding company.

Approval is only required where the value of the asset exceeds £100,000 or 10% of the company's net assets (based on its last set of annual accounts or called-up share capital if it has not yet produced any accounts). No approval is required if the value of the asset is less than £5,000.

384.     These clauses replace sections 320 to 322 of the 1985 Act. The changes include:

  • permitting a company to enter into a contract which is conditional on member approval (clause 176(1)). This implements a recommendation of the Law Commissions. The company is not to be liable under the contract if member approval is not forthcoming (clause 176(3));

  • providing for the aggregation of non-cash assets forming part of an arrangement or series of arrangements for the purpose of determining whether the financial thresholds have been exceeded so that member approval is required (clause 176(5));

  • excluding payments under directors' service contracts and payments for loss of office from the requirements of these clauses (clause 176(6)). This implements a recommendation of the Law Commissions;

  • raising the minimum value of what may be regarded as a substantial non-cash asset from £2,000 to £5,000 (clause 177);

  • expanding the exception for transactions with members to include the acquisition of assets from a person in his character as a member of the company (clause 178(a));

  • providing an exception for transactions made by companies in administration (clause 179). This implements a recommendation of the Law Commissions;

  • not requiring approval on the part of the members of a company that is in administration or is being wound up (unless it is a members' voluntary winding up) (clause 179).

Clauses 183 to 198: Loans, quasi-loans and credit transactions

385.     These clauses require member approval for loans, quasi-loans (as defined in clause 184), credit transactions (as defined in clause 186) and related guarantees or security made by a company for:

  • a director of the company;

  • a director of its holding company;

  • a person connected with a director of the company; or

  • a person connected with a director of its holding company.

386.     Member approval is not required by these clauses for:

  • loans, quasi-loans, credit transactions and related guarantees or security to meet expenditure on company business. The total value of transactions under this exception made in respect of a director and any person connected to him must not exceed £50,000 (clause 188);

  • money lent to fund a director's defence costs for legal proceedings (clause 189) or in connection with regulatory action or investigation (clause 190);

  • small loans and quasi-loans, as long as the total value of such loans and quasi-loans made in respect of a director and any person connected to him does not exceed £10,000 (clause 191(1));

  • small credit transactions, as long as the total value of such credit transactions made in respect of a director and any person connected to him does not exceed £15,000 (clause 191(2));

  • credit transactions made in the ordinary course of the company's business (clause 191(3));

  • intra-group transactions (clause 192); and

  • loans and quasi-loans made by a money-lending company in the ordinary course of the company's business (as long as the requirements of clause 193 are met).

387.     These clauses replace sections 330 to 342 of the 1985 Act. The changes include:

  • abolishing the prohibition on loans, quasi-loans etc to directors and replacing it with a requirement for member approval. This implements a recommendation of the CLR;

  • abolishing the criminal penalty for breach;

  • extending the requirements for member approval of quasi-loans and credit transactions to all companies. Currently, section 330 of the 1985 Act only prohibits quasi-loans and credit transactions by public companies or by companies in the same group as a public company. This extension implements a recommendation of the Law Commissions;

  • extending to all companies the requirement for member approval of loans, quasi-loans and credit transactions in respect of persons connected to a director. Currently, section 330 of the 1985 Act does not prohibit loans, quasi-loans and credit transactions to connected persons by companies that are not public companies or members of the same group as a public company. This implements a recommendation of the Law Commissions;

  • removing some of the requirements currently imposed by section 337 of the 1985 Act on the exception for expenditure on company business (clause 188);

  • widening the exception for expenditure on company business to include directors of the company's holding company and connected persons (clause 188);

  • creating a new exception specifically for expenditure in connection with regulatory action or investigations (clause 190);

  • restricting the exceptions for expenditure on defending legal or regulatory proceedings to proceedings in connection with any alleged negligence, default, breach of duty or breach of trust by the director in relation to the company (clauses 189 and 190);

  • widening the exception for small loans to include small quasi-loans (clause 191(1)) in place of the current exception for short-term small quasi-loans in section 332 of the 1985 Act;

  • widening the exception for small loans and quasi-loans to include transactions with connected persons (clause 191(1));

  • widening the exception for "home loans" to include those connected persons who are employees (clause 193(3));

  • raising the maximum amounts permitted under the exception for expenditure on company business (clause 188), the exception for small loans and small quasi-loans (clause 191(1)) and the exception for small credit transactions (clause 191(2));

  • widening the exceptions for intra-group transactions (clause 192);

  • abolishing the maximum amounts permitted under the exception for money-lending companies (clause 193); and

  • allowing affirmation of loans, quasi-loans and credit transactions entered into by the company in line with the provision in respect of substantial property transactions (clause 198).

Clauses 199 to 206: Payments for loss of office

388.     These clauses require member approval for payments for loss of office. These are payments made to a director (or former director) to compensate them for ceasing to be a director, or for losing any other office or employment with the company or with a subsidiary of the company. They also include payments made in connection with retirement. In the case of loss of employment or retirement from employment, the employment must relate to the management of the affairs of the company.

389.     Member approval is required under clause 201 if a company wishes to make a payment for loss of office to:

  • one of its directors;

  • a director of its holding company;

  • a person connected with one of its directors; or

  • a person connected with a director of its holding company.

390.     Member approval is also required if any person (including the company or anyone else) wishes to make a payment for loss of office to a director of the company

in connection with the transfer of the whole or any part of the undertaking or the property of the company or of a subsidiary of the company (clause 202).

391.     In the case of a payment for loss of office to a director in connection with the transfer of shares in the company or in a subsidiary of the company resulting from a takeover bid, approval is required of the holders of the shares to which the bid relates and of any other holders of shares of the same class (clause 203).

392.     These clauses replace sections 312 to 316 of the 1985 Act. The changes include:

  • extending the requirements to include payments to connected persons (clause 199(3));

  • extending the requirements to include payments to directors in respect of the loss of any office, or employment in connection with the management of the affairs of the company, and not merely loss of office as a director as such (clause 199). This implements a recommendation of the Law Commissions;

  • extending the requirements to include payments by a company to a director of its holding company (clause 201(2));

  • extending the requirements in connection with the transfer of the undertaking or property of the company to include transfers of the undertaking or property of a subsidiary (clause 202(2));

  • extending the requirements in connection with share transfers so as to include all transfers of shares in the company or in a subsidiary resulting from a takeover bid (clause 203(1));

  • excluding the persons making the offer for shares in the company and any associate of them from voting on any resolution to approve a payment for loss of office in connection with a share transfer (clause 203(4)). This implements a recommendation of the Law Commissions;

  • setting out the exception for payments in discharge of certain legal obligations (clause 204);

  • creating a new exception for small payments (clause 205); and

  • clarifying the civil consequences of breach of these clauses (clause 206(1) to (3));

  • resolving conflicts between the remedies where more than one requirement of these clauses is breached (clause 206(4) and (5)). For example, if the payment contravenes both clause 201 and clause 203 because it was a payment by a company to one of its directors and it was a payment in connection with a takeover bid, and none of the required member approvals have been obtained, then the payment is held on trust for the persons who have sold their shares as a result of the offer and not on trust for the company making the payment.

CHAPTER 5: DIRECTORS' SERVICE CONTRACTS

Clause 211: Directors' service contracts

393.     This clause defines what is meant by references to a director's service contract in this Part. The term is used in clauses 163, 168, 174 and 176 and in this Chapter. It includes contracts of employment with the company, or with a subsidiary of the company. It also includes contracts for services and letters of appointment to the office of director. The contract may relate to services as a director or to any other services that a director undertakes personally to perform for the company or a subsidiary.

Clause 212: Copy of contract or memorandum of terms to be available for inspection

394.     This clause requires a company to keep copies of every service contract entered into by the company or by a subsidiary of the company for a director of the company. If the contract is not in writing, the company must keep a written memorandum of its terms. This clause, together with clauses 213 and 214, replaces section 318 of the 1985 Act.

395.     Subsection (3) is new. It requires the service contracts to be kept by the company for at least one year after they have expired, but the subsection does not require the copies to be retained thereafter. As a result of the expanded definition of service contract in clause 211, this clause now applies to contracts for services and letters of appointment, as recommended by the Law Commissions.

396.     As recommended by the Law Commissions, the exemption for contracts requiring a director to work outside the UK (section 318(5) of the 1985 Act) and the exemption for contracts with less than 12 months to run (section 318(11) of the 1985 Act) have not been retained.

397.     Failure to comply with the requirements of this clause is a criminal offence for which every officer of the company who is in default may be held liable on summary conviction to a fine not exceeding level 3 on the standard scale (currently £1,000) or in cases of continued contravention a daily default fine not exceeding one-tenth of that. In a change from the current position under section 318 of the 1985 Act, the company will no longer be liable under the criminal offence.

Clause 213: Right of member to inspect and request copy

398.     This clause gives members a right to inspect without charge the copies of service contracts held by the company in accordance with clause 212. Subsection (2) creates a new right for members to request a copy of the service contracts on payment of a fee set by regulations under clause 788.

Clause 214: Directors' service contracts: application of provisions to shadow directors

399.     This clause applies the requirements of this Chapter to service contracts with shadow directors.

CHAPTER 6: CONTRACTS WITH SOLE MEMBERS WHO ARE DIRECTORS

Clause 215: Contract with sole member who is also a director

400.     Under this clause, contracts entered into by a company with its only member must be recorded in writing if the sole member is also a director or shadow director of the company. This does not apply to contracts entered into in the ordinary course of the company's business. The purpose of this clause is to ensure that records are kept in those cases where there is a high risk of the lines becoming blurred between where a person acts in his personal capacity and when he acts on behalf of the company. This may be of particular interest to a liquidator should the company become insolvent.

401.     This clause replaces section 322B of the 1985 Act, which implements article 5 of the 12th Company Law Directive (89/667/EEC). As the Bill will permit public companies to have a single shareholder, this clause applies to both private and public limited companies.

402.     A failure to record the contract in writing will not affect the validity of the contract (subsection (6)) but other legislation or rules of law might (subsection (7)).

403.     If there is a breach of this clause, every officer of the company in default is liable on summary conviction to a fine not exceeding level 5 on the standard scale (currently £5,000). In a change from the current position under section 322B of the 1985 Act, the company will no longer be liable under the criminal offence.

CHAPTER 7: DIRECTORS' LIABILITIES

404.     The clauses in this Chapter deal with two matters:

  • they restate sections 309A to 309C of the 1985 Act (provisions relating to directors' liability). The only substantive changes to those sections are the creation of a right for members to request a copy of a qualifying third party indemnity provision (clause 221(2)), the removal of criminal liability on the part of the company for failures to comply with the requirements of clause 220 (copy of qualifying third party indemnity provision to be available for inspection) and a requirement for all qualifying third party indemnity provisions to be retained by a company for at least one year after they have expired (clause 220(4));

  • they introduce a substantive reform of the law on ratification of acts giving rise to liability on the part of a director (clause 222).

Provision protecting directors from liability

Clause 216: Provisions protecting directors from liability

405.     This clause prohibits a company from exempting a director from, or indemnifying him against, any liability in connection with any negligence, default, breach of duty or breach of trust by him in relation to the company. Subsection (2) prohibits indemnification by an associated company as well as by his own company. "Associated company" is defined in clause 239 as, in effect, a company in the same group.

406.     Any provision, whether in the company's articles, in a contract or otherwise, attempting to exempt or indemnify a director in breach of this clause is void. But this does not apply to lawful provisions in the articles for dealing with conflicts of interest.

407.     Clause 217 permits the purchase of insurance and clause 218 creates an exception for qualifying third party indemnity provisions.

Clause 217: Provision of insurance

408.     This clause permits a company to purchase and maintain insurance for its directors, or the directors of an associated company, against any liability attaching to them in connection with any negligence, default, breach of duty or breach of trust by them in relation to the company of which they are a director.

Clause 218: Qualifying third party indemnity provision

409.     This clause permits (but does not require) companies to indemnify directors in respect of proceedings brought by third parties (such as class actions in the US). It also permits (but does not require) companies to indemnify directors in respect of applications for relief from liability made under clause 804 (general power of the court to grant relief in case of honest and reasonable conduct) or under section 144(3) or (4) of the 1985 Act (power of court to grant relief in case of acquisition of shares by innocent nominee).

410.     The indemnity may cover liability incurred by the director to any person other than the company or an associated company. This may include both legal costs and the financial costs of an adverse judgement. But the indemnity must not cover liabilities to the company or to any associated company (subsection (2)).

411.     Another condition is that the indemnity must not cover criminal fines, penalties imposed by regulatory bodies (such as the Financial Services Authority), the defence costs of criminal proceedings where the director is found guilty, the defence costs of civil proceedings successfully brought against the director by the company or an associated company and the costs of unsuccessful applications by the director for relief (subsection (3)).

412.     Subsections (4) and (5) explain when legal proceedings will be considered to have concluded for the purpose of the conditions imposed by subsection (3).

413.     An indemnity that complies with these conditions is described as a qualifying third party indemnity provision.

Clause 219: Qualifying third party indemnity provision to be disclosed in directors' report

414.     If a qualifying third party indemnity provision is in force for the benefit of one or more directors or was in force during the previous year, this must be disclosed by the company in the directors' report (as to the directors' report, see Chapter 5 of Part 15). Where the director is of one company but the qualifying third party indemnity provision is provided by an associated company, then it must be disclosed in the directors' reports of both companies. Companies which choose not to indemnify directors will not have to make any disclosure.

Clause 220: Copy of qualifying third party indemnity provision to be available for inspection

415.     This clause requires a company to keep copies of all the qualifying third party indemnity provisions it has made for its own directors, and also copies of all those it has made for directors of associated companies.

416.     Subsection (4) is a new provision. It requires all qualifying third party indemnity provisions to be retained and made available for inspection for a further year after they have expired or terminated. But the company is not required by this clause to retain copies of the indemnity provision thereafter.

417.     Subsection (6) makes a failure to comply with the requirements of this clause a criminal offence. The maximum penalty that can be imposed on summary conviction is a fine not exceeding level 3 on the standard scale (currently £1,000) or in cases of continued contravention a daily default fine not exceeding one-tenth of that. In a change from the current position under section 309C of the 1985 Act, the company will no longer be liable under the criminal offence.

Clause 221: Right of member to inspect and request copy

418.     This clause gives members a right to inspect without charge the copies of the qualifying third party indemnity provisions (or where they are not in writing, the

written memorandum of their terms) held by the company in accordance with clause 220.

419.     This clause also creates a new right for members on payment of a fee to request a copy of the copy or memorandum held by the company. The fee will be set by regulations made under clause 788.

Ratification of acts giving rise to liability

Clause 222: Ratification of acts of directors

420.     This clause preserves the current law on ratification of acts of directors, but with one significant change. Any decision by a company to ratify conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company must be taken by the members, and without reliance on the votes in favour by the director or any connected person. Clause 235 defines what is meant by a person being connected with a director. For the purposes of this clause it may also include fellow directors (clause 222(5)(d)).

421.     If the ratification decision is taken by way of a written resolution (see Chapter 2 of Part 13) the director and his connected persons may not take part in the written resolution procedure (subsection (3)). This means that the company does not need to send them a copy of the written resolution, and they are not counted when determining the number of votes required for the written resolution to be passed.

422.     If the ratification decision is taken at a meeting, those members whose votes are to be disregarded may still attend the meeting, take part in the meeting and count towards the quorum for the meeting (if their membership gives them the right to do so).

423.     Subsection (6) makes clear that nothing in this clause changes the law on unanimous consent, so the restrictions imposed by this clause as to who may vote on a ratification resolution will not apply when every member votes (informally or otherwise) in favour of the resolution. The subsection also makes clear that nothing in this clause removes any powers of the directors that they may have to manage the affairs of the company.

424.     Subsection (7) explains that the requirements imposed by this clause are in addition to any other limitations or restrictions imposed by the law as to what may or may not be ratified and when.

CHAPTER 8: DIRECTORS' RESIDENTIAL ADDRESSES: PROTECTION FROM DISCLOSURE

425.     Under the 1985 Act (and previous Companies Acts), the usual residential address of every director must be entered on the public record held by:

  • the registrar; and

  • each company of which he is a director in its register of directors.

Access to the public record held by the registrar is made in a variety of ways, including daily bulk downloading by some subscribers. There is also a public right to inspect companies' registers of directors.

426.     There is an exception for directors at serious risk of violence or intimidation, e.g. from political activists and terrorists. Under sections 723B - 723E of the 1985 Act, introduced by the Criminal Justice and Police Act 2001, they may apply for a "confidentiality order". A director with a confidentiality order provides a single service address in addition to his usual residential address. The service address is entered on the public record; the usual residential address is kept on a secure register to which access is restricted to specified enforcement authorities. The historic record is not affected by the confidentiality order. There are some 5 million directors of whom about 5,000 (about 1%) have a confidentiality order.

427.     The CLR considered it essential that directors' residential addresses be filed with the central register, so that enforcement and regulatory bodies as well as liquidators and, in some circumstances, creditors and shareholders can discover the individual's residential address. However they were concerned that unrestricted public access to directors' residential addresses had been abused. They considered that there should not be any discretion as to whether particular addresses should or should not be placed on the public record. Therefore, while welcoming the introduction of the confidentiality order regime, they recommended all directors be given the option of:

  • either, as now, providing their residential address for the public record;

  • or, providing both a service address and their residential address, with the service address being on the public record and the residential address being on a separate secure register to which access would be restricted. Access to the restricted register would be available to certain public authorities. Other parties, such as members and creditors, should have a right to apply to the court for access to a director's residential address. (Final Report, paragraph 11.46)

428.     This Chapter of the Bill, together with the provisions on the register of directors' residential addresses in Chapter 1 of this Part, is based on this recommendation. These provisions replace the confidentiality order regime.

 
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Prepared: 26 May 2006