Directors loans – the law and legal risks

What are the rules?

When the new provisions relating to loans to directors in Companies Act 2006 (“2006 Act”) were brought into effect on 1 October 2007 a jubilant client said to me “Have you seen the new Act? That means I can borrow more money from “my” company.”

What was my response to that? As ever with a lawyer “Yes but……..that does not mean a raid on the company is permissible.”

Shareholder Approval is required

Under the 2006 Act loans to directors are permissible but require the approval, by ordinary resolution, of the members of the company unless certain exceptions apply (as to which see below). This applies to all companies, private or public, that are registered in the UK and that are not a wholly owned subsidiary of another company.

The Rules apply to guarantees given by the Company

The rules also extend to the company giving a guarantee or providing security in connection with a third party making a loan to a director and where a director is a director of the company’s holding company the transaction must also have been approved by the members of the holding company.

Quasi –loans

In the case of public companies or a company associated with a public company the rules are extended further to cover quasi-loans (where the company pays or agrees to pay, or reimburses or agrees to reimburse, a third party for the benefit of the director) or credit transactions (where the company supplies any goods or sells any land, or leases or hires land or goods, or otherwise disposes of any land or supplies goods or services on the understanding that payment is to be deferred, for the benefit of a director).

The provisions are there for good reason, to protect the company and its creditors, members and employees.

What are the exceptions to the rules on directors loans?

The exceptions to the general rule that a loan to a director requires shareholder approval are now wider than under earlier legislation. Samples of where shareholder approval is not required are loans to directors in respect of:

• expenditure on company business not exceeding £50,000
• expenditure on defending proceedings against a director for negligence, default or breach of duty or in connection with regulatory action or investigation
• minor business transactions e.g. the small loan/quasi-loan limit has been increased from £5,000 to £10,000 and the credit transaction limit has been increased to £15,000

“Well that’s good new isn’t it?” said my client. “I can at least have £10,000.”

“Yes but…” again I replied “haven’t you already had a loan for £5,000 which you have not yet paid back? That counts towards the £10,000.”

As with all exceptions the devil is in the detail as to the precise extent of the exception and any other conditions which apply.

There are rules to assist the determination of the value of any transaction or arrangements and the person for whom a transaction is entered into.

Legal compliance with the law on director loans

There are particular requirements in the 2006 Act to be followed as to the information which should be given to the members and how approval of the members is obtained.

In the case of my client he held 66% of the voting shares so as he said “I am pretty confident I will have the approval of the members!”

It should also be borne in mind that the Board in approving such a loan must have regard for their duties as directors of the company which require them to consider, in good faith, what will promote the success of the company for the benefit of the members as a whole.

How, I asked my client, did he think that his loan would do that and would his fellow directors be happy to approve the loan for these purposes? His reply was “well they want to keep me happy don’t they? I work very hard for this company and am the top income earner. They would suffer a severe setback if I left”

“Well,” I said “it might be advantageous to keep you happy in view of your value to the company but that must be proportionate to the size of the loan and perhaps the company should have some idea of when it would be repaid?”

Consequences and risks of failing to comply

The criminal penalty for breach of the provisions relating to such loans was abolished by the 2006 Act.

However, as I pointed out to my client, there are civil penalties for non-compliance with the new rules:

• the company can avoid the loan trasaction;
• the director (or the connected person) may be lliable to account for any gain he has made from the transaction or arrangement;
• the director (or the connected person) is liable to indemnify the company for any loss or damage resulting from the transaction or arrangement
• any other director who authorised the transaction or arrangement is liable to account for any gain or indemnify any loss resulting unless they can show they took all reasonable steps to secure compliance

So, in my client’s case, thinking that a small loan to help him purchase a house for his daughter and top up an otherwise expensive mortgage, that might mean him having to repay the loan immediately and pay to the company any profit or cash or asset benefit he gained from using the money loaned.

Can you do anything about it afterwards?

It is possible for the members to affirm the transaction or arrangement after the event within a reasonable period in which case the transaction or arrangement may no longer be avoided but that does not affect the imposition of the other penalties.

Company loans to connected people or entities

And if you were thinking, as I knew my client would be, that a loan could be made to a director’s spouse or child and avoid the requirement for approval of the members, well, think again. Such a loan is to a person “connected with” the director and if that director is the director of a public company or a company associated with a public company (as in my client’s case), the rules must still be followed.

Further considerations

Consideration may also need to be given to:

• whether the loan to a director falls within an exemption to the Financial Conduct Authority’s authorisation regime for consumer credit transactions as this affects the requirements for such an agreement to be enforceable; and
• whether the director will be subject to a tax charge on the basis that he has received a benefit in kind.

My client was keen to have a loan which was interest free and therefore came within the low cost agreement exemption but was not so keen to pay tax on the benefit he had gained!

Advice and assistance

As ever, what seems at first like a pretty straightforward rule has some complexities attached to it. If you would like advice on how to comply with the provisions relating to loans to directors or persons connected with directors please contact us and we will be pleased to assist.

Contact our experts for corporate governance and legal compliance advice

To talk to one of our corporate or commercial solicitors in West London, call us today on 03456 381381 or email corporate@ibblaw.co.uk.