Directors: know your (substantial property) limits!
Dec 18, 2012
Directors often want to transfer assets to, or acquire assets from, the company – often without realising that there is a special procedure that must be satisfied.
Under the Companies Act 2006 (Act), directors are required to disclose to the board any direct or indirect interest they may have in a transaction with the company. In addition, the Act requires shareholder approval for substantial property transactions.
So when does a transaction require shareholder approval?
Well there are two scenarios:
- where a director of a company (or a director of its holding company) or a person ‘connected to’ a director acquires, or is to acquire, from the company a substantial non-cash asset; or
- where a company acquires, or is to acquire, a substantial non-cash asset from one of its directors (or a director of its holding company) or a person ‘connected to’ one of its directors.
Who is ‘connected to’ a director of a company?
Have a look at our other blog, “Are you Connected?”
What do you mean by a ‘substantial non-cash asset’?
A non-cash asset is any property or any interest in property (other than cash), the value of which either: (a) exceeds 10% of the value of company’s assets and is more than £5,000; or (b) exceeds £100,000.
What approval do you need?
Under section 190 of the Companies Act 2006, substantial property transactions require approval from members. Shareholder approval can be given before the transaction is entered into or after the transaction has been agreed provided the transaction is conditional on members' approval being granted. Such a resolution can be passed as an ordinary resolution (e.g, a simple majority of the total voting rights of all eligable shareholders) unless the company's articles require a higher approval level (e.g, a special resolution).
What happens if you fail to obtain shareholder approval?
There are statutory remedies available under the Act. A company is not liable if it fails to obtain shareholder approval, but crucially the people involved in the transaction or the directors who authorised the transaction are. The transaction is capable of being rescinded at the company’s request or instigation unless: restitution of any money, or other asset which was the subject of the transaction, is no longer possible; or the company has been indemnified for any loss or damage suffered by it; or if rights acquired in good faith by a third party who was not aware of the failure to get shareholder approval would be affected. Whether or not the transaction is avoided, the following people would be liable to account to the company for any gain that he has made directly or indirectly from the transaction and (jointly and severally with the following people) to indemnify the company for any loss or damage resulting from the arrangement or transaction:
- any director or director of the holding company with whom the company entered into the transaction;
- any person connected to a director of the company or the company’s holding company with whom the company entered into the transaction;
- the director of the company or the company’s holding company with whom such person is connected; and
- any other director who authorised the transaction on behalf of the company.
In the event that a substantial property transaction takes place without shareholder approval, the parties involved should seek to have the transaction ratified (i.e. subsequently approved) by the shareholders as soon as possible.
Give me an example of a substantial property transaction.
Tom is a director of Company A and Company B. Tom owns 50% of the issued share capital of Company A and is also a shareholder of Company B and owns 15% of the issued share capital and his long-term partner Harry owns 10% of the issued share capital. Company C is a wholly owned subsidiary of Company A.
Let’s start off with a simple example: Tom decides to assign a software program to Company A for £150,000. Because Company A is to acquire the software program (which is a substantial non-cash asset) from its director (Tom), the shareholders of Company A must pass a resolution authorising the transaction.
Ok, now we can get a bit more complicated: Company C wants to make Dick (Tom’s stepson) an offer for his software program. Company C is acquiring a substantial non-cash asset from Dick, a person connected to a director of its parent company (Tom), but because Company C is a wholly owned subsidiary of Company A, Company C does not have to seek the shareholders’ approval. However, if Company A only owned 75% of the shares in Company C, both Company A and C would be need shareholder approval.
You’ll need your thinking cap for this one: Company B wants to sell its software development business. Company A has agreed to purchase Company B’s business. However, instead of paying cash, they will issue 750,000 ordinary £1 shares to Company B. Prior to completion, both Company A and Company B will need to obtain shareholder approval because:
- Company A is acquiring from a person connected to its director (Company B) a substantial non-cash asset (the business); and
- Company B is acquiring from a person connected to its director (Company A) a substantial non-cash asset (the shares in Company A).
If Harry did not have any shares in Company B, then the 20% threshold would not be satisfied, Company B would not be connected to Tom and Company A would not require shareholder consent. If Tom did not own Company A, the company would not be connected to him and Company B would not require shareholder consent.
Head of Corporate
Matt advises clients on a wide range of corporate matters, including setting up businesses, venture capital, joint ventures, and mergers and acquisitions. He has particular expertise in advising entrepreneurs and investors in the IT, technology and digital media sectors. His experience working in-house at Telehouse Europe, a leading provider of co-location services to the IT and telecoms industries, and as part of the IT team at Waterfront (2007- 2009), has given him a good understanding of the legal issues facing technology businesses.
Matt has advised in relation to numerous venture capital investments in tech start-ups and early stage businesses. He is equally able to advise entrepreneurs and investors on the challenges they face and he is valued by his clients for his practical, commercial approach.