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Scottish Law Commission (Discussion Papers)
You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Discussion Papers) >> Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties [1998] SLC 105(6) (DP) (August 1998)
URL: http://www.bailii.org/scot/other/SLC/DP/1998/105(6).html
Cite as: [1998] SLC 105(6) (DP)

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    Part 6


    Part 6 Substantive Improvements 3: Loans and Similar Transactions (Sections 330-342)

    Introduction

    6.1      In this part we review sections 330-342, which restrict directors from taking loans from their company or entering into similar transactions. These sections are complex both in their original drafting and their inter-relationship. The scheme of these provisions is of prohibitions with some exemptions. As noted in Part 3, absolute prohibitions are rare in Part X of the Companies Act 1985. It is suggested there that they can be justified if there is a significant risk of third party effect, such as harm to creditors, sufficient to outweigh the gains to shareholders and directors, or a significant public need.[1] As we see it the reason for the prohibition is to protect creditors and minority shareholders from the depletion in corporate assets through the making of loans, which if they were being made on arms length terms, could usually be raised from third parties.

    6.2      The basic prohibition prevents companies making loans to their directors or directors of their holding companies. This prohibition was first introduced in 1947 following the recommendation of the Cohen Committee.[2] The Committee said:

    We consider it undesirable that directors should borrow from their companies. If the director can offer good security, it is no hardship to him to borrow from other sources. If he cannot offer good security, it is undesirable that he should obtain from the company credit which he would not be able to obtain elsewhere. Several cases have occurred in recent years where directors have borrowed money from their companies on inadequate security and have been unable to repay the loans. We accordingly recommend that, subject to certain exceptions, it should be made illegal for any loan to be made by a company or by any of its subsidiary companies or by any person under guarantee from or on security provided by the company or by any of its subsidiary companies to any director of the company.[3]
    6.3      The amendment made to the Companies Act 1929 by the Companies Act 1947 was replaced by section 190 of the Companies Act 1948. The basic prohibition was as follows:

    (1) It shall not be lawful for a company to make a loan to any person who is its director or a director of its holding company, or to enter into any guarantee or provide any security in connection with a loan made to such a person as aforesaid by any other person ....
    6.4          There were a number of exceptions, including an exception for funds to meet expenditure as a director and for loans made in the ordinary course of business.[4]

    6.5      The Company Law Committee under the chairmanship of Lord Jenkins, which reported in 1962, took much the same view as the Cohen Committee. It said :

    98. Section 190 makes it unlawful for a company to make a loan to any of the company's directors. We have had conflicting evidence about this provision. It has been suggested that this restriction may make it difficult for some companies to obtain suitable directors and that, in particular, loans in connection with house purchase to "working" directors should be permitted. On the other hand, it has been suggested that section 190 can be circumvented and the section should be extended so as to prohibit loans by a company to another company in which the directors of the lending company have a majority interest. For the same reasons as the Cohen Committee, which we have quoted in paragraph 58,[5] we think it undesirable that companies should lend to their directors and we recommend below that section 190 should be strengthened.
    99. We recommend that :-
    ....
    (p) Section 190 should be extended to prohibit loans by a company to another company in which one or more of the directors of the lending company hold singly or collectively, and whether directly or indirectly, a controlling interest.[6]
    6.6      No action was taken to implement the recommendation made by the Jenkins Committee until a number of scandals occurred at the end of the 1970s.[7] In consequence, by the Companies Act 1980, Parliament introduced extensive further controls on loan and similar transactions between a company and its directors. With very minor changes these new controls are the provisions now to be found in sections 330-342 of the Companies Act 1985, following the consolidation of the Companies Acts in that year. Sections 330-342 contain: (1) prohibitions, (2) exemptions, (3) civil remedies and (4) criminal penalties. Some of the exemptions contain financial limits, and so there are provisions which explain how these limits are calculated. The prohibitions can be divided according to the type of company to which they apply. Overall the result is complex and inaccessible. We propose to go through each section separately and then put forward options for the future of these provisions.

    6.7      The principal provisions of the sections can be summarised as follows.

    (a) Prohibitions applying to all companies:
    All companies are prohibited from making loans to their directors or directors of their holding companies or providing guarantees or security in connection with a loan by a third party to any such director.[8] (section 330(2))
    There are exemptions for small transactions, for transactions at the request of the holding company and the funding of a director's expenditure for corporate purposes.
    (b) Prohibitions applying to relevant companies:
    Relevant companies are companies which are public companies or are members of a group of companies which include a public company. They are subject to further restrictions applying to transactions which are not loans but which are analogous to loans. In the case of relevant companies, the restrictions in each case extend not only to directors of the company and its holding company but also to persons who are connected with any such director. "Connected" persons are defined in section 346.
    Transactions which a relevant company is prohibited from carrying out in favour of the above persons are:
    In addition to the exemptions applying to all companies, there are exemptions for
    (c) Money-lending companies:
    There is a further exemption for loans, quasi-loans and guarantees entered into by money-lending companies in the ordinary course of business.
    (d) Disclosure:
    The prohibitions are backed up by requirements in Schedule 6, Part II to the Companies Act 1985 to disclose particulars of transactions in the notes to the annual accounts, but there is an exemption for certain transactions entered into by authorised banks, which may record the relevant transactions in a register instead (sections 343-344). Schedule 6, Part II, and sections 343-344, are discussed in Part 7 below.
    6.8      It should be noted that the term "company" as used in these sections means a British registered company[9] and thus the provisions do not catch a loan made (for example) by a foreign subsidiary (including a company formed in Northern Ireland) to its parent company, even if its parent company happens to be registered in England or Scotland. The term "holding company",[10] on the other hand, includes a body corporate other than a company.[11] We do not consider that these restrictions could be applied to transactions by companies incorporated outside England, Wales and Scotland.

    6.9      In this part we examine the provisions of sections 330-342 and seek consultees views on various questions that seem to us to arise from these provisions. We also examine a possible new exemption for loans which have shareholder approval. We consider these matters in turn under the following heads:

    Sections 330 and 331: General restriction on loans etc to directors and persons connected with them and definitions for the purposes of section 330 and subsequent sections

    330.( (1) The prohibitions listed below in this section are subject to the exceptions in sections 332 to 338.
    (2) A company shall not...
    (a) make a loan to a director of the company or of its holding company;
    (b) enter into any guarantee or provide any security in connection with a loan made by any person to such a director.
    (3) A relevant company shall not...
    (a) make a quasi-loan to a director of the company or of its holding company;
    (b) make a loan or a quasi-loan to a person connected with such a director;
    (c) enter into a guarantee or provide any security in connection with a loan or quasi-loan made by any other person for such a director or a person so connected.
    (4) A relevant company shall not...
    (a) enter into a credit transaction as creditor for such a director or a person so connected;
    (b) enter into any guarantee or provide any security in connection with a credit transaction made by any other person for such a director or a person so connected.
    (5) For purposes of sections 330 to 346, a shadow director is treated as a director.
    (6) A company shall not arrange for the assignment to it, or the assumption by it, of any rights, obligations or liabilities under a transaction which, if it had been entered into by the company, would have contravened subsection (2), (3) or (4); but for the purposes of sections 330 to 347 the transaction is to be treated as having been entered into on the date of the arrangement.
    (7) A company shall not take part in any arrangement whereby...
    (a) another person enters into a transaction which, if it had been entered into by the company, would have contravened any of subsections (2), (3), (4) or (6); and
    (b) that other person, in pursuance of the arrangement, has obtained or is to obtain any benefit from the company or its holding company or a subsidiary of the company or its holding company.
    331.((1) The following subsections apply for the interpretation of sections 330 to 346.
    (2) "Guarantee" includes indemnity, and cognate expressions are to be construed accordingly.
    (3) A quasi-loan is a transaction under which one party ("the creditor") agrees to pay, or pays otherwise than in pursuance of an agreement, a sum for another ("the borrower") or agrees to reimburse, or reimburses otherwise than in pursuance of an agreement, expenditure incurred by another party for another ("the borrower") ...
    (a) on terms that the borrower (or a person on his behalf) will reimburse the creditor; or
    (b) in circumstances giving rise to a liability on the borrower to reimburse the creditor.
    (4) Any reference to the person to whom a quasi-loan is made is a reference to the borrower; and the liabilities of a borrower under a quasi-loan include the liabilities of any person who has agreed to reimburse the creditor on behalf of the borrower.
    (5) ...
    (6) "Relevant company" means a company which...
    (a) is a public company, or
    (b) is a subsidiary of a public company, or
    (c) is a subsidiary of a company which has as another subsidiary a public company, or
    (d) has a subsidiary which is a public company.
    (7) A credit transaction is a transaction under which one party ("the creditor")...
    (a) supplies any goods or sells any land under a hire-purchase agreement or a conditional sale agreement;
    (b) leases or hires any land or goods in return for periodical payments;
    (c) otherwise disposes of land or supplies goods or services on the understanding that payment (whether in a lump sum or instalments or by way of periodical payments or otherwise) is to be deferred.
    (8) "Services" means anything other than goods or land.
    (9) A transaction or arrangement is made "for" a person if—
    (a) in the case of a loan or quasi-loan, it is made to him;
    (b) in the case of a credit transaction, he is the person to whom goods or services are supplied, or land is sold or otherwise disposed of, under the transaction; (c) in the case of a guarantee or security, it is entered into or provided in connection with a loan or quasi-loan made to him or a credit transaction made for him;
    (d) in the case of an arrangement within subsection (6) or (7) of section 330, the transaction to which the arrangement relates was made for him; and
    (e) in the case of any other transaction or arrangement for the supply or transfer of, or of any interest in, goods, land or services, he is the person to whom the goods, land or services (or the interest) are supplied or transferred.
    (10) "Conditional sale agreement" means the same as in the Consumer Credit Act 1974.

    Explanation of the prohibitions

    6.10          The word "loan" only covers a situation where a company advances money on terms that it is to be repaid in money or money's worth. Thus in Champagne Perrier-Jouet SA v Finch[12] the court held that a company which had paid a director's bills and supplied goods to the company which he controlled, on credit, had not made a "loan" to him and therefore did not have a lien on his shares under the terms of its articles. The concept of the quasi-loan was introduced to bring within the scope of the prohibition on loans this sort of transaction, as well as the case where a director commits the company to an item of personal expenditure for which he ought to reimburse the company.

    6.11      The prohibitions are further complicated by the introduction of the concept of credit transactions (basically, the supply of goods or land on credit or on deferred purchase terms).[13] The possibility of the company acquiring the obligation of a third party under an agreement which it could not itself enter is also covered.[14] The section also makes it unlawful for the company to enter into an arrangement whereby another party enters into a transaction which the company could not itself have entered into and obtains a benefit from the company or its holding company.[15] The term "arrangement" is not defined here as it is for example in section 204(5) and (6) of the Companies Act 1985. It is thought that it must be legally enforceable although it may be informally agreed and consist of a series of agreements rather than a single agreement.[16]

    Are restrictions other than on making loans to directors necessary?

    6.12      We discuss below whether it would be possible to rewrite sections 330-344 in a simplified form[17] or alternatively to adopt the radical solution of removing the whole of sections 330-344 from the Companies Act 1985.[18] At this stage we ask whether the prohibitions, other then the basic prohibition in section 330(2), are needed.

    Accordingly, we ask consultees:

    (i) Are the restrictions on quasi-loans and related transactions contained in sections 330-331 required, and, if so, should they extend to directors, holding company directors and connected persons?

    (ii) Are the restrictions on credit transactions and related transactions contained in sections 330-331 required, and, if so, should they extend to directors, holding company directors and their connected persons?

    (iii) Are the additional restrictions in section 330(6) and (7) on indirect arrangements required?

    To which companies should the prohibitions extend?

    6.13      The restrictions which apply to companies which are not relevant companies are far less onerous than those which apply to relevant companies. Although non-relevant companies will often be small, this is not universally true. Independent private companies can have substantial assets and turnover, whereas a subsidiary of a public company may be quite small in size. The distinction adopted in section 330 is between companies which belong to a group which can raise capital from the public and other companies.

    6.14          The distinction adopted between different types of company in the company accounting requirements is between small and medium-sized companies.[19] The principal basis of the distinction between these two types of company is in terms of qualifying requirements related to size as set out below:

    Small company
    Turnover [Not more than £2.8 million]
    Balance sheet total [Not more than £1.4 million]
    Number of employees Not more than 50
    Medium-sized company
    Turnover [Not more than £11.2 million]
    Balance sheet total [Not more than £5.6 million]
    Number of employees Not more than 250.
    The company must have satisfied two or more of these requirements, usually for two consecutive financial years.[20]

    Consultees are asked:

    (i) whether section 330 should continue to apply as now, with some of the restrictions applying only to relevant companies; or

    (ii) whether the same restrictions should apply to all companies; or

    (iii) whether some of the prohibitions, now applying only to relevant companies, should additionally be applied to some companies other than relevant companies and, if so:

    (a) whether such companies should be defined in terms of size; and, if so
    (b) whether this should be on the same basis as for small and medium sized companies or on some other basis, and if so what basis;

    (iv) whether some relevant companies should cease to be subject to the additional restrictions and, if so, in what circumstances.

    Sections 332-338: Exemptions from prohibitions

    (1) Short-term quasi-loans (section 332)

    332.((1)Subsection (3) of section 330 does not prohibit a company ("the creditor") from making a quasi-loan to one of its directors or to a director of its holding company if...
    (a) the quasi-loan contains a term requiring the director or a person on his behalf to reimburse the creditor his expenditure within 2 months of its being incurred; and
    (b) the aggregate of the amount of that quasi-loan and of the amount outstanding under each relevant quasi-loan does not exceed [£5,000].
    (2) A quasi-loan is relevant for this purpose if it was made to the director by virtue of this section by the creditor or its subsidiary or, where the director is a director of the creditor's holding company, any other subsidiary of that company; and "the amount outstanding" is the amount of the outstanding liabilities of the person to whom the quasi-loan was made.
    6.15      The Secretary of State has power to increase the financial limits under this section under section 345. The object of this exemption is to avoid making illegal the situation where a quasi-loan is incurred for a very short period, perhaps because the director uses his company credit card for expenditure which is personal and he reimburses the company promptly on receipt of the statement by it from the credit card company.

    Consultees are asked whether the exemption contained in section 332 is (a) used in practice, and (b) satisfactory.

    (2) Intra-group loans (section 333)

    333.(In the case of a relevant company which is a member of a group of companies (meaning a holding company and its subsidiaries), paragraphs (b) and (c) of section 330(3) do not prohibit the company from...
    (a) making a loan or quasi-loan to another member of that group; or
    (b) entering into a guarantee or providing any security in connection with a loan or quasi-loan made by any person to another member of the group,

    by reason only that a director of one member of the group is associated with another.

    6.16          This exemption is necessary because a company which is a holding company, or a subsidiary, or a fellow subsidiary, may be a connected person of one of its directors, or its holding company directors, if he holds sufficient shares in any of those companies. No financial limit is imposed.

    Consultees are asked whether the exemption contained in section 333 is (a) used in practice, and (b) satisfactory.

    (3) Loans of small amounts (section 334)

    334.( Without prejudice to any other provision of sections 332 to 338, paragraph (a) of section 330(2) does not prohibit a company from making a loan to a director of the company or of its holding company if the aggregate of the relevant amounts does not exceed [£5,000].
    6.17          The Secretary of State has power to increase financial limits under this section.[21] This exemption enables a company to make loans (but not quasi-loans or credit transactions) not exceeding the amount stated[22] to a director or holding company director but not a connected person.

    Consultees are asked whether the exemption contained in section 334 is (a) needed, and (b) satisfactory

    (4) Minor transactions (section 335(1))

    335.((1) Section 330(4) does not prohibit a company from entering into a transaction for a person if the aggregate of the relevant amounts does not exceed [£10,000].
    6.18      The Secretary of State has power to increase financial limits under this section.[23] The exemption enables a relevant company lawfully to enter into credit transactions, and give guarantees and security in support of credit transactions, provided that the prescribed limit[24] is not exceeded. The expression "for a person" is explained in section 331(9).

    Consultees are asked whether the exemption contained in section 335(1) is (a) needed, and (b) satisfactory.

    (5) Transactions in the ordinary course of business (section 335(2))

    335.((2) Section 330(4) does not prohibit a company from entering into a transaction for a person if...
    (a) the transaction is entered into by the company in the ordinary course of its business; and
    (b) the value of the transaction is not greater, and the terms on which it is entered into are no more favourable, in respect of the person for whom the transaction is made, than that or those which it is reasonable to expect the company to have offered to or in respect of a person of the same financial standing but unconnected with the company.
    6.19      It is to be noted that this exemption, again for credit transactions, and guarantees and security in support of credit transactions, contains two hurdles: first, the transaction must be in the ordinary course of the company's business and second, the terms of the transaction must not discriminate in favour of directors or persons connected with them.

    6.20          Under section 335(2)(a), the court looks at the ordinary course of the particular company's business. This means that if, for example, it habitually made loans on the same scale and for the same purposes it could nonetheless satisfy the first requirement by entering into another one of the same scale and for the same purpose[25] even if this was not usual among other companies in the same circumstances. Section 335(2) introduces an objective test with regard to the value of the transactions and its terms. Both tests in section 335(2) involve questions of fact and degree and therefore involve some uncertainty in their application.

    Consultees are asked whether the exemption contained in section 335(2) is (a) used in practice, and (b) satisfactory

    (6) Transactions at the behest of the holding company (section 336)

    336.( The following transactions are excepted from the prohibitions of section 330...
    (a) a loan or quasi-loan by a company to its holding company, or a company entering into a guarantee or providing any security in connection with a loan or quasi-loan made by any person to its holding company;
    (b) a company entering into a credit transaction as creditor for its holding company, or entering into a guarantee or providing any security in connection with a credit transaction made by any other person for its holding company.
    6.21      As already explained, intra-group transactions may be caught by the prohibitions in section 330 where the company making the loan or quasi-loan or entering into the credit transaction, guarantee or security, or its holding company, has a director with respect to whom the company with whom the transaction is made is connected for the purposes of section 346. This exemption takes "upstream" loans, quasi-loans and credit transactions (that is prohibited transactions from a subsidiary to a parent company) outside the scope of prohibitions. There is no financial limit on the amount of the transaction where this exemption is relied on.

    Consultees are asked whether the exemption contained in section 336 is (a) used in practice, and (b) satisfactory.

    (7) Funding of director's expenditure on duty to the company (section 337)

    337.((1) A company is not prohibited by section 330 from doing anything to provide a director with funds to meet expenditure incurred or to be incurred by him for the purposes of the company or for the purpose of enabling him properly to perform his duties as an officer of the company.
    (2) Nor does the section prohibit a company from doing any thing to enable a director to avoid incurring such expenditure.
    (3) Subsections (1) and (2) apply only if one of the following conditions is satisfied...
    (a) the thing in question is done with prior approval of the company given at a general meeting at which there are disclosed all the matters mentioned in the next subsection;
    (b) that thing is done on condition that, if the approval of the company is not so given at or before the next annual general meeting, the loan is to repaid, or any other liability arising under any such transaction discharged, within 6 months from the conclusion of that meeting;

    but those subsections do not authorise a relevant company to enter into any transaction if the aggregate of the relevant amounts exceeds [£20,000].

    (4) The matters to be disclosed under subsection (3)(a) are...
    (a) the purpose of the expenditure incurred or to be incurred, or which would otherwise be incurred, by the director,
    (b) the amount of the funds to be provided by the company, and
    (c) the extent of the company's liability under any transaction which is or is connected with the thing in question.
    6.22          This exemption is very similar to that contained in section 190(1)(c) and (2) of the Companies Act 1948, except that it extends to transactions other than loans and contains a financial limit.

    6.23          In general companies must hold an annual general meeting each year.[26] There is nothing to stop shareholders agreeing to deal with the business of the annual general meeting informally and by unanimous consent and without the holding of an actual meeting. Moreover, since the Companies Act 1989, it has been possible for shareholders of a private company to dispense with the holding of annual general meetings.[27] Shareholders of a company can give their approval under section 337(3)(a) informally without holding a meeting, provided that the matters required to be disclosed by section 337(4) are disclosed to each member by whom or on whose behalf the resolution is required to be signed under section 381A.[28]

    Consultees are asked whether they consider that the exemption contained in section 337 is (a) used in practice, and (b) satisfactory.

    (8) Loan or quasi-loan by a money-lending company (section 338)

    338. ((1)There is excepted from the prohibitions in section 330...
    (a) a loan or quasi-loan made by a money-lending company to any person; or
    (b) a money-lending company entering into a guarantee in connection with any other loan or quasi-loan.
    (2) "Money-lending company" means a company whose ordinary business includes the making of loans or quasi-loans, or the giving of guarantees in connection with loans or quasi-loans.
    (3) Subsection (1) applies only if both the following conditions are satisfied...
    (a) the loan or quasi-loan in question is made by the company, or it enters into the guarantee, in the ordinary course of the company's business; and
    (b) the amount of the loan or quasi-loan, or the amount guaranteed, is not greater, and the terms of the loan, quasi-loan or guarantee are not more favourable, in the case of the person to whom the loan or quasi-loan is made or in respect of whom the guarantee is entered into, than that or those which it is reasonable to expect that company to have offered to or in respect of a person of the same financial standing but unconnected with the company.
    (4) But subsection (1) does not authorise a relevant company (unless it is [a banking company]) to enter into any transaction if the aggregate of the relevant amounts exceeds [£100,000].
    (5) In determining that aggregate, a company which a director does not control is deemed not to be connected with him.
    (6) The condition specified in subsection (3)(b) does not of itself prevent a company from making a loan to one of its directors or a director of its holding company...
    (a) for the purpose of facilitating the purchase, for use as that director's only or main residence, of the whole or part of any dwelling-house together with any land to be occupied and enjoyed with it;
    (b) for the purpose of improving a dwelling-house or part of a dwelling-house so used or any land occupied and enjoyed with it;
    (c) in substitution for any loan made by any person and falling within paragraph (a) or (b) of this subsection,

    if loans of that description are ordinarily made by the company to its employees and on terms no less favourable than those on which the transaction in question is made, and the aggregate of the relevant amounts does not exceed [£100,000].

    6.24      Section 338(3) is very similar to section 335(2), as to which see paragraphs 6.19-6.20 above. Section 338(5) was considered necessary to prevent a money-lending company from having to keep track of a large number of customers who happened to be connected persons of a director.

    6.25          Section 338(6) enables a money-lending company to give house purchase loans to its directors on favourable terms. We do not know the extent to which this exception is actually used in practice.

    Consultees are asked:

    (i) With regard to the exemption in section 338(3) (taken on its own):

    (a) should this exemption be retained;
    (b) is this exemption used in practice;
    (c) is this exemption satisfactory?

    (ii) With regard to the exemption in section 338(3) taken with section 338(6) (house purchase loans):

    (a) should this exemption be retained;
    (b) is this exemption used in practice;
    (c) is this exemption satisfactory?

    Sections 339-340: "Relevant amounts" for purposes of section 334 and other sections and determining the "value" of transactions or arrangements

    339.((1) This section has effect for defining the "relevant amounts" to be aggregated under sections 334, 335(1), 337(3) and 338(4); and in relation to any proposed transaction or arrangement and the question whether it falls within one or other of the exceptions provided by those sections, "the relevant exception" is that exception; but where the relevant exception is the one provided by section 334 (loan of small amount), references in this section to a person connected with a director are to be disregarded.
    (2) Subject as follows, the relevant amounts in relation to a proposed transaction or arrangement are...
    (a) the value of the proposed transaction or arrangement,
    (b) the value of any existing arrangement which...
    (i) falls within subsection (6) or (7) of section 330, and
    (ii) also falls within subsection (3) of this section, and
    (iii) was entered into by virtue of the relevant exception by the company or by a subsidiary of the company or, where the proposed transaction or arrangement is to be made for a director of its holding company or a person connected with such a director, by that holding company or any of its subsidiaries;
    (c) the amount outstanding under any other transaction...
    (i) falling within subsection (3) below, and
    (ii) made by virtue of the relevant exception, and
    (iii) made by the company or by a subsidiary of the company or, where the proposed transaction or arrangement is to be made for a director of its holding company or a person connected with such a director, by that holding company or any of its subsidiaries.
    (3) A transaction falls within this subsection if it was made...
    (a) for the director for whom the proposed transaction or arrangement is to be made, or for any person connected with that director; or
    (b) where the proposed transaction or arrangement is to be made for a person connected with a director of a company, for that director or any person connected with him;

    and an arrangement also falls within this subsection if it relates to a transaction which does so.

    (4) But where the proposed transaction falls within section 338 and is one which [a banking company] proposes to enter into under subsection (6) of that section (housing loans, etc), any other transaction or arrangement which apart from this subsection would fall within subsection (3) of this section does not do so unless it was entered into in pursuance of section 338(6).
    (5) A transaction entered into by a company which is (at the time of that transaction being entered into) a subsidiary of the company which is to make the proposed transaction, or is a subsidiary of that company's holding company, does not fall within subsection (3) if at the time when the question arises (that is to say, the question whether the proposed transaction or arrangement falls within any relevant exception), it no longer is such a subsidiary.
    (6) Values for purposes of subsection (2) of this section are to be determined in accordance with the section next following; and "the amount outstanding" for purposes of subsection (2)(c) above is the value of the transaction less any amount by which that value has been reduced.
    340.((1) This section has effect for determining the value of a transaction or arrangement for purposes of sections 330 to 339.
    (2) The value of a loan is the amount of its principal.
    (3) The value of a quasi-loan is the amount, or maximum amount, which the person to whom the quasi-loan is made is liable to reimburse the creditor.
    (4) The value of a guarantee or security is the amount guaranteed or secured.
    (5) The value of an arrangement to which section 330(6) or (7) applies is the value of the transaction to which the arrangement relates less any amount by which the liabilities under the arrangement or transaction of the person for whom the transaction was made have been reduced.
    (6) The value of a transaction or arrangement not falling within subsections (2) to (5) above is the price which it is reasonable to expect could be obtained for the goods, land or services to which the transaction or arrangement relates if they had been supplied (at the time the transaction or arrangement is entered into) in the ordinary course of business and on the same terms (apart from price) as they have been supplied, or are to be supplied, under the transaction or arrangement in question.
    (7) For purposes of this section, the value of a transaction or arrangement which is not capable of being expressed as a specific sum of money (because the amount of any liability arising under the transaction or arrangement is unascertainable, or for any other reason), whether or not any liability under the transaction or arrangement has been reduced, is deemed to exceed [£100,000].
    6.26          It would appear that section 339(1) should also refer to section 338(6) as well as section 338(4).

    6.27          Section 340(7) creates a rule to govern the situation where value is unquantifiable. It is automatically deemed to exceed £100,000 so that none of the exceptions which impose financial limits are available. This rule also applies in Schedule 6, and we consider its function there separately below.[29]

    6.28      These provisions are clearly very complex.

    Consultees are asked if they have any comment on sections 339-340 apart from their complexity.

    Section 341: Civil remedies

    341.((1) If a company enters into a transaction or arrangement in contravention of section 330, the transaction or arrangement is voidable at the instance of the company unless...
    (a) restitution of any money or any other asset which is the subject matter of the arrangement or transaction is no longer possible, or the company has been indemnified in pursuance of subsection (2)(b) below for the loss or damage suffered by it, or
    (b) any rights acquired bona fide for value and without actual notice of the contravention by a person other than the person for whom the transaction or arrangement was made would be affected by its avoidance.
    (2) Where an arrangement or transaction is made by a company for a director of the company or its holding company or a person connected with such a director in contravention of section 330, that director and the person so connected and any other director of the company who authorised the transaction or arrangement (whether or not it has been avoided in pursuance of subsection (1)) is liable...
    (a) to account to the company for any gain which he has made directly or indirectly by the arrangement or transaction; and
    (b) (jointly and severally with any other person liable under this subsection) to indemnify the company for any loss or damage resulting from the arrangement or transaction.
    (3) Subsection (2) is without prejudice to any liability imposed otherwise than by that subsection, but is subject to the next two subsections.
    (4) Where an arrangement or transaction is entered into by a company and a person connected with a director of the company or its holding company in contravention of section 330, that director is not liable under subsection (2) of this section if he shows that he took all reasonable steps to secure the company's compliance with that section.
    (5) In any case, a person so connected and any such other director as is mentioned in subsection (2) is not so liable if he shows that, at the time the arrangement or transaction was entered into, he did not know the relevant circumstances constituting the contravention.
    6.29          The code of remedies created by this section is very similar to that created by section 322[30] save that there is no provision for loss of the right of rescission if the transaction is affirmed. As the transaction is prohibited, it cannot be affirmed.[31] Section 341(3) preserves any liability arising under the general law. A director who receives a loan prohibited by section 330 will be liable for breach of fiduciary duty and to compensate the company.[32]

    6.30      We are not aware of any defects in this section.

    Consultees are asked whether they have any comments on section 341.

    Section 342: Criminal penalties for breach of section 330

    342.((1)A director of a relevant company who authorises or permits the company to enter into a transaction or arrangement knowing or having reasonable cause to believe that the company was thereby contravening section 330 is guilty of an offence.
    (2) A relevant company which enters into a transaction or arrangement for one of its directors or for a director of its holding company in contravention of section 330 is guilty of an offence.
    (3) A person who procures a relevant company to enter into a transaction or arrangement knowing or having reasonable cause to believe that the company was thereby contravening section 330 is guilty of an offence.
    (4) A person guilty of an offence under this section is liable to imprisonment or a fine, or both.
    (5) A relevant company is not guilty of an offence under subsection (2) if it shows that, at the time the transaction or arrangement was entered into, it did not know the relevant circumstances.
    6.31          We discuss the question whether provisions of Part X should carry criminal sanctions more fully in Part 10 of this consultation paper. At this stage:

    Consultees are asked whether, if criminal penalties are to be imposed for breach of section 330, they should cover offences by relevant companies (and their officers), or all companies (and their officers).

    6.32          The question is raised in Part 3[33] whether there might exist circumstances, in addition to those already permitted by the Act,[34] in which it could be justified for the company rather than a third party to give a loan to a director or a connected person of his with shareholder approval, though any such exemption would have to be subject to strict limits and the present prohibition should be maintained if the interests of creditors would be adversely affected. The following paragraphs of this part discuss the possibility of a new additional exemption for loans made with the consent of shareholders.

    A possible additional exemption for loans made with the consent of shareholders

    6.33      The decision whether to make a loan is normally taken by the directors.[35] The prohibitions discussed above mean that directors in many situations cannot lawfully authorise loans in favour of either themselves or their holding company directors or any of their connected persons. These rules protect shareholders. They also protect creditors who might otherwise find that the assets of the company to which they could look for payment had been lent to directors and persons connected with them.[36] However there are situations in which it can be said the prohibitions have no purpose. Most obviously this occurs where the directors are the shareholders and there are no creditors or the company is fully able to meet all its liabilities.

    6.34      We seek consultees' views on the question whether there is any need in practice to create an exemption from all or any of the transactions prohibited by section 330 to meet this kind of case and whether it is desirable to introduce a yet further exemption for this purpose. Any new exemption would have to contain appropriate safeguards for minority shareholders and creditors.

    Safeguards for shareholders

    6.35          As we see it, the most appropriate safeguard for shareholders would be either a special resolution or unanimous consent. It would not be practicable to use, say, the model of section 337(3) because the loan may be irrecoverable as soon as it is made. Another safeguard that should be considered is a financial limit applying to, say, transactions made by virtue of this new exemption within the same financial year.

    6.36          Unanimous consent is a possibility suggested in Part 3 above,[37] but it would be unusual for the Companies Act to require the unanimous consent of members.[38] Unanimous consent is usually permitted as an alternative to a meeting.[39] If a special resolution is required, it is for consideration whether the votes of any shareholder who will benefit under the transaction should be disregarded as they would be under section 174 if they would cause the resolution to pass when it would not otherwise have done so and whether there should be a requirement for disclosure of the statutory declaration to members both before and at the meeting.[40]

    Safeguards for creditors

    Option (1): The company must have to provide for the whole of the value of the transaction out of its distributable profits
    6.37      The effect of this option would be that the company would have to transfer an amount equal to the loan from its distributable reserves to its undistributable reserves. Where a private company gives financial assistance, for the purposes of an acquisition of its shares it must provide for that assistance out of its distributable profits where the net assets are reduced.[41] Where a loan, quasi loan or credit transaction is made, or a guarantee or security is given, net assets ought not to be thereby reduced immediately after the transaction. If they were, it is difficult to see why the transaction was made.

    Option (2): The company's directors must make a statutory declaration as required by section 173 of the Companies Act 1985
    6.38      Section 156 provides that where a private company wishes to give financial assistance for the purposes of an acquisition of its shares, its directors must make a statutory declaration.[42] Likewise, where a private company wishes to make a payment out of capital for the redemption or purchase of its shares, its directors must make a statutory declaration. The forms of statutory declaration are similar but not identical. In both cases the directors must state that they have enquired into the company's affairs (and also, where section 173 applies, its prospects) and that they are satisfied that there is no ground on which the company could then be found unable to pay its debts. The statutory declaration under section 156 then contemplates that the company might either carry on business or be wound up in the next 12 months. Only the former possibility is contemplated by the statutory declaration under section 173, and that seems the more appropriate precedent where loans are made under this new exemption. The declaration requires the directors to state that, having regard to their management intentions during the year after the date of the transaction and the company's resources in that period they are of the opinion that the company will be able to carry on in business as a going concern and will accordingly be able to pay its debts as they fall due throughout that year. The directors must take into account the company's prospective and contingent liabilities. The statutory declaration must have annexed to it a report from the auditors stating that they are not aware of anything to indicate that the directors' opinion in the statutory declaration is unreasonable.[43]

    6.39      If a statutory declaration is required it would have to be given within a short period of the special resolution as otherwise the statutory declaration may become out of date.[44] If rights are given to members or creditors to object to the proposed payment, no action can be taken on the proposed resolution until the period for such an application has expired. We suggest that a period of six weeks in total should suffice for this.

    To what types of transactions and companies should the new exemption refer?

    6.40      The new exemption could apply only to loans in favour of directors and/or directors of their holding company, or it could extend to any transaction that would otherwise be prohibited by section 330.

    6.41          A further question is whether the new exemption should apply to all companies, or only non-relevant companies,[45] or some other class of companies. We consider that the new exemption should not be available where the company is a relevant company since in those companies there are likely to be larger numbers of shareholders who could be adversely affected by the transaction. However as indicated above,[46] the class of non-relevant companies may itself be too wide. We discuss above the possibility of companies being classified according to size, but in this particular context it may be more appropriate to see whether there is an identity between ownership and control, so that an objection to actions of directors in authorisung transactions for their or their connected persons' benefit would be less likely. One of the recommendations in the Law Commision's report on Shareholder Remedies[47] was limited to this class of company, which was in essence a private company in which all or substantially all the members were directors.

    Publicity requirements

    6.42      Section 175 imposes new rules for publicity to be given to the payment out of capital, including

    (1) a notice in the Gazette and a national newspaper informing creditors of the intention to make the payment and of their right to apply to the court;
    (2) making the statutory declaration available for inspection; and
    (3) filing a copy of the statutory declaration and auditors' report with the registrar.

    Objections by members or creditors

    6.43          Where a payment is to be made out of capital using the procedure described above, a member or creditor may, within five weeks of the date of the passing of the special resolution approving the payment apply to the court for an order cancelling it.[48] The court can adjourn the proceedings to see if arrangements can be made for the purchase of the member's shares. It can confirm or cancel the resolution.[49]

    Consultees are asked:

    (i) Is there any need in practice to create a new exemption to meet the case where directors hold all or a majority of the shares and creditors are not prejudiced?

    (ii) Is it desirable to create a new exemption for this situation?

    (iii) Do they consider that there should be safeguards for shareholders and, if so, which do they consider to be the best option:

    (a) a special resolution; or
    (b) unanimous approval by the members?

    If they think that some other option is preferable, they are asked to state what that option comprises and why they prefer it.

    (iv) Do they consider that there should be safeguards for creditors and, if so, which of the options discussed in paragraphs 6.37-6.39 do they consider to be the best option:

    (a) option 1: the company must have to provide for the whole of the value of the transaction out of its distributable profits; or
    (b) option 2: the company's directors must make a statutory declaration as required by section 173 of the Companies Act 1985?

    If they think that some other option is preferable, they are asked to state what that option comprises and why they prefer it.

    (v) Should the new exemption apply to:

    (a) loans to directors;
    (b) loans to holding company directors;
    (c) guarantees or security in support of the above;

    Or, in the case of relevant companies:

    (d) loans in favour of connected persons;
    (e) quasi-loans in favour of directors or their connected persons;
    (f) credit transactions in favour of directors or their connected persons;
    (g) guarantees or security in respect of any of the above;

    In the case of all companies:

    (h) indirect arrangements caught by section 330(6) or (7) of the Companies Act 1985?

    (vi) Should the new exemption apply to:

    (a) all companies;
    (b) only companies which are not relevant companies as defined by section 331(6);
    (c) only another class of companies (please describe)?

    (vii) Do consultees think that if this new exemption is adopted:

    (a) there should be the same arrangements for publicity as for payment out of capital and as described in paragraph 6.42 above;
    (b) there should be power for the court to cancel the approval given by the shareholders on the application of a member or creditor as described in paragraph 6.43 above?

    (viii) Do consultees think that if this new exemption is adopted, shareholders who may benefit from the transaction should have their votes disregarded if the resolution would not have been passed without them?

    (ix) Do consultees think that if the new exemption is adopted members should have the right to inspect the statutory declaration and the auditors' report?

Note 1   See para 3.16 and paras 3.54-3.55 above.    [Back]

Note 2   See the Report of the Committee on Company Law Amendment (1945) Cmd 6659.    [Back]

Note 3   Ibid, para 94, pp 49-50.    [Back]

Note 4   Section 190(1) provisos (c) and (d).    [Back]

Note 5   The Jenkins Committee quoted part of the passage in para 6.2 above.    [Back]

Note 6   Paras 98-99, pp 34-37. See also para 6.22 of the Hong Kong Consultancy Report in Appendix L below.    [Back]

Note 7   Relating to secondary banks and also to Peachey Property Corporation, which was the subject of a DTI investigation: see para 1.10, n 7 above.    [Back]

Note 8   The prohibitions do not therefore on their face apply to persons other than directors, but if the loan is made, for example, to a company which is wholly-owned by the director the loan may be treated as made to him: Wallersteiner v Moir [1974] 1WLR 1015.    [Back]

Note 9   Section 735 (1).    [Back]

Note 10   Section 736.    [Back]

Note 11   However Scottish firms are not included: see s 740.    [Back]

Note 12   [1982] 1 WLR 1359, 1363. Although the case concerned the question whether a transaction constituted a "loan" for the purpose of one of the company's articles, Walton J also said that this was the meaning of the term in the context of s 190 of the Companies Act 1948 (now s 330(1)).    [Back]

Note 13   Section 330 (4) and s 331 (7).    [Back]

Note 14   Section 330(6).    [Back]

Note 15   Section 330(7).    [Back]

Note 16   See generally Re British Basic Slag Ltd's Application [1963] 1WLR 727.    [Back]

Note 17   See paras 9.34-9.43 below.     [Back]

Note 18   See paras 9.3-9.7 and 9.22-9.24 below.     [Back]

Note 19   See s 247. Words in square brackets were substituted by the Companies Act 1985 (Accounts of Small and Medium-Sized Enterprises and Publication of Accounts in ECUs) Regulations 1992, SI 1992/2452, reg 5(1) and (2).    [Back]

Note 20   See s 247(1) and (2). There are exceptions for the company's first financial years and for situations where it qualifies in one only of the two years.    [Back]

Note 21   Section 345.    [Back]

Note 22   To be calculated as provided in ss 339-340.    [Back]

Note 23   Section 345.    [Back]

Note 24   To be calculated in accordance with ss 339-340.    [Back]

Note 25   See generally Steen v Law [1964] AC 303, which concerned the Australian equivalent of s 54(1)(a) of the Companies Act 1948, and Fowlie v Slater, 23 March 1979 (unreported, Divisonal Court) which concerned s 54(1) (a) of the Companies Act 1948. A distinction is to be drawn between the phrase found in s 335(2)(a) and the expression "in the ordinary course of business", which requires an objective examination by reference to the standard of the ordinary course of business and could result in a transaction, exceptional so far as the particular company was concerned, nonetheless being "in the ordinary course of business": see, for example, Countrywide Banking Corpn Ltd v Dean [1998] 2 WLR 441.    [Back]

Note 26   Except that it may hold its first annual general meeting at any time within 18 months of its incorporation: see generally, s 366 of the Companies Act 1985.    [Back]

Note 27   Section 366A.    [Back]

Note 28   Schedule 15A, Para 8.    [Back]

Note 29   See paras 7.5-7.6 below.     [Back]

Note 30   Para 6.15 above.     [Back]

Note 31   See para 11.41 below..     [Back]

Note 32   See A F Budge (Contractors) Ltd v Budge, (unreported) 17 July 1995.     [Back]

Note 33   Para 3.54 above.    [Back]

Note 34   See s 337.    [Back]

Note 35   Depending on the terms of the company's constitution.    [Back]

Note 36   See paras 3.54-3.55 above.    [Back]

Note 37   See para 3.55 above.    [Back]

Note 38   Section 125(5) requires the consent of all the members to a variation of class rights where the rights are attached by the memorandum and there is no provision for their variation.    [Back]

Note 39   See Cane v Jones [1981] 1 WLR 1451; and see ss 381A and 381C of the Companies Act 1985.    [Back]

Note 40   As in s 174 .    [Back]

Note 41   Section 155(2) of the Companies Act 1985.    [Back]

Note 42   Ibid, s 156.    [Back]

Note 43   Section 173(5).    [Back]

Note 44   Section 174 requires the capital payment to be made no earlier than five weeks and no later than seven weeks after the date of the resolution. The statutory declaration must be made on the day the special resolution is passed or within the preceding week (s 174).    [Back]

Note 45   Relevant companies are defined by s 331(6) above.    [Back]

Note 46   Paras 6.13-6.14 above.    [Back]

Note 47   Law Com No 246, para 8.3.     [Back]

Note 48   Section 176.    [Back]

Note 49   Section 177.    [Back]

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