Companies Act 2006 Update – Changes to English Company Law Coming into Force on 1 October 2008

October 1, 2008

Companies law in England and Wales is undergoing reform and modernisation by way of the phased implementation of the Companies Act 2006 (the "2006 Act"). Various parts of the 2006 Act become effective on 1 October 2008. This alert summarises the main changes coming into force from that date.

The main provisions effective 1 October 2008 include:

• Provisions relating to the directors’ conflicts of interest duties – Part 10 of the 2006 Act;
• Requirement for every company to have at least one natural person as a director – Section 155 of the 2006 Act;
• Repeal of the restrictions on financial assistance for the acquisition of shares in private companies – Sections 151-153 and 155 to 158 (1985 Act);
• Share capital reduction through a new solvency statement route Sections 641 – 644 of the 2006 Act;
• Control of political donations and expenditure provisions relating to an independent candidate – Sections 362-379 of the 2006 Act;
• Objection to company names and the Company Names Tribunal – Sections 69-74 of the 2006 Act;
• Changes to the requirements of annual returns; and
• Trading disclosures – Sections 82 to 85 of the 2006 Act.

Codified Directors Duties

The 2006 Act introduces a statutory statement of duties that replaces several common law and equitable rules. The codified duties will be owed to the company and only the company will be able to enforce them. Most of these provisions came into force on 1 October 2007, however the provisions dealing with directors’ conflicts of interest come into force on 1 October 2008.

(i) Directors’ Conflict of Interests (section 175 of the 2006 Act)

The basic principle contained in section 175 of the 2006 Act is that a director must "avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company". While there is no definition of "interest" in the 2006 Act, the duty is expressed to apply, in particular, to the exploitation of any property, information or opportunity and it is immaterial whether the company could have taken advantage of such property, information or opportunity.

So for example, a conflict situation may arise where:

• a director holds other directorships for example, the director sits on the board of a supplier or customer; or
• a director is appointed to the board by a major shareholder in, for example, a joint venture arrangement or private equity/venture capital context.

Although it is not expressly stated in section 175 of the 2006 Act, a director should also consider the interests of a person "connected" with him in deciding whether or not there is a conflict situation. The definition of "connected" in the 2006 Act is wide enough and covers amongst others a director’s parents, spouse, children, step-children and a civil partner.

There are three exemptions to the duty to avoid a conflict of interests. The duty under section 175 of the 2006 Act is not infringed:

• if the conflict arises in relation to a transaction or arrangement with the company (in which case the director is obliged to disclose his interest);
• if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or
• if the matter has been authorised by the independent directors without the conflicted director either counting towards the quorum or voting on the resolution.

Under the current law, if a director finds himself in a conflict situation only the shareholders may authorise the conflict. There is a substantial relaxation of this common law rule in the Companies Act 2006, which takes effect on 1 October 2008:

• in the case of private companies formed on or after 1 October 2008, the board may authorise a conflict of interest unless this power is invalidated by the company’s articles;
• for private companies formed before 1 October 2008, the directors are not automatically given the power to approve conflicts, instead the company must either pass a resolution or amend its articles to give the directors this authority;
• for public companies incorporated on or after 1 October 2008, their articles of association must specifically allow directors to authorise conflicts of interest; and
• for public companies incorporated prior to 1 October 2008, their articles of association will need to be amended to not only permit independent director authorisation of conflicts of interest, but also provide for specific conflicts of interest such as existing multiple directorships.

It should always be noted that section 175 of the 2006 Act clearly states that the directors’ authority is only valid if the director who is in the conflict situation does not count in the quorum or vote on the resolution giving the authority.

If the company’s articles allow a director to vote and count in a quorum on a matter in which he is interested in, it is unclear whether the authority will be upheld by the courts given the wording of section 175 of the 2006 Act. The cautious view, therefore, is that the procedure in section 175 of the 2006 Act for giving director’s approval of a conflict should be followed, and if this means that no directors qualify to constitute a quorum then the shareholders should be asked to approve the conflict instead. 

(ii) Transactions or arrangements with the company (section 177 and sections 182-187 of the 2006 Act)

The section 175 duty to avoid conflicts of interests does not apply to transactions or arrangements that are with the company. Conflicts arising in these situations must be declared to the other directors in accordance with one of the following provisions:

• section 177 of the 2006 Act – the duty to declare an interest in a proposed transaction or arrangement with the company; or
• section 182 of the 2006 Act – the obligation to declare an interest in an existing transaction or arrangement with the company.

Under these provisions a director must declare direct and indirect interests of which he "ought reasonably" to have been aware. As with the duty to avoid conflicts of interests, directors should consider the interests of persons "connected" with them when deciding whether to make a declaration. It follows that a director need not be a party to the transaction for the obligation to apply.

This declaration regime is similar to that contained in section 317 of the Companies Act 1985 (the "1985 Act") but there are some differences:

• a director need not make a declaration if his interest cannot reasonably be regarded as likely to give rise to a conflict, if the other directors are already aware of it or if it concerns the terms of his service contract that have been or are to be considered at a board meeting;
• the declaration must be made to the "other directors", meaning a sole director of a private company will no longer need to hold a meeting alone and make a declaration to himself;
• the declaration may be made at a board meeting, by written notice or by general notice; and
• the notice must state the nature and extent of the director’s interest.

Under the 1985 Act it was only necessary to declare the nature of the interest and not the extent. In addition a director must also make a further declaration if the initial declaration proves to be, or becomes, inaccurate or incomplete.

(iii) Duty not to accept benefits from third parties – section 176 2006 Act

Section 176 of the 2006 Act states that "A director must not accept a benefit from a third party conferred by reason of

(a) his being a director, or

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

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

Abolition of prohibition on financial assistance for most private companies

The long-awaited removal of the financial assistance prohibition comes into effect on 1 October 2008. As the law stands, private companies are prohibited from giving financial assistance for the acquisition of their own shares or the shares of their holding company. The only exception to this is that private companies may grant such assistance if they carry out the statutory "whitewash" procedure.

From Wednesday 1 October 2008, private companies will no longer be prohibited from giving financial assistance for the purpose of the acquisition of their shares, or the shares of their private holding company, and the "whitewash" procedure (involving statutory declarations of solvency by each director, an auditors’ report and sometimes a special resolution of shareholders) will also be abolished from that date.

The restrictions will continue to apply to public companies and to private companies giving financial assistance for the purpose of the acquisition of the shares of their public holding company.

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

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

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

• is "likely to promote the success of the company for the benefit of its members";
• will involve an unlawful reduction of the company’s capital;
• amounts to a distribution of the company’s assets, thus requiring adequate levels of distributable reserves; and
• is vulnerable to challenge as a transaction at an undervalue under insolvency legislation.

Reduction of capital for private companies: new solvency statement procedure (section 641-644 of the 2006 Act)

From 1 October 2008 a private company will have a new means of reducing its share capital. The provisions introduce a new solvency statement procedure for the reduction of capital by private limited companies which may be followed instead of the court based procedure. The new procedure requires that:

(i) a statement of solvency be made by all directors in accordance with section 643 of the 2006 Act not more that 15 days before a special resolution reducing its capital is passed; and

(ii) the special resolution, solvency statement and a statement of capital be delivered to the Registrar of Companies within 15 days of passing the special resolution.

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

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

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

Other main changes taking effect on 1 October 2008

(i) Requirement for every company to have at least one natural person as a director (sections 155-159)

Every company will be required to have at least one director who is a natural person, ie, an individual. The legislative intent is to ensure that there is at least one individual who can be accountable for the actions of the company. Those companies which did not have a natural person as a director on 8 November 2006 (the date on which the 2006 Act received Royal Assent) will have until 1 October 2010 to make any necessary changes.

(ii) Political donations and expenditure to independent election candidates (sections 362-379)

Small additional changes to Part 14 CA 2006 (which came into effect in October 2007) will come into effect on 1 October 2008 and will extend those provisions which concern the control of political donations and expenditure to independent political candidates. Part 14 of the 2006 Act requires a company to be authorised by its members before making a political donation in excess of £5,000 in one year to a political party, political organisation or an independent candidate (i.e. a candidate who is not a member of a political party but is standing for election to public office). A company must also be authorised by its members before it incurs expenditure in respect of political activities such as advertising, promotion or otherwise supporting a political party, organisation or an independent candidate in an election.

Initially the October 2007 changes did not apply to independent candidates and the effect of the 1 October 2008 changes are to extend these provisions to independent candidates.

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

(iii) Objection to company names (sections 64-74 of the 2006 Act)

There will be a new right for a person to object to a company’s name on the grounds that the name was chosen with the principal intention of seeking money from the objector or preventing the objector registering the name himself where it is one in which the objector has previously acquired reputation or goodwill. The intention is to deter opportunistic registration. In such circumstances, the Company Names Tribunal has the power to issue an order to direct a company to change its name and if the company fails to adhere to such an order the Tribunal may choose a new name for the company.

(iv) Changes to annual returns requirements

Under the 2006 Act, since 1 October 2007 companies have been permitted to restrict access to their register of members. Annual returns made up to a date on or after 1 October 2008 will now contain reduced information on a company’s shareholders. The information on the annual return will now depend on whether the company is a traded company – e.g. whether it has any of its shares admitted to trading on a regulated market (which includes the LSE and PLUS-listed market not AIM (as AIM is not a regulated market)). Traded public companies are required to provide names and addresses for those shareholders holding at least 5 per cent. of any issued share class. Private non-traded companies are only required to provide names of shareholders, not addresses. Note that no details are required for shareholders that hold or continue to hold less than 5 per cent. of any issued share class in a traded public company.

(v) Trading Disclosures

Among the provisions of the 2006 Act coming into force this October are new rules relating to trading disclosures, which govern the display by a company of its registered name and other corporate details, which extend the existing requirements.

From 1 October 2008, a company must display its registered name:

• at its registered office.
• at any ‘inspection place’; and
• at any other location at which it carries on business.

An inspection place means any location (other than a company’s registered office) at which a company keeps any company records available for inspection as required by the Companies Acts (for example, the location of its register of members).

There are two exceptions to such trading and disclosure rules as follows:

• a company that has been dormant at all times since its incorporation need not display its registered name at its registered office or at any inspection place; and
• a company need not display its registered name at a business location (other than its registered office or any inspection place) if that location is used principally for living accommodation.

Certain information must also be displayed on company documents, the information required will depend on the nature of the document and the rules will apply whether the document is in hard copy, electronic or other form. For example, business letters, order forms and websites must contain the following information:

• the company’s registered name;
• company number; and
• registered address together with the place of registration.

Investment companies and private community interest companies must disclose their status as such and companies exempt from using the word ‘limited’ as part of their name must disclose their status as a limited company. Any reference to share capital made by a company must be a reference to paid up share capital.

The company’s registered name must appear on the following: notices and official publications; bills of exchange; promissory notes; endorsements; cheques; orders for money, goods or services; bills of parcels; invoices and other demands for payment; receipts; letters of credit; applications for licenses to carry on a trade or activity and all other forms of business correspondence and documentation not already mentioned.

It follows that this information should be included on all business e-mails, even those sent on handheld communications devices.

Finally if a company’s business letters include the name of any director (other than in the text or as a signatory), it must include the name of every director of the company and if a company receives a written request from any person with whom it has a business relationship as to the address of the company’s registered office or any inspection place (and the type of records kept at either location), it must respond in writing within five working days.

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details please contact the Gibson Dunn attorney with whom you work or James Barabas (+44 (0)20 7071 4253, [email protected]) in the firm’s London office.