A07147947/1.1/04 Jan 2007

The Companies Act 2006: A Guide for Private Companies January 2007

⏐ A07147947/1.1 ⏐ January 07

Table of contents

Introduction 1

1 Directors’ duties 6

2 Consequences of breach and derivative claims 13

3 Other provisions affecting directors 17

4 Shareholder communications 23

5 Meetings and voting 26

6 Constitutional reforms 31

7 Share capital and capital maintenance 31

8 Company Secretary, Company records and the Registrar of Companies 44

9 Company names 47

10 Narrative reporting and liability 49

11 Auditors and their liability 50

Further information 53

Please refer to www.linklaters.com/regulation for important information on the regulatory position of the firm.

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Introduction This Guide is intended as an introduction to the major issues for private companies arising from the Companies Act 2006. The Act restates existing companies legislation and introduces wide-ranging reforms, particularly a number of deregulatory measures for private companies. The result is a widening of the gap between the regulatory burden for quoted companies and that for private companies, which could encourage more businesses to stay, or go, private.

Note: this Guide is relevant only to private companies. Separate Guides have been produced which focus on listed companies and their subsidiaries and are available on request.

Implementation timetable The Act was granted royal assent on 8 November 2006. A small number of its provisions came into force on that date, or are expected to be effective from January 2007. However, the Government has committed to bring the remaining provisions into force by October 2008.

Executive summary This Guide looks in detail at the following key areas of change:

– directors’ duties and liabilities

– shareholder resolutions, meetings and communications

– share capital and capital maintenance

– constitutional reforms and company records

– auditors and their liability

These are discussed in summary in this Introduction with references to where they are considered in more detail in this Guide.

Directors duties and liabilities Parts 1 to 3 of the Guide considers the Act’s provisions on directors duties and their liabilities. In summary, the changes affecting directors include some of the most controversial provisions of the Act, but also some very welcome reforms. They include:

Codification of directors duties - there is now a statutory statement of seven duties, namely:

– to act in accordance with the directors’ powers,

– to promote the success of the company for the benefit of members,

– to exercise independent judgment,

– to exercise reasonable care, skill and diligence,

– not to accept benefits from third parties,

– to avoid conflicts of interest, and

– to declare interest in proposed transactions with the company.

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The codification should enable directors to be clearer in their own minds as to what their basic duties are, although there is still plenty of scope for interpretation and debate as to their application in particular circumstances. See further paragraph 1.3.

List of factors directors should have regards to - within the statutory statement of directors’ duties is the first direct embodiment of principles of corporate social responsibility into UK company law in the form of a list of factors to which directors must have regard. See paragraph 1.3.2.

Conflicts of interest - a new provision enables a director’s conflict of interest to be authorised by the other directors, but situations of possible conflict are likely to continue to create difficulties. See paragraph 1.4.

Derivative claims procedure - the risk of litigation against directors is increased by a new procedure to enable shareholders to take action on behalf of a company in the case of any negligence, default, breach of duty or breach of trust on the part of a director. See paragraph 2.4.

Transactions with directors and connected persons - the rules prohibiting certain transactions between a company and its directors or connected persons have been relaxed in some respects. See paragraph 3.1.

Directors service agreements - copies of all directors’ service agreements will have to be made available to shareholders on request. See paragraph 3.1.4.

Directors’ home addresses - there will no longer be an obligation for home addresses to be made available on the register at Companies House. However, the new provision will not apply to existing directors who already have their home addresses registered at Companies House, unless they move house. See paragraph 3.3.

Director: natural person - at least one director must be a natural person, whereas previously it was possible to have entirely corporate directors. See paragraph 3.6.

Shareholder resolutions and meetings

Part 5 of this Guide considers the changes introduced in relation to shareholder resolutions and meetings, the main changes for private companies being:

AGMs - private companies no longer need to hold AGMs, lay accounts in general meeting or appoint auditors annually unless they opt to do so. See paragraph 5.1.

Written resolutions - these will no longer require unanimity, but instead the consent level will be the same as for passing on ordinary or special resolution as appropriate. See paragraph 5.2.

Notice period for meetings - these are changed to 14 days for all meetings (subject to the right to call a meeting on short notice). To hold a meeting on short notice, 90 per cent (or such higher per cent as provided in the Articles up

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to 95 per cent) is required. Previously, the reduction of the 95 per cent was only available to private companies that passed an elective resolution (requiring the agreement of all the members). See paragraph 5.5.

Share capital and capital maintenance

Part 6 of this Guide considers the provisions in the Act dealing with share capital. The most significant for private companies being the repeal of the rules prohibiting financial assistance for the acquisition of private company shares.

Repeal of the rules prohibiting financial assistance - the prohibition on financial assistance will be abolished by the Act in so far as it relates to private companies (provided they are not subsidiaries of a public company).

The changes will greatly simplify private company acquisitions, public-to-private transactions (once the target has converted into a private company) and internal group reorganisations. Loans, guarantees or security given by a private company to finance its acquisition will be permitted and will no longer need to be authorised by the “whitewash procedure”. Private companies giving financial assistance will, however, still need to consider the Act’s codified general duties and common law maintenance of capital rules. There are some concerns as to how the common law maintenance of capital rules will impact on this area once the rules are repealed. This is to be clarified by the Government, possibly by the early part of 2007. See paragraph 6.3.

Authorised capital - the concept of authorised capital is being abolished, so a company will no longer need to include a ceiling on the number of shares which may be issued in its memorandum and articles of association. See paragraph 6.1.

Shareholder authorisation to allot shares - private companies with only one class of share capital will no longer require directors to be authorised by ordinary resolution to allot relevant securities unless the Articles provide otherwise. See paragraph 6.2.

Capital reductions - currently these require court approval. The Act introduces another procedure for capital reductions which can be carried out by means of a members’ resolution and a directors’ solvency statement. See paragraph 6.4.

Distributable profits - the Act introduces a power to specify in what circumstances a reduction of capital can result in the creation of distributable profits. See paragraph 6.4.

Intra-group transfers - the Act confirms that an intra-group transfer at book value, where the market value of the asset transferred is higher, does not require distributable profits equal to the difference, if the company has distributable profits when the transfer is made. See paragraph 6.5.

Redenomination - a procedure is introduced enabling companies to redenominate all or part of their share capital into a foreign currency without court approval. See paragraph 6.6.

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Variation of class rights - a simplified regime is introduced for the variation of class rights. See paragraph 6.7.1.

Constitutional reforms and company records

The Government’s key objectives for the Act included “think small first” - a strong emphasis on making life easier for private companies by reducing administrative burdens and eliminating antiquated procedures. The reforms to various aspects of company administration bring benefits to private companies and are set out in Parts 7 to 9 of this Guide.

Consolidation into Articles - the provisions of a company’s constitutional documents is consolidated into the Articles. See paragraph 7.1.1.

Objects clause - the requirement for a company to have an objects clause is removed, so freeing companies from the uncertainties of the ultra vires rule. See paragraph 7.1.2.

Entrenched Articles - the Act will make it more difficult for companies to entrench provisions and includes additional formalities when Articles containing entrenched provisions are amended .The decision to entrench provisions of the Articles can only be made on formation of the company or with consent of all members. See paragraph 7.1.4.

New company formation procedure - this is changed to enable company formation online. See paragraph 7.2.

Company secretary - there will no longer be a legal requirement to appoint a company secretary for private companies, although one may be appointed if the company so decides. See paragraph 8.1.

Shareholders’ register - the Act makes it more difficult for anyone who wants to inspect a company’s shareholder register, as they will be required to send a written request to the company with details of why they want the information and whether it will be disclosed to a third party. The company may apply to the court for them to review the request if they do not wish to provide the information. See paragraph 8.3.

Electronic communications - revised procedures are introduced for obtaining consent from shareholders to use electronic communications, and communications by means of a website, to disseminate company information. See paragraph 4.1.

Filing accounts - the period permitted for filing accounts will be shortened from ten to nine months. See paragraph 5.1.

Change of name - the Articles may provide that the Company’s name may be changed other than by way of special resolution, e.g. a board resolution to do so is now permissible. There is also a new right to challenge the improper or opportunistic registration of a company name to which someone else has a better claim. See paragraph 9.2.

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Auditors and their liability

The main provisions which are introduced by the Act in relation to private companies are set out in Part 11 of this Guide and are as follows:

Liability limitation agreements - auditors will be able, for the first time, to agree with a company that their liability in respect of their audit responsibilities is limited. The limit cannot reduce the auditors’ liability to less than is fair and reasonable, and must be subject to shareholder approval, to be given on an annual basis. See paragraph 11.1.

New auditor offence - auditors will be subject to a new offence where they knowingly or recklessly cause an audit report to be false or misleading or to omit any statement that is required. See paragraph 11.2.1.

Sign off of reports - the audit report must be signed by an individual auditor, rather than in just the firm’s name. See paragraph 11.2.2.

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1 Directors’ duties

1.1 Introduction

In this Part 1 and the following two parts, we examine the provisions of the Act that will directly affect directors. The duties of directors are codified, while a new derivative claims procedure is designed to make it easier to ensure that a company obtains redress where the directors are at fault. The Act also revises the requirements relating to transactions between a company and its directors or their connected persons and makes a number of more administrative changes affecting directors.

1.2 General duties of directors

The Act seeks to take the current state of the common law on directors’ duties and put it in statutory form, with the intention of making these duties clearer and more accessible (Sections 170-181). However, effective codification of such a complex area of law is not easily achieved. In particular:

- it risks creating a more rigid and restrictive regime,

- the statement of duties does not cover all of the duties a director may owe to a company, for example the duty to consider the interests of creditors in times of threatened insolvency.

1.3 The statutory statement of directors’ duties

The statutory statement of directors’ general duties is stated to be based on, but to replace, common law and equitable principles. Yet, somewhat paradoxically, the Act provides that “regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties” (Section 170(4)). It will therefore still be necessary to refer to the existing historic body of case law to understand the new provisions.

The seven duties of directors as stated in the Act are described below, followed by a discussion of the consequences of breaches of duty.

1.3.1 Duty 1: To act within powers

A director must act in accordance with the company’s constitution and only exercise his powers for the purposes for which they were conferred (Section 171). This is a restatement of the principle that a director must exercise his powers in accordance with the terms on which they were granted, and for a proper purpose.

1.3.2 Duty 2: To promote the success of the company

A director must act in good faith in the way the director considers to be most likely to promote the success of the company for the

Directors must act in accordance with the company’s constitution

Directors must act in good faith to promote the company’s success

The codification of directors’ duties is one of the Act’s most important provisions

The statement of duties should be treated with caution as it is not comprehensive

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benefit of its members as a whole and in doing so have regard to certain matters (see below) (Section 172).

The phrase “success of the company for the benefit of its members” replaces the familiar common law formulation “in the best interests of the company”. The Government has stated that “success” will normally mean (for commercial companies) “long-term increase in value”.1

The directors must have regard to certain matters in discharging this duty. These include:

– the likely consequences of any decision in the long term,

– the interests of the company’s employees (this corresponds to the existing section 309 of the 1985 Act),

– the need to foster the company’s business relationships with suppliers, customers and others,

– the impact of the company’s operations on the community and the environment,

– the desirability of the company maintaining a reputation for high standards of business conduct, and

– the need to act fairly as between members of the company.

Section 172 has attracted more headlines and more concern as to the burdens it might impose upon business than any other Section of the Act. The community, the environment, customers and suppliers, and business reputation - are specifically identified for the first time. In any particular case, directors may have to consider how the interests of members are to be balanced against those of other stakeholders, and even how competing interests of different stakeholders are to be balanced against one another.

Arguably - and this was the view of the Company Law Review, which recommended the inclusion of these factors in the statement of directors’ duties - these are all factors which a director would have always needed to have borne in mind, where relevant, in the exercise of his normal duty of skill and care. On this basis, Section 172 can be construed as nothing more than common sense.

1.3.3 Duty 3: To exercise independent judgment

A director must exercise independent judgment (Section 173). This does not prevent directors from taking advice where appropriate and the Section also specifically states that:

1 Lord Sainsbury of Turville, Hansard col. 245, 11 January 2006.

Directors must exercise independent judgment

Directors must have regard to external interests including those of employees, business counterparties, the environment and the community

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– directors may act in accordance with the company’s constitution, which includes resolutions of shareholders, and

– the discretion of the directors may be fettered by the terms of an agreement to which the company is party.

1.3.4 Duty 4: To exercise reasonable care, skill and diligence

This duty (Section 174) sets a minimum standard required by law of all directors, which is increased should the director possess a higher standard of general knowledge, skill or experience. The director owes a duty to his company to exercise the same standard of care, skill and diligence that would be exercised by a reasonably diligent person with:

(i) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as the director in relation to that company (an objective test), and

(ii) the general knowledge, skill and experience that the director actually has (a subjective test).

Non-executive directors will need to consider themselves as bringing all their own skills and knowledge to the Board, at the same time as being judged by the same objective standard as the executive directors.

1.3.5 Duty 5: To avoid conflicts of interest

(Section 175) - See paragraph 1.4, “Conflicts of interest” below.

1.3.6 Duty 6: Not to accept benefits from third parties

A director must not accept benefits from third parties (Section 176). Acceptance of such a benefit is only permitted if authorised by members or if it “cannot reasonably be regarded as likely to give rise to a conflict of interest”. It may be hard in practice to determine whether the reasonable likelihood test is met, and, in the absence of any de minimis threshold, existing practices, such as generous forms of corporate hospitality, may be called into question.

1.3.7 Duty 7: To declare interests in proposed transactions with the company

(Section 177) - See paragraph 1.4, “Conflicts of interest” below.

1.4 Conflicts of interest

The one area in which the Government intended to make a substantive change to the existing law on directors’ duties is in relation to conflicts of interest. The Act will alter the law on conflicts in relation to matters where the company is not itself party to a transaction by permitting independent directors (rather than only members) to authorise another

Directors must not accept benefits from third parties

Directors must bring to bear their own specialist skills and experience as well as those that any director in their position would be presumed to have

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director’s conflict. Individuals in positions where conflicts may arise will need to consider carefully how to operate under the new regime.

1.4.1 Types of conflict

The Act distinguishes between three different situations in which directors have potential or actual conflicts of interest (in addition to the duty not to accept benefits from third parties, discussed in paragraph 1.3.6 above). These are:

– conflicts with the interests of the company in relation to transactions/arrangements to which the company is not a party - for example the exploitation of an opportunity, whether or not the company could have taken advantage of it (see paragraph 1.4.2 below),

– conflicts in relation to proposed transactions/ arrangements to which the company will be party (see paragraph 1.4.3 below); and

– conflicts in relation to existing transactions/arrangements to which the company is party (see paragraph 1.4.4 below).

Each of these types of conflict is dealt with in a different way, as described below.

In each case, the new conflict of interest provisions do not apply to situations which cannot reasonably be regarded as likely to give rise to a conflict of interest. This exclusion may need to be relied upon in many situations where there is a theoretical possibility of interests conflicting. It provides limited comfort, however, since it may be difficult in practice to determine when this exclusion can be relied on.

The Act defines “conflict of interest” to mean both a conflict of interest and a conflict of duties.

1.4.2 Transactions/arrangements to which the company is not a party

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” under Section 175 (the fifth codified duty).

This applies in particular to the exploitation of property, information, or opportunities whether or not the company would be able to take advantage of them itself.

The unconflicted directors of a company may authorise such conflicts provided that, in the case of a private company, they are not prohibited from doing so by the constitution. Where Board authorisation is not permitted by the constitution, conflicts can still be authorised by the members.

The Act sets out three types of potential conflict of interest, with different rules applying to each type

Directors must avoid any situation which could possibly create a conflict

Articles permitting directors to have conflicts will be allowed, to the extent currently lawful

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In order to preserve the current position that certain types of conflict are expressly permitted in companies’ Articles of Association (i.e. without further authorisation), Section 180(4) provides that the conflict duties are not infringed where a company’s Articles contain provisions dealing with conflicts and a director acts in accordance with those provisions. However, the extent to which provisions will be allowed is limited to “such provision as has previously been lawful for dealing with conflicts” (Section 232(4)). Existing such provisions typically allow directors at least to be a director or employee of a different company, and to be party to a transaction, in which the company is interested (provided such interest is disclosed).

Directors who hold more than one position, like many non-executive directors or employees nominated to the board of an investee company, will always need to consider carefully whether they are in a position which can “reasonably be regarded as giving rise to a conflict”. If so, they will need to consider whether it is of a kind authorised by the company’s constitution - if not, they must seek explicit approval from the other directors who have no interest in the matter. It is, however, not clear whether it will be possible to authorise potential conflicts arising out of, say, a directorship of another company, in general terms, or whether each particular matter giving rise to a potential conflict would need specific authorisation.

1.4.3 Proposed transactions/arrangements to which the company will be a party

If a director has any direct or indirect interest in any proposed transaction or arrangement with the company, he will have a duty to declare both the nature and the extent of that interest to the other directors (Section 177). This is the seventh and final codified duty (see paragraph 1.3.7 above).

Unlike under Section 317 of the 1985 Act, a director is not obliged to declare his interest at the meeting at which entering into the transaction is first considered but only before it is entered into by the company. Of course, a company’s Articles may provide for a stricter approach.

Directors are required to update declarations of interests in proposed transactions or arrangements that become inaccurate or incomplete before the company enters into the transaction or arrangement. No materiality threshold applies when considering what constitutes inaccuracy or incompleteness. For example, a small change in a director’s shareholding in a company specified in a general notice of declaration would trigger the obligation to update.

Directors have a duty to declare interests in proposed contracts with the company

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1.4.4 Existing transactions/arrangements to which the company is a party

A parallel obligation to declare the nature and extent of interests in transactions/arrangements already entered into by the company is imposed under Section 182, but not identified as one of the codified duties. Instead, directors will commit a criminal offence if they:

– fail to declare a direct or indirect interest in an existing transaction or arrangement with the company to the other directors (unless it was already declared before the transaction was entered into by the company under the seventh codified duty described above),

– fail to update a declaration of interest in an existing transaction or arrangement with the company that becomes inaccurate or incomplete (regardless of whether the initial declaration was made before or after the transaction or arrangement was entered into by the company and whether the inaccuracy or incompleteness is material),

– fail to comply with the requirements as to form and content of their declarations or updates in existing transactions or arrangements, including the requirement to make such declarations or updates “as soon as reasonably practicable”.

As under Section 317 of the 1985 Act (which applies to both existing and proposed contracts), failure to declare an interest is an offence punishable by a fine. However, the new offence under the Act is broader in that:

– it applies more generally, to transactions and arrangements, whether or not legally binding,

– it requires the extent of interests to be declared,

– declarations must be updated.

1.4.5 Scope of interests to be declared

Interests to be declared, whether in relation to proposed or existing transactions, may include those of “connected” persons (see paragraph 1.4.6 below). Directors are not required to make or update a declaration of interest if they are not aware of the interest or transaction in question. However, directors are presumed to be aware of matters of which they “ought reasonably” to have been aware. In other words, a director might breach his duty or commit an offence where, although not in fact aware of an interest, he would be expected to be aware of it. It is not clear how far a director’s due diligence should extend in this respect.

Directors can commit a criminal offence if they do not make or update declarations of interest in existing transactions or arrangements with the company

The provisions apply in such a way as to require directors actively to consider potential conflicts

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There is also no obligation to declare an interest if, or to the extent that, the non-conflicted directors are already aware (or ought reasonably to have been aware) of the interest.

1.4.6 Definition of connected persons

The definition of “connected person” is based on that provided in Section 346 of the 1985 Act, but is extended (Section 252-256). The new definition will catch (in addition to the individuals and entities who are connected persons under the current law):

– the director’s parents,

– his children and step-children over 18 years old,

– a person (other than a sibling or other close family member) with whom the director lives as partner in an “enduring family relationship”,

– a civil partner, and

– children or step-children of the director’s unmarried partner if they are under 18 years old and live with the director.

A Law Commission proposal to extend the definition further to include the director’s siblings was not taken up.

The definition of “connected person” is extended

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2 Consequences of breach and derivative claims

The Act does not attempt to codify the remedies for breaches of duties. However, it introduces a new derivative claims procedure (Sections 260-269) which potentially adds a significant level of litigation risk for directors. Although the procedure contains in-built safeguards (to halt for example, actions that do not show a prima facie case), these safeguards may not be sufficient to prevent claims against directors.

2.1 To whom are duties owed?

The Act does not change the important principle that the duties of directors are normally owed to the company.

The Act also does not attempt to codify the circumstances in which duties to consider or act in the interests of creditors arise. However, the duty to promote the success of the company is expressly subject to any other enactment or rule of law establishing such duties in relation to creditors - for example, duties under the Insolvency Act 1986 (Section 172(3)).

2.2 Remedies

A significant omission from the Act is any attempt to codify the remedies for breach of the statutory duties. It merely states that the consequence of a breach will be “the same as would apply if the corresponding common law rule or equitable principle applied” (Section 178). The new statutory duties, with the exception of the duty to exercise reasonable care, skill and diligence, are said to be enforceable in the same way as fiduciary duties. A breach of a fiduciary duty gives rise to a range of potential remedies, including damages, restitution of property, and accounting for profits made, as well as injunctive and declaratory relief. By contrast, the remedy for a breach of the duty of care and skill would be one of damages.

2.3 Ratification of directors’ breaches

The Act partially codifies the existing law on ratification of acts of directors, with one significant change (Section 239). Breaches of duty or trust, or acts of negligence or default by directors, can (as at present) be ratified by a resolution of members. However, the Act requires that the votes of any member who is “connected with” any director whose conduct is being ratified must be disregarded if they are cast in favour of the resolution. “Connected person” in this context is the extended version of the 1985 Act definition described in paragraph 1.4.6 above.

The common law principle that all the members of the company, unanimously and whether or not by a formal vote, may ratify directors’ actions is unaffected.

Duties are still owed to the company

Shareholders with an interest in a matter may not vote to ratify the directors’ actions

The Act does not fully codify remedies

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2.4 Derivative claims

The Act contains a new derivative claims procedure that will allow a shareholder to apply to the court to pursue a claim, on behalf of the company, against a director for negligence, default, breach of duty or breach of trust.

2.4.1 Scope of claims

The scope of claims which can potentially be brought under the Act is wide, the key protection being that the Court’s permission is required for a claim to proceed. In particular:

– a claim can be brought by any member (even if they were not a member at the time the actions complained of took place),

– there is no need for a particular number of members, nor a percentage threshold of shareholding, to launch a claim,

– claims may be brought in respect of any actual or proposed act or omission involving negligence, default, breach of duty or breach of trust on the part of a director,

– there is no need to demonstrate any actual loss suffered by the company, or any benefit gained by the directors, before commencing a claim,

– claims may be brought against both directors and other persons - the latter might, for example, include counterparties to a transaction which is alleged to involve, or result from, the negligence or breach of duty of the directors.

2.4.2 Prevention of abuse

The protection against vexatious claims lies in the double hurdle that a claim must cross before it can proceed:

– first, the applicant would be required to show a prima facie case against the defendant. The court would consider this on the basis of the claimant’s evidence only, without requiring any evidence from the defendant. If the claimant’s evidence did not show a good case, the court would have to dismiss the claim. This reduces the opportunity to embark on “fishing” litigation,

– second, the claim can only proceed with the court’s permission. The court has the power to adjourn at this stage, for example, to allow a general meeting or consultation with shareholders to take place.

The court cannot give permission if it is satisfied that:

– a person acting in accordance with the duty to promote the success of the company (Section 172) would not seek to continue the claim, or

– the act or omission has been authorised or subsequently ratified by the company.

The new derivative claims procedure is potentially a fertile new source of litigation against directors

The grounds on which claims may be brought are widened and do not require evidence of fraud or loss

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Where these factors do not apply, the court has discretion as to whether to permit a claim to proceed. In exercising this discretion, it must have “particular regard” to the views of independent shareholders, and also to the following factors:

– whether the person bringing the claim is acting in good faith,

– the importance of the claim to a person acting to promote the success of the company,

– the likelihood that the act giving rise to the claim would be authorised or ratified by the company,

– whether the company has decided not to bring the claim, and

– whether the member could pursue the claim in his own right. Although a claim may only be pursued with the permission of the court, there is a risk that a court might find it difficult to conclude that the claim should not be allowed without a substantive consideration of the issues. The test the court has to consider is an objective one and there is no scope to rely, as a defence, solely on the good faith business judgment of directors.

2.5 Directors’ indemnities

Those companies which have not already taken advantage of the wider powers to indemnify their directors introduced by the 2004 Act may wish to consider doing so in light of the new risks to which they are subject under the Act. These provisions, which are restated without substantive amendment in the Act, allow indemnities, or the purchase of insurance, in relation to liabilities incurred by a director to third parties - i.e. persons other than the company or an associated company. Since the company will be the beneficiary of any claim brought under the derivative claims procedure, directors will not be able to be protected by their companies against successful derivative claims.

2.6 Directors’ defence funding

The related rules permitting loans to directors for defence funding purposes are slightly modified by the Act. Section 205 allows companies, as at present, to lend money or do other things to help to fund the defence costs of a director of the company in legal proceedings (whether civil or criminal), without needing to obtain the approval of the company’s shareholders. The revised wording permits a company to provide funding for the directors of their holding company. However, defence funding can only be provided in this way where proceedings are brought in connection with any alleged negligence, default, breach of duty or breach of trust by a director in relation to the company or an associated company. This is narrower than the current rules which permit loan funding for any type of civil or criminal proceedings without shareholder approval, whether or not they relate to the company.

The existing legislation (section 337A of the 1985 Act) is unclear as to whether the funding of a director’s defence costs in regulatory

Companies cannot indemnify directors against a successful derivative claim

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proceedings is permitted. Section 206 creates a new exception for expenditure in connection with regulatory actions and investigations, permitting a company to provide directors of the company (or its holding company) with funds to defend themselves against investigations or proceedings by regulatory authorities in connection with any alleged negligence, default, breach of duty or breach of trust of such director in relation to the company or any associated company, without needing to seek the approval of members.

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3 Other provisions affecting directors

3.1 Transactions between a company and directors

The Act restates and amends the provisions of the 1985 Act dealing with transactions between directors and companies. These are complex provisions which have always been difficult to follow, and in their new form they are only slightly clearer. They fall into four categories considered further below:

– substantial property transactions (3.1.1 below),

– loans, quasi-loans and credit transactions (3.1.2 below),

– payments for loss of office (3.1.3 below),

– long-term service contracts (3.1.4 below).

Generally, there are some substantive changes, including a consistent theme that these transactions can be entered into with the approval of an ordinary resolution of members (unless the company’s constitution imposes a higher standard). In addition, where a company enters into a transaction with a director of its holding company, approval is required by members of both the company and the holding company. The provisions also apply to transactions with directors’ connected persons (see the definition referred to in paragraph 1.4.6 above).

The Act removes the criminal sanctions associated with some of these offences.

3.1.1 Substantial property transactions

These provisions (Sections 190-196) apply to arrangements under which a director of a company or of its holding company, or a person connected with such a director, acquires from the company (directly or indirectly) a “substantial non-cash asset” (for example, the purchase of a company flat). They also apply to the acquisition from such a person of a substantial non-cash asset by the company. Such arrangements must not be entered into without approval by a resolution of the members of the company and (if the person entering into the transaction is a director of the holding company or a connected person of such a director) of its holding company.

The Act introduces some relaxations to the existing regime, in that:

– an arrangement may be entered into conditional upon shareholder approval - currently shareholder approval is required before the contract is entered into,

– anything to which a director is entitled under his service contract is excluded,

The Act clarifies, but also alters, the rules on transactions by a director with his company

Property sales to directors will become easier to approve and new exemptions apply

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– transactions with a company that is being compulsorily wound up or in administration, are exempt on the basis that the management of the company is in the hands of the liquidators or administrators,

– the de minimis threshold is raised from £2,000 to £5,000 (if more than 10 per cent of the company’s asset value - for larger companies the current £100,000 threshold remains).

The exemption for matters provided under a service contract is particularly welcome and will give companies considerable latitude. For example, present concerns that Section 320 of the 1985 Act catches the provision of accommodation to directors would fall away where it was provided for in the service contract. On the other hand, shareholders may therefore wish to scrutinise directors’ service contracts more carefully. Payments for loss of office, however, are covered separately, as described below.

3.1.2 Loans, quasi-loans, credit transactions and related transactions

The current provisions (Sections 330-342 of the 1985 Act) prohibit loans, quasi-loans, credit transactions and related transactions with directors or their connected persons. These transactions are incapable of approval by shareholders and contravention is a criminal offence.

The Act removes the criminal penalties (Sections 197-214). Significantly, it is now possible for shareholders to approve such arrangements provided disclosure is made in advance of the nature of the transaction, amount of the loan and purpose for which it is required, and of the extent of the company’s liability under any related transaction.

The numerous existing exemptions remaining and the financial limits that apply to some of these exemptions have in most cases increased, so as to allow:

– loans and quasi-loans to an aggregate value of £10,000 (£5,000 under the current law),

– credit transactions to a value of £15,000 (£10,000 under the current law),

– ordinary course lending by banks and similar institutions on normal terms (the current £100,000 limit is abolished).

A new exemption has been created for funding expenditure incurred by a director in defending himself in an investigation by a regulatory authority or action proposed by a regulatory authority in connection with any alleged negligence, default,

The prohibitions on loans and similar transactions in favour of directors are relaxed

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breach of duty or breach of trust by him in relation to the company or an associated company.2

The existing exemption permitting a company to provide funding to a director to meet expenditure for the purposes of the company has been relaxed by the removal of the requirement for shareholder approval and the increase of the permitted amount to £50,000.

Where it is not possible to value a transaction, it is deemed to exceed £50,000 - this is lower than the current £100,000 deemed value for such transactions.

3.1.3 Payments for loss of office

The existing provisions on payments for loss of office are complex and, in a number of respects, inconsistent and ambiguous. The Act simplifies and rationalises these provisions, but potentially prohibits more payments than the existing law.

The new provisions include a comprehensive definition of payments for loss of office (Section 215). Broadly, this covers payments (including the provision of benefits):

– on dismissal, redundancy or retirement in respect of a director’s loss of office or employment,

– connected with loss of office on a sale of a business of the company,

– connected with loss of office on a transfer of shares in the company as a result of a “takeover bid” (undefined).

The provisions are extended to capture payments both to connected persons and to past directors, and the new definition places it beyond doubt that a payment to an executive director in his capacity as an employee is caught. However, there are helpful new exceptions for:

– payments made in discharging an existing legal obligation (including the provisions of a pre-existing service contract),

– payments in settlement of a claim arising in connection with the termination of a person’s office or employment,

– small payments (totalling less than £200).

Each type of payment may now be made if it has been approved by a resolution of the company’s shareholders. In addition, the civil consequences of breach are clarified and conflicts between different potential remedies for the same breach are resolved.

2 See “Protections for directors” in paragraph 2.6 above.

The rules on payments to directors for loss of office are clarified and their scope broadened

New exemptions apply to the requirement for shareholder approval of such payments

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3.1.4 Directors’ service contracts

The Act prohibits directors’ service contracts with a guaranteed term of more than two years, unless shareholders approve the contract in advance (Section 188). This contrasts with the five year period allowed under the 1985 Act and applies to both private and public companies.

The term “service contract” is given a new, wider definition, and covers not only the typical service contract between a director and the company but also letters of appointment and contracts for services (i.e. consultancies). It also applies where a personal services company contracts to supply the services of a director. Furthermore, there is no territorial restriction so as to exclude contracts to work wholly or mainly outside the UK. There is also no exclusion (as there is at present) from the disclosure regime for service contracts which expire or can be terminated within 12 months.

Shareholders will be able to scrutinise the provisions of directors’ service contracts at their leisure. In addition to the existing obligation to make service contracts available for inspection by members, under Section 229:

– members will be entitled on request, and on payment of a prescribed fee (to be set out in regulations), to be provided with a copy of any director’s “service contract” (or a written memorandum setting out its terms if not in writing),

– the copies and memoranda of terms must be retained for at least one year after cessation of the contract and must remain available for inspection during that time.

Contravention will be a criminal offence for which officers of the company will be liable to a fine. In addition, the court may by order compel an immediate inspection or direct that the copy requested be sent to the person requesting it.

The existing prohibition on tax-free payments to directors is to be repealed.

3.2 Notification of directors’ interests provisions

The obligations under Section 324 and related Sections of the 1985 Act regarding disclosure of directors’ interests in shares or debentures are to be repealed.

3.3 Directors’ home addresses

A very welcome effect of the Act, so far as directors are concerned, is that there will be no obligation for home addresses to be made available on the public register held by the Registrar of Companies.

Directors’ service contracts, to which rules on public inspections apply, are more broadly defined

Members will have a new right to receive a copy of service contracts

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The 1985 Act enables directors to withhold their residential address from the public register if they can establish a serious risk of violence or intimidation. Police certification of this risk is required. In the face of increased concerns about such threats - particularly from animal rights activists - the Act will allow directors in all cases simply to use a service address rather than their home address on the public register (Sections 240-246). The service address can be “the company’s registered office”. Directors must also provide their usual residential address to the company, and the company must maintain a new register of directors’ usual residential addresses (Section 165). This will not be open to public inspection.

When companies file particulars of directors with the Registrar of Companies they must provide both the service address and the usual residential address, but the latter will not be normally open to public inspection at Companies House. The Act lays down a procedure under which the Registrar of Companies may put the usual residential address on the public register if there is evidence that the service of documents at the service address is not effective to bring them to the notice of the director. Changes to both service addresses and residential addresses must be notified to the Registrar of Companies.

The flaw in the non-disclosure procedure is that, as now, there is no obligation on the Registrar of Companies to cleanse the historic record, so that, unless they have moved house, directors whose home address has once appeared in the register will remain exposed. However, the Act does contain provisions enabling the Secretary of State to make regulations, requiring the Registrar, if an application is made, to remove specific addresses from the public register.

3.4 Disclosure

The Act makes a number of changes to the disclosures required to be made in a company’s register of directors. Particulars of a director’s other directorships will no longer need to be recorded. Other changes include (Sections 163-164):

– under the provisions requiring former names to be disclosed, it is only necessary to disclose names by which the person was known for business purposes and there is no longer an exception for a married woman’s former name,

– in addition to filing its corporate name and registered or principal office, a corporate director will need to disclose the register where it is registered and its registration number. Corporate directors that are non-EEA companies will also need to disclose particulars of legal form and the law by which the company is governed.

3.5 Age restrictions

There is no maximum age limit for directors, however, there is a new minimum age requirement for a director of 16 (subject to the power of the Secretary of State to prescribe exceptions). Those under the age of

Other directorships need not be disclosed on the public register

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16 will automatically cease to be directors once the new provisions come into force (Section 157).

3.6 Natural persons

The minimum number of directors for private companies of one remains unchanged but the Act introduces a requirement for all companies to have at least one director who is a natural person (Section 155).

3.7 Disqualification overseas

The Act gives a new power (Section 1182) to the Secretary of State for Trade and Industry to make rules to prevent a person from becoming a director of a UK company, or from being concerned in the promotion, formation or management of companies, if he is subject to restrictions under overseas laws on carrying on these activities or on acting as a receiver of a company’s assets. This power is designed to deal with the risk that persons declared unfit to be directors elsewhere might seek to continue to operate through a UK company. However, it raises concerns that individuals could be prevented from acting as directors in the UK where they have been the subject of more onerous or arbitrary regulation overseas than applies in the UK.

Companies must have at least one director who is a natural person

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4 Shareholder communications

In this part we focus on the changes that will affect communications between companies and their shareholders, including electronic communications.

4.1 Electronic communications

Recent years have seen considerable developments in electronic communications law. However, the existing regime is defective in that it is only possible to communicate electronically with shareholders if they consent to this. The Act’s provisions on electronic communication by private companies, provide the next step in the modernisation process. The relevant provisions are to take effect on 20 January 2007.

The main features of the new regime are:

4.1.1 Use of a company website

One significant change is that shareholders will be required to “opt out” of website communications rather than to “opt in” to them, as at present. This should increase the volume of shareholder communications in electronic form, in comparison with the current position.

A shareholders’ resolution, or permission contained in the company’s Articles, is necessary authorising the company to communicate with shareholders by posting documents on its website. Companies will also need to ask shareholders individually for their consent for website communications (unless such consent is already in place), making sure that this request clearly explains that shareholders who do not respond within 28 days will be deemed to have consented to non-receipt of hard copies of documents if the company posts them on its website. A request for consent may only be sent once every 12 months. Annual updating of company records is therefore likely.

Companies must notify shareholders who have consented (or are deemed to consent) to website communications when it posts new shareholder documents on its website. Such notifications will need to be sent in hard copy, unless the shareholder has also consented to email or fax communication and has provided relevant details. The notification must explain how to access the document on the website and, in the case of a notice of meeting, must include details of the date, time and place of the meeting (Section 309).

A similar regime will apply for communication via the website with holders of debt securities and other debentures, subject to authorisation by holders of the relevant class(es) of securities or to authorisation having been included in the instrument creating the debt securities in question.

The requirement for shareholder consent is a significant drawback in the existing regime.

Shareholders have to opt out of website communications

A shareholders’ resolution is required to take advantage of the new regime.

Notification of the publication of information and the website is required

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4.1.2 E-mail and other electronic communications

Consent for communications using electronic means (which is most likely to be e-mail) must be given by individual shareholders and it will be necessary to obtain email addresses. If not already common practice therefore, companies will need to begin to request such information and set up procedures to update their address lists on a regular basis as email addresses are often subject to change.

4.1.3 Right to hard copy version

A shareholder or debenture holder who has received documents or information from a company other than in hard copy form is still entitled to require the company to send him a hard copy version within 21 days, even if he has consented or is deemed to have consented to electronic communications. This must be provided free of charge and it will be an offence to fail to do so.

4.1.4 Hard copy communications

Hard copy communications must be sent to shareholders at the registered address or at some other address specified for this purpose.

It is common for companies to provide in their Articles (as does Regulation 112 of Table A) that no notices need to be sent to shareholders with registered addresses outside the UK, and for whom no service address in the UK has been provided. Whilst this provision will continue to be effective for the requirements of the Articles, it will not override any statutory requirements to provide notices, documents or other information to all shareholders in hard copy form, in which case the company communications provisions of the Act will need to be followed.

4.1.5 Sending or supplying documents to a company

Electronic communication with the company will also be possible, subject to the company agreeing (or being deemed to have agreed) to this method of communication. Such communication can only be sent to an address specified by the company (or deemed to have been specified).

4.2 Enfranchising indirect shareholders

The Act aims to help “indirect investors”, who hold shares through one or more intermediaries, to become more involved in a company’s affairs through access to information, and the exercise of rights, normally reserved to registered shareholders.

Shareholders always have the right to request hard copies.

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4.2.1 Nomination of non-shareholders to exercise shareholders’ rights

Section 145 enables a registered shareholder to nominate another person to exercise or enjoy all or any of the shareholder’s rights (including voting rights) to the extent specified by the shareholder, subject to the inclusion of a provision to that effect in the company’s Articles. This provision is available to both private and public companies. The Articles would need to be carefully drafted to define the circumstances in and the extent to which shareholders’ rights could be passed to someone other than the registered holder, and the administration of the exercise of these rights (for example, to avoid duplication) would also be a major and expensive undertaking. The position is complicated by the fact that, although a person can be nominated by the registered holder to enjoy or exercise certain (or all) shareholder rights, only the registered holder can enforce rights against the company.

4.2.2 Other rights

All companies - private and public - will be obliged (Section 152) to allow nominees, or others who hold shares on behalf of more than one person, to split voting and other rights in respect of their holdings, so that they can be exercised in different ways.

There is also a procedure (Section 153) to allow indirect investors to participate in making requisitions relating to the circulation of a statement relating to a meeting.

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5 Voting and meetings

5.1 AGMs

Private companies will no longer be required to hold an annual general meeting. Under current law, a private company needs to pass an “elective resolution” (requiring the agreement of all the members) if it wishes to dispense with the holding of AGMs. The Act changes this “opt out” system to an “opt in” one, so that a private company will only need to hold AGMs if it wishes to do so.

A number of consequences flow from removal of the requirement for a private company to hold an AGM:

– Accounts and reports: There is no longer a need to lay accounts and reports in general meeting but it must send them to members within 9 months of the year end, reduced from 10 months, or, if earlier, by the date it actually files its accounts and reports with the Registrar of Companies (Section 424), and

– Appointment of auditors: The term of office of auditors will generally run from the end of the 28 day period following circulation of the accounts until the end of the corresponding period the following year. This will apply even if the auditor is appointed at a meeting where the company’s accounts are laid.

To avoid the need for an AGM, the auditors are generally deemed to be reappointed, subject to certain specified circumstances, for example, if the Articles require actual reappointment or at least 5 per cent of the members (or any lesser percentage specified in the Articles) send a notice excluding deemed reappointment (Section 488).

Subject to transitional provisions, existing private companies may need to check that their Articles do not require them to hold AGMs before ceasing to do so.

5.2 Written resolutions

The Act (Sections 288-300) introduces new procedures for written resolutions. Rather than requiring unanimity for written resolutions, the Act introduces the concept of ordinary and special written resolutions. An ordinary resolution can be passed by the agreement of 50 per cent of all those eligible to vote, while a special resolution requires the agreement of 75 per cent of those eligible to vote. Together with the removal of the requirement for private companies to hold an AGM, the new procedure should relieve private companies from the requirement to hold general meetings in normal circumstances although, as now, it will not be possible to pass a written resolution to remove a director or an auditor before the expiry of his/its term of office.

Private companies will not need to take any steps to opt out of holding an AGM

Written resolutions can be passed by 50 per cent of the members, or 75 per cent in the case of a special resolution

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The main features of the new procedure are that:

5.2.1 a written resolution can be proposed by the directors or by members holding 5 per cent (or a lower percentage if specified in the Articles) of voting rights, although the company can apply to the court not to circulate a written resolution on the basis that the shareholders are abusing their rights,

5.2.2 a resolution can be communicated to members in hard copy or electronic form or by means of a website, depending on how the company communicates with its members (see further paragraph 5.1 above). The form of the written resolution can be sent to all members simultaneously or by circulating the same copy of the resolution to all members in turn or by using a combination of the two,

5.2.3 a written resolution does not have to be physically signed by shareholders. A member is treated as signifying his agreement to a resolution when the company receives from him an authenticated document (in hard copy or electronic form) identifying the resolution and indicating his agreement. Once signified in this way, agreement to a written resolution cannot be withdrawn,

5.2.4 the resolution lapses if not passed before the end of the period specified in the Articles or 28 days from the circulation date,

5.2.5 the company must circulate a statement with the resolution informing the members how to signify agreement and the date the resolution is to pass if it is not to lapse,

5.2.6 there is no longer a requirement to send a copy of the resolution to the auditors,

5.2.7 there is a new procedure for members to require the circulation of written resolutions, together with a statement of up to 1,000 words.

The reduction in the majority required to pass a written resolution and the flexibility in the means of circulation and assent should make life easier for private companies. Unlike the existing regime for written resolutions, the Act does not preserve the right of companies to follow other procedures for written resolutions in their Articles. This should not cause significant problems in practice, however, given the flexibility allowed by the Act.

5.3 Offers of shares by private companies

The one limitation on private companies, compared with public companies, is the inability to offer shares or debentures to the public. Under the 1985 Act, it is a criminal offence for a private company (other than one limited by guarantee and without a share capital) to do so. This

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is the price of the more relaxed regulatory regime, particularly in respect of matters such as shareholder meetings, that private companies enjoy.

The Act (Sections 755-760) maintains the basic prohibition, but importantly allows a private company to offer securities to the public:

– as part of arrangements under which it is to re-register as a public company before the securities are allotted, or

– if, under the terms of the offer, it undertakes to re-register as a public company within six months.

These provisions should make it easier for companies moving from the private to the public domain to complete offerings and raise capital without first needing to convert to public company status (including satisfying the £50,000 minimum capital requirement for public companies).

The prohibition no longer carries criminal sanctions. Where a company has offered securities in breach of this provision, the court can order the company to re-register as a public company, unless it does not meet the requirements for doing so and it is impractical or undesirable to require it to take steps to do so. Alternatively a remedial order may be made, requiring the company, an officer of the company or any other person knowingly concerned in the contravention to put anyone affected by the contravention in the position he would have been in if it had not occurred. This can include an order that the offending securities be repurchased at such price and on such other terms as the court sees fit.

Unfortunately the Act has not taken the opportunity to update the antiquated definition of “offer to the public” for these purposes. It therefore remains out of line with the provisions of FSMA dealing with offers of securities to the public.

5.4 Voting

5.4.1 Enhanced proxy rights

The Act gives enhanced statutory rights to proxies (Section 324). Shareholders will be able to appoint more than one proxy, all of whom will be entitled to exercise all or any of a shareholder’s rights to attend, speak and vote at a meeting on a show of hands or on a poll.

Multiple proxy appointments are specifically permitted, provided each proxy represents a different part of the appointor’s holding. A proxy will have one vote on a show of hands, subject to the Articles, but the Articles may not provide for a proxy or proxies to have fewer votes on a resolution on a show of hands than the appointing member would have if present.

These provisions appear to give additional voting power to a shareholder who both appoints a proxy (or proxies) and also

The Act makes mandatory the right of proxies to vote at shareholder meetings on a show of hands

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attends the meeting in person, although this effect can be excluded by the Articles.

The deadline for delivery of proxy forms to the company must not be earlier than 48 hours before the meeting (Section 327). In a change to current practice, weekends and bank holidays must be ignored in calculating this period. This means that shareholders potentially have slightly less time to deliver their proxy forms, although a company’s Articles can provide for delivery of a proxy notice later than the minimum 48 hour period.

5.4.2 Political donations

The Act simplifies and clarifies the regime requiring shareholder authorisation of companies’ political donations or expenditure (Sections 362-379). The current legislation (Part 10A of the 1985 Act, Sections 347A-K) is ambiguously drafted and wide ranging and there has been much uncertainty and debate about its application. As a result, directors currently run the risk of incurring personal liability for accidentally failing to comply with these provisions – including liability to repay unauthorised donations/expenditure, plus interest and damages. No ratification of unauthorised payments is permitted and access to the court process for relief where a director has acted honestly and reasonably is specifically excluded.

The Act’s extensive redrafting of this legislation brings some welcome changes to what is currently an unnecessarily burdensome process. Most notably:

– where several companies within a group may make political donations or expenditure, there will be no need for a separate authorising resolution of the holding company to be proposed in respect of each relevant company - a single resolution may cover a holding company and/or one or more of its subsidiaries,

– an authorising resolution can also be drafted to apply to a company and all of its subsidiaries (whether they are subsidiaries at the time the resolution is passed, or become subsidiaries at any time during the currency of the resolution) without identifying them individually,

– only the ultimate UK holding company of a subsidiary making political donations or expenditure (rather than each holding company within a group) will need to pass an authorising resolution. As at present, no resolution of the subsidiary itself is required if it is wholly owned by a UK company,

– trade unions are expressly excluded from the definition of a “political organisation” and “donations” (in the artificially wide meaning the term carries for these purposes) to trade unions

The Act provides a degree of useful clarification on political donations

The requirement for resolutions for each relevant group company is removed

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are no longer caught by the legislation, provided such donations are not made to a union’s political fund,

– the regime for overseas subsidiaries - which imposed obligations on UK holding companies to procure such subsidiaries not to make political donations or incur political expenditure without appropriate authorisation by the holding company - is abolished, and

– the prohibition on retrospective ratification by shareholders of unauthorised payments is to be lifted, and the exclusion of the directors’ right to appeal to the court for relief is to be removed.

5.5 Simplification of notice periods and short notice requirements

The Act contains a number of deregulatory provisions making it easier and quicker for companies to hold meetings. In particular, the notice requirement for a special resolution is reduced from 21 days to 14 days subject to the Articles.

Since the key difference between a special resolution and an extraordinary resolution (requiring a 75 per cent majority of the affected class of shares on a variation of rights) is that an extraordinary resolution only requires 14 days’ notice, the shortening of the notice period required for special resolutions also has the incidental effect of doing away with the concept of extraordinary resolutions.

As a result, any general meeting of a private company can be called on 14 days’ notice (subject to anything in the Articles).

The Act will allow members of a private company holding 90 per cent (or such higher percentage as may be specified in the Articles, but not more than 95 per cent) to agree to hold a meeting (including an AGM) on short notice. Previously, reduction of the 95 per cent threshold was only available to private companies that passed an elective resolution (requiring the agreement of all the members).

The notice period for special resolutions is reduced to 14 days

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6 Share capital and capital maintenance

The reforms relating to a company’s share capital are mostly highly technical in nature – for example, the abolition of the concept of authorised share capital. As a result of this, familiar filings with the Registrar of Companies will take a different form. Other routines, such as authorising the directors to allot shares, will also be affected. Of particular importance is the abolition of financial assistance for private companies.

6.1 Authorised capital

The familiar concept of authorised capital is being abolished, so eliminating the rather cumbersome dual requirement for a company, in order to allot and issue new shares, to have both “authorised but unissued share capital” and shareholder authorisation to allot shares comprised in that share capital. Under the Act, shares can simply be created and allotted by board resolution, subject to the necessary shareholder authorisation as described below. The requirement to state a company’s share capital in its constitution will cease.

The Government has consulted on transitional provisions, and raised the possibility of existing companies being restricted from allotting shares beyond the amount of authorised share capital until the Articles (which going forward will contain details of authorised capital previously set out in the Memorandum of Association – see “Constitutional Reforms” in Part 7 below) are amended by the elimination of references to authorised capital. This seems a sensible solution which preserves the status quo in the meantime.

6.2 Allotment of shares

6.2.1 Shareholder authorisation to allot shares

The regime governing the power of directors to allot shares, and to grant rights to subscribe for, or to convert any security into, shares, is amended and restated (Sections 549-551). The only substantive change from the existing regime is the exclusion of private companies with only one class of share capital from the allotment authority regime. This exclusion does not, however, override whatever restrictions on allotments (and grant of subscription or conversion rights) may be imposed by the company’s Articles. This provision renders unnecessary the provision in the 1985 Act allowing a private company, by elective resolution, to confer allotment authorities on directors for a fixed period exceeding five years, or for an indefinite period, and accordingly this has not been carried through into the Act.

There is an important change of terminology which will have an impact for example on Articles of Association. This is the abolition of the concept of “relevant securities” which currently

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covers both shares, and rights to subscribe or convert into shares. Shares and rights to subscribe/convert are now dealt with separately under the allotment authorisation regime.

Transitional provisions are likely to provide that allotment authorities under the existing statutory provisions remain valid until expiry in accordance with their terms. This will enable companies to seek authorisation under the new legislation at a convenient time.

6.2.2 Pre-emptive offers and disapplication of rights

The statutory pre-emption regime for new issues of equity under Sections 89-95 of the 1985 Act, is amended and restated in Part 18 of the Act (Sections 560-577) and is left broadly unchanged. However, there are two important provisions relating to pre-emptive offers of new securities to shareholders:

(i) The inclusion in the pre-emptive offer regime of a legislative power (exercisable by statutory instrument) to reduce the mandatory 21-day period for pre-emptive offers to not less than 14 days.

(ii) The period of the pre-emptive offer can commence when the offer is sent (whether by hard copy (eg post) or in electronic form) – at present the period cannot begin before receipt of the offer by all shareholders.

As under the existing legislation, private companies will be able to exclude the requirement to make pre-emptive offers to shareholders, and/or the manner in which such offers are made, by provision to that effect in their Articles. Where private companies choose not to exclude the operation of the pre-emption regime, they can pass a special resolution (or include a provision in the Articles) disapplying the statutory pre-emption requirement, either for a specific allotment or for allotments generally. For those private companies with one class of share capital only, any such disapplication need not be tied to an allotment authorisation (and so need not be limited in time) as no such authorisation is required under the Act for such companies (as explained in paragraph 6.2.1 above). For all other private companies, a disapplication resolution must (as at present) always be linked to an allotment authority, so that shares allotted under the disapplication resolution must also be covered by an allotment authority. When the allotment authority is used up or expires, the related disapplication also ceases to have effect.

6.2.3 Alteration of share capital

Companies are permitted under Sections 121-123 of the 1985 Act to increase, consolidate, divide, sub-divide and cancel their

Private companies can exclude or disapply the statutory pre-emption regime

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share capital by ordinary resolution and a notification regime is established requiring notice of any such alteration of share capital to the Registrar of Companies. The list of actions is not comprehensive and required updating.

Under the Act, there will be a comprehensive list (Section 617) of methods by which a company is permitted to alter its share capital.

As explained in paragraph 6.6 below, the Act introduces a simplified process for redenominating share capital from one currency to another without the need to apply to the court for a capital reduction as at present. This complements the common law rule that shares may be denominated in any currency, and that different classes of shares may also be denominated in different currencies, which is captured in statute for the first time (Section 542(3)).

The notification regime for any alteration of share capital will require the filing with the Registrar of Companies of a “Statement of Capital” giving the precise number of issued shares and specified details about those shares, including nominal value, the amount paid up or unpaid on each share, and the rights attached to each class of shares. This requirement extends to the basic “return of allotments” (currently dealt with in Section 88 of the 1985 Act). The DTI has at last relented and given up the requirement to file originals or certified copies of contracts conferring the entitlement to allotment; this requirement has often given rise to concerns over confidentiality of sensitive information contained in the contract.

6.3 Financial assistance

The 1985 Act currently prohibits any company from giving financial assistance for the purpose of an acquisition of shares in the company or its parent. This is subject to certain exemptions and, in the case of private companies, a whitewash procedure.

The prohibition on financial assistance will be abolished by the Act in so far as it relates to private companies.

The changes will greatly simplify private company acquisitions, public-to-private transactions (once the target has converted into a private company) and internal group reorganisations. Loans, guarantees or security given by a private company to finance its acquisition will be permitted and will no longer need to be authorised by the “whitewash procedure” involving approval by special resolution, a directors’ solvency declaration and a report by the auditors. Directors of private companies giving financial assistance will, however, still need to consider the Act’s codified general duties and common law maintenance of capital rules.

The Act will set out an exhaustive list of methods by which share capital can be altered

Statutory constraints are abolished for private companies

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Concerns were raised during the parliamentary debates on the Bill as to whether common law rules regarding maintenance of capital (based on the rule in Trevor v Whitworth3) may still operate to prevent a private company from giving financial assistance for the purpose of the acquisition of its own shares. The Government decided against making any express adjustment to the amended legislation to meet this concern, arguing that it was unnecessary to do so.

However, the Government has promised4 that a “savings” provision will take effect on commencement, confirming that the removal of the prohibition on private companies giving financial assistance for the purchase of its own shares will not prevent such companies entering into transactions which they can lawfully enter into under the existing whitewash procedure. The Government’s intention appears to be that the relaxation of the prohibition on private companies effected by the Act will not revive any common law which existed before the introduction of the prohibition and was overtaken by it. The precise wording of this savings provision will be critical; it is not clear to what extent the features of the whitewash – such as that the assistance must be not reduce net assets or, to the extent it does, the assistance must be provided out of distributable profits will be a pre-requisite for reliance on the savings provision.

6.4 Reductions of capital

At present all reductions of capital by limited companies require approval of the court, whose principal function is to satisfy itself that the company’s creditors will not be prejudiced by the reduction. The involvement of the court builds extra time and cost into the procedure and it has long been thought that an adequate level of protection can be afforded to creditors outside a court process.

Under the Act (Sections 642-644), private companies will in future have the ability to reduce their capital without court approval by way of a special resolution supported by a solvency statement.

The solvency statement is required to state that each of the directors has formed the opinion that the company is solvent and will continue to be able to pay its debts as they fall due during the year immediately following the date of the statement. If the statement is made without reasonable grounds, each director in default will be guilty of an offence punishable by a fine and/or imprisonment.

A consensus will need to be developed as to what the directors should do in order to show that they had “reasonable grounds” in forming the opinions expressed in the solvency statement. The DTI decided that it was unnecessary for the solvency statement to be supported by an auditor’s opinion (as, for example, in the case of a financial assistance whitewash), but directors may take the view that they require comfort on

3 (1887) 12 App Cas 4 Lord Sainsbury, Hansard Col 443, 2 November 2006

A “savings” provision in relation to the common law will need careful consideration

Reduction of capital without court sanction will be available for private companies

The risk of criminal sanctions against directors may cause companies to continue to seek court approval

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solvency from their auditors. There is also the question as to whether directors of private companies will choose to use this method, rather than the familiar court-approved reduction, as directors who make the solvency statement without having reasonable grounds are at risk of criminal sanctions.

One of the most common reasons for reducing capital is to create distributable reserves. A new statutory provision (Section 654) provides that a reserve arising from the reduction of a company’s share capital will only be distributable in cases to be specified in regulations made under that Section. At present there is no indication as to whether the Government proposes to make regulations or what cases they may cover, although it seems probable that the methods of creating distributable profits by reduction of capital which are permitted by TECH 7/03 will be covered (this is guidance issued by the Institute of Chartered Accountants in England and Wales which states that the reserve which arises on a reduction of capital, automatically constitutes a realised profit where the court has approved the reduction). What is not clear is whether, and/or to what extent, reductions by companies under the new regime described above, without court approval, will be included. It would seem perverse if they were not.

6.5 Intra-group transfers

Currently, the law governing distributions to shareholders, including distributions in kind, is contained in both the 1985 Act and the common law. “Distributions in kind” can include transactions such as a sale to a shareholder of an asset at an undervalue, or a sale at an overvalue. For many years, there has been concern that, in the context of intra-group reorganisations, common law principles may require distributable profits covering the full difference between book value and market value of any asset transferred at book value. This concern was aggravated in 1989 by the leading case of Aveling Barford5 which established that, where a company which does not have any distributable profits transfers an asset to a shareholder at an undervalue, this will be an unlawful distribution.

The Act introduces a new statutory provision (Section 845) which determines the quantum of a distribution in kind where a company proposing to make such a distribution has positive distributable profits. It confirms the principle (for many years accepted by leading company lawyers) that, where a company has some (i.e. greater than zero) distributable profits and transfers an asset to a shareholder at not less than book value, there is a distribution but the amount of the distribution is zero. Where the transfer is made at less than book value, the amount of the distribution is equal to the difference, and will need to be covered by distributable profits. This provision expressly overrides any common law rule to the contrary (Section 851). However, in relation to other (cash) distributions, it will still be necessary to

5 Aveling Barford Limited v Perion Limited and Others [1989] BCLC 626.

Regulations will determine the circumstances in which a reserve arising on a reduction of capital will be distributable

A company with positive distributable profits can transfer assets intra-group at book value

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consider the common law and, in relation to all distributions (cash and in kind), it will still be necessary to have regard to a company’s constitution and any applicable statutory provisions (e.g. the codified general duties of directors).

For the purposes of this provision, a company’s profits available for distribution are increased by the amount (if any) by which the consideration received for the asset transferred exceeds its book value. Accordingly, the “profit” arising on transfer will be taken into account when determining whether the company’s distributable profits are positive and so can take advantage of this provision. This means that a company with negative distributable profits (say minus £1,000) can lawfully sell an asset intra-group at £1,001 in excess of its book value even if the market value exceeds book value by £10,000. But a sale at book value would be an unlawful distribution.

Although this new provision does no more than confirm what many believe to be the correct legal analysis under existing law, it is most helpful to have it set out in statute for the first time, so resolving the many uncertainties which have existed in this area for company lawyers and their clients.

6.6 Redenomination of share capital

Currently, the only way in which a company can convert its shares from one currency to another under existing law is by way of a court-approved reduction of capital. A company may wish to do this, for example, if its income and cost base are largely expressed in a foreign currency, so that it makes commercial sense to prepare its accounts in that foreign currency. Unless its share capital is denominated in the same currency as its functional accounting currency, the company may find that the translation of an amount standing to the credit of share capital account creates an unwelcome volatility in year end results.

The Act will facilitate redenominations into a different currency (Sections 622-628):

– unless its Articles provide otherwise, a company will be able to convert some or all of its share capital into a foreign currency by simply passing an ordinary resolution changing the nominal value of the shares. A resolution can be made conditional, but the conditions must be satisfied within 15 days of the resolution being passed,

– where the redenomination produces a strange nominal value per share, it will be possible by special resolution passed within three months of the resolution effecting the redenomination to reduce the company’s share capital to achieve a more suitable nominal value. The amount by which the company’s share capital is reduced must not exceed 10 per cent of the nominal value of the company’s allotted share capital immediately after the reduction. The amount of the reduction has to be transferred to a “redenomination reserve” which can only be used for paying up bonus shares,

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– if it is desired to increase the new nominal value of the shares, it will (as is the case at present) be possible to apply distributable reserves to adjust the nominal value.

This new procedure avoids the need for involvement of the court and allows what ought to be sufficient flexibility in calculating an equivalent amount in foreign currency.

6.7 Other changes

6.7.1 Variations of class rights

The 1985 Act provides a complicated regime for the variation of class rights. For most companies, this regime is an irrelevance as modern Articles of Association typically include a provision dealing with variation of class rights which will override the statutory regime in most cases. Even where it does not, the statutory requirements are typically the same as a company’s Articles, requiring either consent in writing of holders of 75 per cent of the issued shares of the relevant class, or an extraordinary resolution passed at a separate general meeting of the holders of that class.

The Act simplifies this regime. Only if the Articles do not provide for the variation of class rights does the statutory regime take over which is unchanged from the existing regime, except that a special resolution is required rather than an extraordinary resolution (because the “extraordinary resolution” concept is being abolished).

6.7.2 Share premium account

The 1985 Act requires the transfer to “share premium account” of any excess over nominal value when shares are allotted at a premium (whether for cash or non-cash assets), subject to the “merger relief” provisions (which disapply this requirement) in the context of share-for-share acquisitions satisfying strict criteria. The share premium account is treated as share capital under the maintenance of capital regime, although specific uses are permitted.

Under the Act (Section 610), the available uses of the share premium account are to be limited, as set out in the table below:

Share premium account: permitted uses

1985 Act Change under the Act

Paying up fully paid bonus shares

No change

Writing off

- expenses

Prohibited in case of issue of debentures

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1985 Act Change under the Act - commissions paid

- discounts given

relating to issue of new shares or debentures

In the case of issue of shares, only the premium on the issue of those shares may be used

Writing off “preliminary expenses”

Prohibited

Providing for premium payable on redemption of debentures

Prohibited

The restriction of uses for the share premium account will mean it will be harder to take advantage of share premiums.

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7 Constitutional reforms

In the interests of simplicity and the “think small first” concept, the Act makes some fundamental reforms to the way that companies are constituted and administered. These are most far-reaching in the case of private companies. Many of the constitutional changes will affect not just companies newly formed under the provisions of the Act, but also existing companies. The effect on existing companies will become clearer with the issue of transitional provisions, which will be consulted on from early 2007.

7.1 Memorandum and Articles of Association

7.1.1 Memorandum provisions deemed to form part of the Articles

The Act implements the recommendation of the Company Law Review that all rules on the internal workings of a company should be set out in one document, the Articles of Association. Currently, a company’s Memorandum of Association is a fundamental part of a company’s constitution, defining its purposes and the powers of the directors. The Memorandum of a company formed under the Act will only contain details of the initial subscriber(s) for shares (Section 8). It will therefore become “an historical snapshot”,6 pertinent to the initial formation of a company, but with no continuing relevance.

For existing companies, provisions that were in the Memorandum will not be deleted by the Act, but will be treated as provisions of the company’s Articles (Section 28). Articles registered by a company will need to be contained in a single document and (similarly to the position under the 1985 Act) it will continue to be a requirement that such Articles be divided into paragraphs numbered consecutively (Section 18). Subject to transitional provisions, this may mean that existing companies at some point will need to file a new set of Articles which expressly include and number the provisions imported from the old Memorandum. If this is not done then future references to the combined provisions may be unclear, for example, in resolutions which purport to amend or delete these provisions.

7.1.2 Abolition of the objects clause

The effect of the objects clause of an existing company will, however, be altered by the new regime. Historically, under the common law, a company could only act within the powers set out in the objects clause in its Memorandum – anything outside the objects would be “ultra vires” or void. The Companies Act 1989 went a long way towards abolishing the concept of ultra

6 Lord Sainsbury of Turville, House of Lords Debate, 30 January 2006, Grand Committee, Col. GC4.

The nature of a company’s Memorandum will be fundamentally altered by the Act

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vires, by providing that a transaction outside the company’s capacity would not thereby be invalidated (now Section 35(1) of the 1985 Act). This is replicated in Section 39 of the Act.

The Act provides that a company’s objects will be unrestricted, unless the Articles specifically restrict them (Section 31).

It is unclear how this principle applies to the objects clauses which will usually be set out in the Memorandum of an existing company and will eventually be deemed to form part of the Articles. On a common sense interpretation it may be thought that a surviving object should not be said to operate as a specific restriction on what the company can do, as a restriction would involve words stating that a company should not do a particular thing, which would be unusual for commercial companies. However in a pre-consultation paper on transitional arrangements published in August 2006 the DTI stated that in their view such surviving objects clauses which are “drafted as a list of things that the company is set up to do, or has the power, to do - which is what most existing companies have - will, in future, be read as a restriction on what the company can do.”

Even if this view is revised, companies may wish to consider their individual Memoranda and decide whether any existing objects may be unnecessarily restrictive (or, at best, redundant) in the new deregulated regime and should be removed. It would seem unlikely that changes introduced by the Act should cause problems or require immediate action given that the objects themselves will not have changed.

Where a company wishes to amend or remove a statement of objects in (or deemed to be in) the Articles, whether or not it contains restrictions, it will have to follow a special procedure for notifying the Registrar of Companies of the change. The change will not be effective until registered by the Registrar (Section 31).

7.1.3 Company capacity and directors’ authority

The clear statements in the Act that a company’s objects are unrestricted unless specifically restricted, and that acts of a company cannot be called into question even if they breach restrictions in the constitution, are welcome. However, directors will still be under a duty to observe restrictions in the constitution (Section 171) and may be liable to the company (on the basis of a claim brought by the company or a derivative claim brought by shareholders) if they execute a transaction in breach of such a restriction.

As at present, particular care will need to be taken by directors to ensure that they act in accordance with the company’s constitution, particularly in cases where directors or their

Objects will not limit a company’s powers unless they include a specific restriction

In most cases, the objects clause will become redundant

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connected persons are themselves party to the transactions (Clause 41). Directors may be personally liable to indemnify the company if they act in excess of their powers in relation to a transaction of this kind.

7.1.4 Entrenched provisions

The Act introduces new procedures and restrictions relating to the entrenchment of provisions in a company’s constitution (Sections 22-24). These will make it more difficult for companies to introduce such provisions, as well as requiring additional formalities when Articles containing entrenched provisions are amended.

A “provision for entrenchment” is defined as a provision in the Articles “to the effect that specified provisions of the Articles may be amended or repealed only if conditions are met, or procedures are complied with, that are more restrictive than those applicable in the case of a special resolution” (Section 22(1)).

For existing companies, any such provisions set out in their Memorandum will be deemed to be part of the Articles (Section 28).

Companies will only be able to adopt provisions entrenching rights in Articles on initial formation or with the agreement of all the members to the amendment of the Articles or by order of a court or other authority with power to alter a company’s Articles (Section 22). If a company has such provisions in its Articles, it will have to make a statement to the Registrar of Companies confirming that the Articles have been complied with whenever the Articles are amended (even if the amendment does not relate to an entrenched provision).

This will affect companies whose Articles (rather than shareholders’ agreement) confer super-voting rights on a particular shareholder in relation to particular matters. An existing entrenched provision can be altered or removed in accordance with the Articles, but the introduction of a new one would require unanimity.

7.1.5 Other provisions on Articles of Association

The Secretary of State will have the power to prescribe model Articles for different types of company formed under the Act, including a set for private companies.

The model Articles being proposed for private companies limited by shares are very short and commendably simple compared with the model Articles set out in Table A under both the 1948 and the 1985 Companies Acts. However, they contain no

Provisions which are more difficult than usual to amend can only be introduced into an existing company’s Articles with the agreement of all parties

New model Articles are likely to be simpler than the traditional versions

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provisions on, for example, notices to shareholders, the conduct of shareholder meetings or alternate directors. The reason for the lack of provision relating to shareholder meetings is the presumption that private companies will not hold AGMs and will pass most resolutions by written resolution (see further paragraph 6.2 above).

Nevertheless, the minimalist approach in these model Articles will not necessarily suit private companies which are larger and private equity owned.

For existing companies, the version of the model Articles that was in force at the time that a particular company was registered will continue to apply.

Some provisions in existing Articles may become unclear or redundant because of changes being made by the Act. For example, given that extraordinary and elective resolutions will no longer exist, it will make no sense to refer to them in Articles, so existing companies may wish to amend their Articles of Association for greater coherence.

Existing companies should also consider whether there is any conflict between the provisions of their Memorandum and the Articles. Under the current law, in the case of an inconsistency the Memorandum will prevail. Since Section 28 of the Act leaves unclear the relationship between provisions of the Memorandum and Articles the Act treats the provisions of the Memorandum as provisions of the Articles, the position is unclear.

The Act includes a new provision to strengthen the power of the Registrar of Companies to enforce the requirement for companies to file an updated set of Articles when they make an amendment. Failure to do so will (as at present) be a criminal offence (punishable by a fine of £1,000 and a daily default fine) (Section 26). In addition, the Registrar will have power (Section 27) to give notice to a company to comply with its filing obligations within 28 days. If the company does not comply, it will be liable for a civil penalty of £200.

7.2 Company formation

The Act is intended to simplify the rules on formation of companies. For a company limited by shares, the documents and statements to be submitted to the Registrar of Companies will be (Section 9):

– the Memorandum stating the names of the subscribers forming the company, and signed by them,

– an application for registration (specifying many of the details that used to be contained in the Memorandum, such as the proposed name, details as to registered office, whether the liability of

The Act leaves unclear the relationship between provisions of the Memorandum and the Articles

A new penalty regime applies for failure to file amended Articles

The new suite of documents required to form a company reflects wider constitutional reforms

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members is to be limited by shares or guarantee and whether the company is a private or public company),

– a statement of capital and initial shareholdings (the concept of authorised share capital has been abolished - see Alterations of share capital in paragraph 6.2.3 above),

– a statement of the proposed officers (including directors and, for private companies which wish to have a secretary, the secretary),

– the address of the intended registered office,

– a copy of any proposed Articles of Association,

– a statement of compliance (which need not be witnessed and can be made in electronic or paper form). This will replace the requirement for a witnessed statutory declaration. Rules to be made by the Registrar of Companies (under Section 1068) will determine the form of this statement and who will have to make it.

The new provisions have been drafted to be consistent with online incorporation which will be offered by the Registrar of Companies from 1 January 2007.

One person acting alone will be able to form any kind of company (not just a private company) by subscribing his or her name to the Memorandum. However, a public company will continue to need two directors.

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8 Company Secretary, Company records and the Registrar of Companies

8.1 Company secretary

Private companies will no longer be required to appoint a company secretary (Section 270).

The functions and tasks normally carried out by company secretaries – including maintaining company records and filing statutory returns – are not, however, being abolished. Directors of private companies which choose not to have a secretary will need to determine who should carry out these tasks. Private companies which wish to retain a company secretary may do so. As before, if a private company appoints a secretary then the secretary’s particulars must be put on the public record and the secretary will have the same status in relation to the company as the secretary of a public company. In particular, this means that they would be able, with a director, to execute company documents (Section 44).

In addition, a secretary of a private company – or a person carrying out the functions of a secretary – will still be an officer of the company and, as such, is potentially liable for offences under the Act.

8.2 Company records

The Act clarifies and updates existing requirements as to company records. Company records are now defined (Section 1134) and include registers, minutes, agreements and other documents required to be kept by company legislation. They may be kept in hard copy or electronic form, provided that they are adequately recorded for future reference. If kept in electronic form, they must be capable of being reproduced in hard copy form. There is also a new provision that company records may be arranged in such manner as the directors see fit (Section 1135). This should enable companies to separate information about past members from that about current members and is intended to avoid disputes as to whether electronic registers fully comply with the detailed statutory requirements.

The Act generally reduces the time period for which companies must keep records:

– companies currently have to keep minutes of directors’ and company meetings indefinitely. The Act reduces this to 10 years from the date of the relevant meeting (Sections 248 (directors) and 355 (general meetings)),

– the retention period for records in relation to former members is reduced from 20 years to 10 years (Section 121).

The retention period for many company documents is reduced

Private companies will not have to appoint a company secretary

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8.3 Access to register of members

The Act attempts to deal with the problem of third parties purchasing copies of the register and using it for direct mailing, or in some cases, intimidation of shareholders.

The public right of access to the register and index of members’ names is retained, but anyone wishing to inspect and request copies needs to provide information about themselves and the use to which the information is to be put. A company can apply to the court for a direction that it need not comply with a request for inspection or copy on the grounds that it is not for a “proper purpose”. The period for compliance is reduced from 10 to 5 days. Within this time the company must either comply or apply to the court for relief from the obligation (Sections 116-118).

Other changes to the law governing the register of members include:

– where a person exercises his right of inspection or is provided with a copy of the register, the company is under a new obligation to inform him of the most recent date on which alterations were made to the register and to confirm that there are no further alterations to be made (Section 120),

– joint holders of a share are to be treated as a single member. All their names must be stated but only a single address is required (Section 113),

– the period for which companies are liable for errors in the register is reduced from 20 years to 10 years (Section 128), and

– the repeal of Section 358 of the 1985 Act will mean that it is no longer possible to close the register for 30 days each year. The ability to close the register is useful for larger private companies in relation to the declaration and payment of dividends and, if they continue to hold meetings, for determining the entitlement to attend and vote.

8.4 Dealings with the Registrar of Companies

The Act seeks to streamline the system for company filings, in particular to ensure the accuracy and timeliness of information on the public register and to facilitate electronic communications:

– the Registrar of Companies will have greater powers to specify the form and manner in which companies submit information (Sections 1068-1071). From 1 January 2007, the Registrar must ensure that all documents required to incorporate a company may be delivered by electronic means,

– there is a new offence of knowingly or recklessly filing information that is misleading, false or deceptive in a material particular (Section 1112),

– in certain limited circumstances the Registrar of Companies will be able to contact companies who have provided incomplete or

Companies must comply with new formalities where a person is entitled to inspect the register of members

The Registrar of Companies will have greater flexibility to deal with errors or inconsistencies in company filings

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internally inconsistent information in order to obtain the missing element without having formally to reject the incoming form (Section 1075). This only applies where the companies have agreed with the Registrar of Companies that it should apply,

– the Registrar of Companies will be able to accept a replacement document where a document was delivered in the wrong form or contained unnecessary material (Section 1076), and

– the Registrar of Companies may notify a company of an apparent inconsistency on the public register and require it to provide additional or replacement documents to resolve the inconsistency (Section 1093).

The provisions of Sections 1075-1076 and 1093 seek to deal with the difficulty of removing incorrect information from the public record. There is currently no statutory power for the Registrar to do this and the courts only have limited jurisdiction to order amendments. In addition, there is now a provision for the court to make an order for rectification of the register (Section 1096). Where the registration has had legal consequences, the order may only be given where the court is satisfied that (i) the presence of the material has caused or may cause damage to the company and (ii) the company’s interest in removing the material outweighs any interest of other persons in the material continuing to appear on the register.

In addition, under Section 1095, the Secretary of State may in the future make regulations requiring the registrar to remove from the register materials which are invalid, ineffective, unauthorised or factually incorrect.

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9 Company names

The Act contains provisions to assist victims of “name-squatting” and reforms to the manner in which a company can change its name.

9.1 Right to object to names

The Act creates a new right to challenge the improper or opportunistic registration of a company name to which someone else has a better claim (Sections 69-74). Under the existing law, an aggrieved party may write to the Registrar of Companies but the Registrar has limited powers to intervene.

Under the new provisions any person or company may object to a company’s name if it is the same as, or misleadingly similar to, one in which the applicant (i.e. the objector) has goodwill. Goodwill is described as including “reputation of any description” (although there is no further clarification of what evidence of reputation will be required). An objection may be made at any time after the name is registered to a company names adjudicator (to be appointed by the Secretary of State).

There is a list of circumstances which will raise a presumption that the name was selected legitimately – for example, that the name was registered before the applicant started the activities in which it claims goodwill. If these do not apply, the objection will be upheld. Even if one of the specified grounds does apply, the objection will still be upheld if the applicant can show that the main purpose of the respondent in registering the name was to obtain money (or other consideration) from the applicant or to prevent the applicant from registering the name.

9.2 Change of name

Currently, a company can only change its name by special resolution or following a direction from the Secretary of State in circumstances which only apply to companies which are not required to use “limited” in their name. The Act provides four further means (Section 77):

– whatever means are provided in the company’s Articles,

– on the determination of a new name by a company names adjudicator if an objection under the new right of challenge (Sections 69-74) is upheld,

– where the court so determines in an appeal against a decision of the company names adjudicator, and

– where a company’s name is restored to the register (Section 1033).

In addition, there is a new procedure for a company to follow if it passes a special resolution to change its name, where the change is conditional on some other event. The notice given to the Registrar of Companies of the change must specify that it is conditional and state whether the event has occurred (Section 78). They are frequently passed, for example, where a company plans to change its name on completion of

Those who have legitimate goodwill in a name will be able to challenge persons who opportunistically register a company with that name

There will be greater flexibility in the manner of changing a company’s name, and new procedures for conditional name changes

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an acquisition. It is important to note that a conditional resolution will not enable a company to reserve a name and that the Registrar is not required to issue a new certificate of incorporation until further notice by the company that the event has occurred.

9.3 Restricted names

The Act also provides a new power for the Secretary of State to make regulations specifying what letters, symbols etc. may be used in a company’s registered name and what formats (Section 57). This has been prompted by the trend to adopt special script and symbols in company names and is intended to prevent companies adopting names that people would find hard to trace in the public record.

New rules may outlaw names that use unusual symbols or letters

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10 Narrative reporting and liability

10.1 Narrative reporting

Section 417 of the Act restates the requirements for companies, other than small companies, to prepare a business review to be contained in their directors report, currently set out in Section 234 of the 1985 Act7.

10.2 Changes to the business review

In relation to private companies, section 417 makes two significant changes to the business review requirements:

– Section 417(2) states the purpose of the business review as being to inform members of the company and help them assess how the directors have performed their duty (as stated in Section 172) to promote the success of the company, having regard to factors such as employees, the community and the environment, and

– Section 417(10) exempts the directors from disclosing information about impending developments or matters in the course of negotiation if the disclosure would be seriously prejudicial to the company’s interests.

10.3 Directors’ liability to the company for directors’ reports

Section 463 which relates to the directors’ report (including the business review), directors’ remuneration report, and information in summary financial statements derived from either of these reports, provides that:

– a director will be liable to compensate the company for any loss it suffers as a result of any untrue or misleading statement in, or omission from, such a report, but only if he knew (or was reckless as to whether) the statement was untrue or misleading, or knew the omission to be dishonest concealment of a material fact, and

– no director, auditor or other person will have any liability to anyone other than the company resulting from reliance on these reports.

The provision thus limits the liability of directors in relation to directors’ reports to the company only.

7 Section 234 was inserted by the Companies Act 1985 (Operating and Financial Review

and Directors’ Report etc) Regulations 2005.

Directors will be liable to their company if recklessly or knowingly, they include misleading information or omit material facts, but not otherwise

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11 Auditors and their liability

The most significant change in the Act so far as auditors are concerned - the ability to limit liability - has been negotiated by the profession with the Government to meet concerns that auditors’ unlimited liability reduces competition in the profession and risks the demise of another major firm.

11.1 Limitation of liability

Sections 534-538 allow shareholders of private and public companies, by ordinary resolution, to agree to limit the liability of their auditors in respect of any negligence, default, breach of duty or breach of trust, occurring in the course of an audit, by means of a liability limitation agreement (an “LLA”). The key features of this important new development are as follows:

– no limitation in any LLA can reduce the auditors’ liability to less than such an amount as is fair and reasonable in all circumstances, having regard to the auditors’ responsibilities, their contractual obligations to the company and the professional standards expected of them,

– unless the need for approval is waived by the company’s shareholders, approval of an LLA may be secured either before or after the company enters into the agreement with the auditor,

– an LLA with the auditors must be disclosed in the annual accounts or directors’ report, as required by regulations to be produced in due course,

– an LLA is only effective in relation to acts or omissions occurring in the course of the audit for one financial year,

– the company’s shareholders have the right, by ordinary resolution, to terminate an LLA in respect of any act or omission subsequent to the date set by the resolution.

Additional provisions deliver to auditors their goal of proportionate liability. These provide that:

– the limit on the amount of the auditor’s liability need not be a sum of money or a formula so could be expressed as a proportion of any loss suffered by the company, having regard to the auditor’s responsibility for such loss, and

– when considering what is fair and reasonable, no account should be taken of matters arising after the loss or damage has been incurred or matters affecting the possibility of recovering compensation from other persons liable in respect of the same loss or damage.

The second point deals with the concern that the auditor may be the only person with any money to meet a judgment by the time of court proceedings, leaving a risk that the court may find it reasonable for the auditor to compensate for the whole of the loss suffered by the company.

Auditors must still bear liability to the extent fair and reasonable

Changes affecting auditors include the ability to limit liability, subject to shareholder approval

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A concern, particularly among mid-tier accountancy firms, was the risk of LLAs developing in a way that would damage competition in the audit market. The Government therefore took a reserve power8 to make regulations about how LLAs are expressed, particularly with a view to preventing adverse effects on competition.

11.2 Audit accountability and transparency

11.2.1 Offences: There are two new criminal offences for auditors (Section 507), where they:

– knowingly or recklessly cause an audit report to include “any matter that is misleading, false or deceptive in a material particular”, or

– knowingly or recklessly cause a report to omit a statement that is required under certain sections of the Act.

Each such offence is punishable by a fine. The offence can be committed by a director, member, employee or agent of an audit firm, if such person is an accountant who would be eligible for appointment as auditor of the company.

There is concern that the introduction of these offences will encourage excessive caution amongst auditors and thereby increase audit costs. Moreover, there may be more qualified audit reports as auditors may be less willing to take any level of risk.

11.2.2 Signature of senior auditor: Where the auditor is a firm, the auditors’ report will need to be signed by the “senior statutory auditor” in his own name, for and on behalf of the audit firm (Section 504). This is a requirement of the EU Statutory Audit Directive. The senior statutory auditor will be identified according to standards issued by the European Commission pursuant to that Directive or, in the absence of these, by guidance issued by the Secretary of State. The provision makes clear that the signature of the audit report does not, of itself, give rise to any liability issues for the senior statutory auditor.

11.2.3 Disclosure of engagement terms: There is a new power for the Secretary of State to publish regulations requiring a company to disclose information about the terms on which the auditor is appointed, remunerated or performs its duties and any change in those terms (Section 493). There is a similar power in relation to the disclosure of non-audit services provided by the auditor to the company (Section 494).

11.2.4 Statements on resignation: There are changes to the rules governing the making of statements by auditors when they leave office. Under Section 519 of the Act, a departing auditor must

8 Section 535(2)

New offences applicable to auditors may affect audit procedures and increase costs for companies

The lead audit partner will have to sign the audit report

Auditors must always make a statement on resignation

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deliver a statement of the circumstances connected with his ceasing to hold office, and if there are no such circumstances, a statement to that effect. Such statement must be delivered to the company and filed with the Registrar of Companies.

11.2.5 Appointment and dismissal of auditors

The appointment and reappointment of auditors of private companies has been simplified in light of the fact that private companies will no longer be required to hold an AGM:

– an auditor’s term of office will generally run from the end of the 28-day period following circulation of the accounts until the end of the corresponding period the following year (Section 485). This will apply even if the auditor is appointed at a meeting where the company’s accounts are laid, and

– the auditor is now deemed to be reappointed unless, for example, he was appointed by the directors or the company’s Articles require actual reappointment or the members resolve that he should not be reappointed. Five per cent of members or such lower percentage as is set out in the Articles may prevent a deemed reappointment by notice to the company (Section 487).

Special notice and a shareholder’s meeting will still be required for a private company to dismiss an auditor before the end of its term of office.

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Further information If you would like to discuss any aspect of the Companies Act, please contact Richard Youle (020 7456 4817), Charlie Jacobs (020 7456 3332), Carlton Evans (020 7456 3602) or your usual contact at Linklaters.