In the past, UK companies were forbidden from lending to their directors. Judicial penalties were the outcome if this rule was broken. The Companies Act 2006 removed the ban on company loans to directors, and section 197(1)(a) established the general principle that
‘A company may not make a loan to a director … unless the transaction has been approved by a resolution of the members of the company.’
And it is this requirement that is the starting point when considering whether prior shareholder approval should be obtained for a company loan to a director.
But it is only a starting point. In this article we will first examine the exceptions and then look at the process of properly approving a director’s loan.
What do the government consider to be a director’s loan?
The government will consider as a loan to a director any payments that cannot be categorised as:
- Reimbursement of business expenses
- Repayment of advances made to the company
Director’s loans can also refer to monies that a director has lent to the company, but different issues will arise when this is the case.
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Does a director’s loan always require shareholder approval?
Whilst many loans to directors do require prior shareholder approval, this may not be the case if the amount involved is small, or it is to meet expenditure incurred on behalf of the company. Consider the following exceptions, where in all cases shareholder consent is not required:
- Director’s loans of no more than £10,000: where the sum of all company loans connected to a director is no more than £10,000 (Companies Act 2006, s.207 (1)).
- Director’s loans for credit transactions of no more than £15,000: where the director acquires goods or services from the company on deferred payment terms and the total of all such credit transactions is no more than £15,000 (Companies Act 2006, s.207 (2)).
- The loan is to finance spending on behalf of the company: where the loan either enables the director to perform his duties as an officer, or covers costs incurred carrying out the company’s business. However, shareholder approval will be required if the total of all amounts outstanding relating to a director exceeds £50,000 (Companies Act 2006, s.204).
- The loan is to fund criminal or civil defence proceedings: where these costs are incurred by the director in his role as officer of the company. However, if the director is not successful in his defence he will be required to reimburse the company no later than the date when the conviction or judgement becomes final (Companies Act 2006, s.205). If he is successful, the loan can either be repaid or the company may write off the director’s loan.
- The loan is to fund defence proceedings relating to regulatory investigation: where the costs are incurred by the director in his role as officer of the company (Companies Act 2006, s.206).
How is the total value of an individual director’s loan calculated?
The total value of a director’s loans should be reflected in the position of his director’s loan account. The director’s loan account records all monies paid into or lent to the company by the director and offsets against this any monies or assets borrowed from the company. A director’s loan account is said to be ‘overdrawn’ if on balance the director owes the company money.
However, when calculating the balance on the director’s loan account you must also consider whether the company might be a close company. In section CTM60060 of the Company Taxation Manual HMRC define a close company as one that is:
- Controlled by five or fewer participators; or
- Controlled by any number of participators if they are also directors of the company; or
- In the event of the company being wound up, more than half the assets would be distributed to five or fewer participators or to participators that are also directors.
A ‘participator’ is defined in section CTM60107 of the Company Taxation Manual as
‘ … any person having a share or interest in the capital or income of the company.’
If the company is a close company, any payments made to persons that are connected to the director should be included in his director’s loan account. Connected persons include family, friends, business partners and other persons associated with the director. It is worth noting this point, as private companies are often owned and controlled by their directors and will often be regarded as close companies.
If the director’s loan account is overdrawn by no more than £10,000 (or £15,000 for credit transactions) even after including any company loans made to persons connected to the director, prior shareholder approval of the loan may not be required.
How is a company loan to a director approved?
Whether or not shareholder endorsement is required, it is good practice to ensure that any proposed director’s loan is considered by the board and board approval is obtained before proceeding. The Companies Act 2006 tasks all directors with a duty to promote the success of the company, and the board should consider this duty before approving the loan.
Similarly, directors are charged with a duty to avoid conflicts of interest. The director to which the loan pertains should declare their interest and preferably not take part in any vote to obtain board approval of the loan. Without such careful consideration and full documentation of the board approval process, it is possible that a claim could be made that the directors have behaved in breach of their statutory duty to act in the best interests of the company.
Even if the director involved is the only, or the controlling shareholder, a proper approval process should still be followed.
Broadly, the steps involved to obtain appropriate approval of a director’s loan are as follows:
1. Written notice of interest in the proposed director’s loan
According to section 177 of the 2006 Companies Act, the director interested in the proposed loan must declare their interest before the company enters into the transaction. The declaration can be made in any of the following ways:
- at a meeting of the directors;
- by submitting a written notice of interest (Companies Act 2006, s.184);
- by submitting a general notice (Companies Act 2006, s.185).
If the declaration is found to be erroneous or incomplete, a further declaration is required.
You may find it helpful to use our template Written Notice of director’s interest in the proposed loan, which should be sent in hard copy or electronic form to the other directors. We also provide a template written notice for use when the proposed loan is to a person ‘connected’ to the director. Either template can also be used to propose a meeting of the directors to consider the planned loan (see point 2 below).
2. Board meeting to consider the director’s loan
A meeting of the directors should be called. At the board meeting both the proposed loan and the director’s declaration of interest should be discussed. If the directors are satisfied that the loan is in the best interests of the company, board approval of the proposed loan should be documented in the minutes.
You can use our free template board minute to approve a loan to a director.
Templates for approving a company loan to a director
Free templates to support the formal approval of a company loan to a director.
3. Shareholder approval of the proposed loan to the director
Assuming that the loan has been endorsed by the board, the next step is to consider whether shareholder approval is also required. If it is, section 197 of the 2006 Companies Act requires a simple majority (more than 50%) of the company’s members to pass an ordinary resolution. However, it is worth checking the company’s articles of association, as if these require a higher level of approval (i.e., a special resolution) this stipulation prevails. Of course, even if a director’s loan does not require prior shareholder consent, the board may consider it prudent to do so.
We offer a free template shareholders’ resolution for use when member approval of the company loan to a director is to be obtained via vote at a general meeting (such as the AGM). Alternatively, if you would prefer to obtain approval of a company loan to a director by circulating a written resolution, you will find this template useful. Our template board minute to approve a loan to a director includes both a directors’ resolution to call a general meeting for the purposes of the vote or to circulate a written resolution. It is therefore suitable for either route.
4. Written memorandum of the terms of the loan
Regardless of whether approval is to be sought at a general meeting or via written resolution, section 197(4) of the 2006 Companies Act requires a memorandum to be drawn up containing the following details of the loan:
- the nature of the transaction;
- the amount of the loan;
- the purpose for which it is required;
- the extent of the company’s liability with regards to the loan.
If the shareholders’ resolution is to be passed in writing the memorandum must be attached to the resolution to be sent to all members. Where the resolution is to be passed at a general meeting, the memorandum must be available at the company’s registered office address for at least 15 days ahead of the meeting, as well as being available at the meeting itself.
Our memorandum of terms of loan template will assist with this step.
What are the consequences if the loan is not properly approved?
Serious consequences can result if the proper approval process is not followed, particularly if the loan is for more than £10,000. Section 213 of the 2006 Companies Act advises that the loan may be considered ‘voidable’ or invalid. The director benefitting from the company loan and any directors that authorised the loan may have to:
- account to the company for any gain made as a result;
- indemnify the company for any ‘loss or damage’ resulting from the now void loan.
In addition, failure to demonstrate the proper approval process could result in a civil claim that the directors have behaved in breach of their fiduciary duty to act in the best interests of the company and its shareholders.
It may be possible for the shareholders to retrospectively authorise a director’s loan, provided the ordinary resolution is passed ‘within a reasonable period’ (Companies Act 2006, s.214).
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