Loans to Directors - the new Authorisation Procedure

Introduction

Part III of the Companies Act, 1990 ("the 1990 Act") regulates financial dealings between companies and their directors and restricts the capacity of directors to put their own financial interests above that of the company when engaging in such dealings.

Section 31 of that Act was intended to tackle the perceived problem of the giving of "soft loans" to company directors. However, in the ten years of its application, many bona fide commercial transactions have been caught unwittingly in its net. The section has been called "a veritable mine field for lending institutions and their legal advisors".

The Prohibition

Essentially, Section 31 prohibits a company from making loans or quasi loans, entering into credit transactions, or providing guarantees or security in connection with loans, quasi loans or credit transactions in favour of "relevant persons", who are principally the following:-

• It's directors, the directors of its holding company, shadow directors of the company or its holding company, and "connected persons".
• Connected persons" include:
• Such director's spouse, parent, brother, sister or child
• A trustee who holds on trust for the director, his spouse or any children or any body corporate he controls, or
• A business partner of that director.

A body corporate is deemed to be connected with a director of a company if it is controlled by that director. A director is deemed to control a body corporate if he is, either alone or together with the persons mentioned in the three categories above, interested in half or more of the equity share capital of the company, or entitled to exercise, or control the exercise, of half or more of the voting power at any general meeting of the company. Prior to the introduction of the Company Law Enforcement Act 2001 ("the CLEA 2001"), a shareholding or control of the voting power of more than half was necessary to constitute "control".

Consequences of Breach

The main consequences of a breach of Section 31 are: -

• the transaction is voidable at the instance of the company, i.e. such transactions may be set aside by a Liquidator in the course of a winding up
• personal liability may be imposed on the directors
• criminal sanctions may apply

Unfortunately, the section also often had the effect of putting "a stop" to many bona fide commercial transactions, principally those involving commercial lending.

The Authorisation Procedure

A means of avoiding the prohibition in Section 31 on such guarantees or provision of security to relevant persons was introduced by Section 78 of the CLEA 2001. The new authorisation procedure now permits a company to provide a guarantee or security in connection with a loan made to a "relevant person" of the company, provided the new authorisation procedure has been followed.

It should be noted that the authorisation procedure does not apply to a company making loans or quasi-loans in favour of a relevant person.

The authorisation procedure (which is set out in Section 34 of the Companies Act 1990, as amended) requires: -

• The passing of a special resolution, i.e. 75% or more of the votes cast must be in favour.
• A majority of the directors must make a Statutory Declaration stating that, having made a full enquiry into the affairs of the company, they have formed the opinion that the company, having entered into the guarantee or provided the security, will be able to pay its debts in full as they become due.
• The Statutory Declaration must also state the purpose for which the company is entering into the transaction and the benefit which will accrue to the company.
• The Statutory Declaration must be accompanied by a report from an "independent person" who is qualified to be the auditor of the company.

If all the members of the company are in favour of the resolution then it may be passed as a written resolution instead.

If all of the members of the company do not vote in favour of the resolution, a further 30 days must be pass before the company can go ahead with the transaction to allow any dissenting shareholders to apply to Court.

Directors' Liabilities

If a director makes a Statutory Declaration without having reasonable grounds for his opinion that the company will be able to pay its debts in full when they become due, he can be held personally liable for all or any of the debts or other liabilities of the company by the Court on the application of a Liquidator, creditor, or member of the company.

Further if a company is wound up within 12 months after the making of the Statutory Declaration and its debts are not provided for in full within 12 months after the commencement of the winding up, it shall be presumed, until the contrary is shown, that the director did not have reasonable grounds for his opinion.

Accordingly, directors involved in such a transaction should consider carefully the consequences of making such Declarations.

Exceptions to the S.31 Prohibition

The authorisation procedure supplements the exceptions originally provided by the 1990 Act. These are: -

The 10% Exception - Unchanged

Section 32 of the 1990 Act, unchanged by the CLEA 2001, provides that the prohibition on loans, quasi loans and credit transactions contained in Section 31 shall not apply to an transaction which has a value of less than 10% of the companies net assets. It is important to note that this exception does not apply to guarantees by the company, or the provision of security in connection with a loan, quasi loan or credit transaction.

Since the introduction of the CLEA 2001, where the arrangements referred to come to exceed the 10% rule and the situation is not remedied with two months, that transaction is voidable at the instance of the company in certain circumstances. Cases where a proposed transaction has the potential to exceed the permitted 10% will clearly require careful monitoring to ensure that the transaction does not become vulnerable at a later date.

The Intra-group Exception - Amended

Section 35 of the 1990 Act has been amended by the CLEA 2001 and essentially provides that all transactions entered into by a company for the benefit of its holding company, its subsidiary or a subsidiary of its holding company are not prohibited by Section 31.

Accordingly, all such intra-group types of transactions are now permitted and the old anomaly whereby Section 35 applied only to transactions entered into by a subsidiary in favour of its holding company, but not the other way, no longer applies. This will have the effect of permitting bona fide commercial transactions previously prohibited, without the need to restructure the group.

The Directors' Expenses Exception - Unchanged

No change has been effected to Section 36 of the 1990 Act, which provides that Section 31 shall not prohibit the company providing guarantees in relation to vouched directors expenses. Directors should note that Section 36(2) provides that any such loans must be repaid to the company within six months from the date on which any liability was incurred.

The Ordinary Course of Business Exception - Unchanged

Again, there has been no change to Section 37 of the 1990 Act, which exempts transactions entered into in the ordinary course of the business of a company where the company is in the business and has, as one of its principal objects, the lending of money, making of guarantees or provision of security, e.g., banks.

Summary

• The CLEA 2001 should assist practitioners and businesspeople by providing a procedure for facilitating bona fide commercial transactions unintentionally caught by Section 31.
• It has equalised the rules regarding intra-group loans, thus avoiding some of the complex and costly restructuring formerly required.
• It also has clarified a number of ambiguities in the 1990 Act.

For further information or general enquires please contact
Eamon Jones
E-mail: ejones@kilroys.ie
Telephone: +353-1-4395600
Fax: +353-1-4395601/4395602

© Kilroys Solicitors 2002