Restrictions on a private company’s powers to make loans or provide guarantees or security to its directors
The basic restriction contained in section 197(1) of the Companies Act 2006 provides that a private company shall not:
(a) make a loan to a director of the company or of its holding company; or
(b) enter into any guarantee or provide any security in connection with any loan made by any person to such a director,
unless approved by an ordinary resolution of the members of the company.
In addition, if the director concerned is, also, a director of the company's holding company, the transaction should be approved by a resolution of the members of the holding company as well (section 197(2) of CA 2006). For the purposes of section 197(1) shadow directors are equally treated as directors, so the same restrictions apply as regards the provision of company loans to them or the granting of guarantees or security in their favour (section 223(1)(b) of CA 2006). It is also worth noting that the term “guarantee” in this section can be interpreted quite broadly, so it would be safe to assume that it will also include any indemnity and could potentially extend to capture joint and several liabilities as well.
However, there is an interesting exception to the said rule: No approval from the members will be required where the company carrying out the said transactions is either not a UK-registered company, or is a wholly owned subsidiary of another body-corporate (section 197(5) of CA 2006). This essentially means that in many cases where there is a group structure ultimately the said restrictions won’t apply. However, one must pay attention to the holding company rule, as granting company loans or guarantees might be alright at the subsidiary level, but member approval may still be required at holding company level if the director of the subsidiary is also the director of the holding company.
The legal effect of a transaction being in breach of section 197 is that such transaction is voidable by the company save against a bona fide purchaser for value without notice, whilst the director of the company or its holding company or a connected person is liable to account for any benefit and indemnify the company for any loss suffered by the company (section 213 CA). Therefore, any creditor that accepts a payment which it knows is the result of a breach by a company of section 197 might be held to be a constructive trustee and liable to account to the company for the amount received. However, section 214 provides that any breach of section 197 can be affirmed by the necessary member's resolution 'within a reasonable period' after which the transaction can no longer be avoided. Unfortunately, there is no clear indication, though, as to what constitutes a "reasonable period".
One should note that there are further restrictions extending to family members and other connected persons where the company concerned is a public company or a company associated with a public company, but they are not addressed in this post which focusses on private companies.
