Division 4 of Part VIII of the Companies Act 1997 deals with transactions in which a director stands on both sides. It begins by defining when that is so.
Section 117(1) — the five limbs
(a) is a party to, or will or may derive a material financial benefit from, the transaction; or
(b) has a material financial interest in another party to the transaction; or
(c) is a director, officer, or trustee of another party to, or of a person who will or may derive a material financial benefit from, the transaction — not being (i) the company’s holding company of which the company is a wholly owned subsidiary; (ii) a wholly owned subsidiary of the company; or (iii) a wholly owned subsidiary of a holding company of which the company is also a wholly owned subsidiary; or
(d) is the parent, child, or spouse of another party to, or of a person who will or may derive a material financial benefit from, the transaction; or
(e) is otherwise directly or indirectly materially interested in the transaction.
“Where, and only where” makes the list exhaustive — but paragraph (e) is a catch-all for any other direct or indirect material interest, so little escapes.
The group carve-out in paragraph (c) keeps ordinary intra-group dealing out of the regime, but only for wholly owned relationships. A director sitting on the boards of a parent and a partly owned subsidiary is interested in transactions between them — because minority shareholders in the subsidiary need the protection.
“Spouse” is defined in section 2 to include a person with whom the director lives in a relationship of the kind there described, so the family limb is not confined to formal marriage.
A director is not interested where the transaction comprises only the giving by the company of security to a third party which has no connection with the director, at the request of the third party, in respect of a debt or obligation of the company for which the director or another person has personally assumed responsibility under a guarantee, indemnity, or by the deposit of a security.
This is the everyday case of a director who has guaranteed the company’s bank facility, and the bank then asks the company to give security. Without subsection (2) the director would be interested in the company’s own borrowing arrangements every time.
Section 118(1) — what must be disclosed
(a) where the monetary value is able to be quantified: the nature and monetary value of that interest; or
(b) where it cannot be quantified: the nature and extent of that interest.
- “Forthwith after becoming aware” — not at the next board meeting, and not before the transaction is signed. The trigger is awareness.
- It applies to a proposed transaction as well as a concluded one.
- Two separate acts are required: an entry in the interests register, and (if there is more than one director) disclosure to the board. The interests register is one of the company records under section 164.
- A sole director must still make the register entry — there is simply no board to tell.
Section 118(1A) — when disclosure is not required
(a) the transaction is between the Director and the company; and
(b) it is or is to be entered into in the ordinary course of the company’s business and on usual terms and conditions.
Both conditions must be met. A director who buys the company’s product at the standard price need not make a disclosure. A director who buys it at a discount, or buys something the company does not ordinarily sell, must. Note the parallel with section 119(4), under which a transaction entered into in good faith in the ordinary course of business and on usual terms and conditions is presumed to be at fair value.
Section 118(2) — the general notice
A general notice entered in the interests register or disclosed to the board, to the effect that a director is a shareholder, director, officer, or trustee of another named company or other person and is to be regarded as interested in any transaction which may, after the date of the entry or disclosure, be entered into with that company or person, is a sufficient disclosure in relation to that transaction.
A general notice removes the need to disclose each individual transaction with the named entity — a substantial saving for a director who sits on several boards. But it operates only for transactions entered into after the date of the entry or disclosure, and it must name the company or person.
Good practice is to file a general notice on appointment, listing every entity in which the director has an interest, and to update it whenever a new interest arises.
Sections 118(3) and (4) — the consequences of not disclosing
(3) A failure to comply with subsection (1) does not affect the validity of a transaction entered into by the company or the director.
(4) Every director who fails to comply commits an offence and is liable on conviction to the penalty in section 413(3).
Subsection (3) protects the transaction from invalidity for want of disclosure. It does not protect it from section 119, under which a transaction in which a director is interested may be avoided by the company within three months after it is disclosed to all the shareholders — unless the company received fair value.
Failing to disclose therefore does not shorten the avoidance window; it delays the start of it, because the three months runs from disclosure to shareholders. Late disclosure keeps the transaction at risk for longer.
Sections 121 and 122
- Section 121 — nothing in sections 118 and 119 applies to (a) remuneration or any other benefit given to a director in accordance with section 139, or (b) an indemnity given or insurance provided in accordance with section 140. Those sections have their own controls.
- Section 122 — subject to the constitution, an interested director may vote on the transaction, attend and count in the quorum, sign documents on the company’s behalf, and do any other thing in his capacity as a director in relation to it, as if he were not interested.
The Act does not disqualify an interested director from voting — that would paralyse small companies where every director has interests. But section 122 is subject to the constitution, which may exclude interested directors from voting or from the quorum.
And voting does not neutralise the other duties. Under section 115(2)(b) a director with a material personal interest in the subject matter cannot use the business judgment rule for that decision, and section 112 still requires good faith and a belief that the transaction is in the company’s best interests. The prudent course in a substantial interested transaction is to disclose, abstain, and let the disinterested directors decide — or to obtain unanimous shareholder approval under section 89(2)(f).
Sources
- Companies Act 1997 — ss 2, 89, 107, 112, 115, 117–122, 139, 140, 164, 413
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.