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Loans to Directors

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Until recently, under Section 330 of the Companies Act 1985, loans to directors were prohibited except in certain limited situations. The result of this was that a liquidator could pursue a director under an action for misfeasance where it was established that a director had taken a loan from the company.

However, the newly appointed Section 197 of the Companies Act 2006 has brought about a significant change in this area as it is now permitted to make a loan to a director provided it has been approved by resolution in an appropriate shareholder meeting.

Section 1971 requires a memorandum setting out the nature of the transaction, the amount of the loan2 and its purpose and the extent of the company's liability under any transaction connected with the loan. Such a memorandum must be placed before the members before a resolution is voted in relation to a loan to a director. The Act has therefore provided safeguards which are necessary with such a substantial change in procedure.

Although, generally, transactions require members' approval it should be noted that the 2006 Act has increased the level of 'minor transactions' from £5,0003 to £10,0004. The significance of this change is that a director can take a loan from the company without the need for shareholder approval, and therefore without having to justify the purpose of the loan to the members.

Although this new provision will adversely affect claims for misfeasance where a satisfactory resolution has been passed by the members, should this not be the case then the transaction remains voidable as was the case under Section 330 of the 1985 Act.

The corporate veil has once again tightened in this area meaning it is therefore essential that should a transaction which appears to be a director loan come to light, the appropriate minutes of the meeting approving the transaction are obtained and that the companies' articles are scrutinised to determine whether the loan was approved by the required means.

1 Companies Act 2006
2 Companies Act 2006, Section 197(4)
3 Companies Act 1985, Section 334
4 Companies Act 2006, Section 207

Paul Balderson can be contacted on 0113 3993479 or paulbalderson@keeblehawson.co.uk.

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