WHICH HAND IS YOUR POCKET IN?
28 / 03 / 2019
WeWork are often in the news these days, along with their charismatic founder, Adam Neumann. Mr Neumann has reportedly made millions of dollars by renting many properties which he owns back to WeWork and this has attracted a slew of recent coverage. In response to questioning, a spokesman for WeWork stated that all such deals are approved by the board and disclosed to investors. However Neumann is WeWork’s largest individual shareholder with voting control over the company, so one could argue he could not be prohibited from going ahead with the transactions.
He is not alone in seeing the opportunities for personal investment as well as corporate investment. How can directors make sure they’re clear about personal investment and company investment? The starting point is that directors have a duty to declare to the board of their company any interest they might have in a transaction involving the company. Where that interest relates to an arrangement between the company and the director to buy or sell certain assets, shareholder approval might also be needed. These transactions are referred to as “substantial property transactions” and are governed by Section 90 of the Companies Act 2006.
When is shareholder approval needed?
Shareholder consent is needed when a director – or a person connected to a director – buys a substantial “non-cash asset” from the company. There’s a trap for the unwary here: if the individual buying land is a director of the company’s holding company, shareholder approval is still needed from the shareholders of the selling company and also from the shareholders of the holding company. Exactly the same terms apply on a purchase, where a company is buying a substantial non-cash asset from a director or someone connected with the director.
Normally at least 50% of the shareholders have to approve the transaction but it is important to check the company’s articles of association thoroughly. Sometimes the articles stipulate a higher percentage of approval is needed.
Shareholders’ approval can be given at a general meeting of shareholders or if the company’s articles do not prohibit it, by a written resolution which all shareholders can sign. The number of shareholders in a company and their geographical location often dictates which is the better route to follow in each case. If the shareholders’ approval cannot be obtained before contracts are exchanged for the substantial property transaction, the contract can be conditional on such approval being given. And beware of transactions where there is a holding company involved. In that case shareholder approval is needed from both the shareholders of the company and of the relevant holding company.
What is a substantial non-cash asset?
There is a definition in Section 1163 of the Companies Act 2006 which is “any property or interest in property other than cash”. These non-cash assets are “substantial” if the value is either (a) greater than £5,000 and more than 10% of the value of the company based on its statutory accounts or (if there are no statutory accounts) the amount of its called up share capital; or (b) more than £100,000.
It is quite clear that almost all property transactions will therefore be caught by this threshold. Even with lower value properties, if there are a number of assets or a series of transactions, those have to be added together to work out whether those thresholds are met.
What is a connected person?
The definition of connected persons is very wide. Directors need to be alert to their wider relationships to make sure they declare an interest where applicable. Connected persons include a spouse, civil partner, or family member (including step-children). A connected “person” can also be a company if the director has a 20% interest in that other company.
What happens if you don’t obtain approval?
If shareholder approval hasn’t been obtained the transaction can be voidable (reversed) at the company’s request unless it’s not possible for the asset to be returned to its original owner or the company has had an indemnity for any loss or damage it has suffered as a result of the transaction. If neither of these things has happened but the property has been acquired in good faith by an unconnected person who wasn’t aware the relevant approval was obtained and who would be affected by the avoidance, it will also be too late to unwind the transaction.
The relevant director, or the relevant connected person and any other person who authorised the transaction (for example, by signing the contract or the transfer deed) will be jointly and severally liable to pay the company for any gain they made in respect of the transaction or to indemnify them for any loss or damage as a result of that. Directors should be aware that this liability carries on whether or not the transaction is unwound.
It is possible to obtain retrospective ratification from shareholders but this is clearly not an ideal situation for the company, the relevant director or connected person to find themselves in. Any shareholder who feels deceived might ask more questions than they would have done if the approval was sought at the correct time. In addition there is no guarantee that more than 50% of the shareholders will retrospectively ratify the transaction. One form of comfort for directors is that once the transaction has been ratified it can no longer be set aside.
Are there any exceptions?
The most important class of exception to this rule is for transactions between a company and a person in his character as a member of that company or a shareholder. This is intended to cover scenarios such as payment of a dividend in specie or the distribution of assets to a member on winding up of a company. There can be some tax advantages from payment of a dividend in specie so this is a key category of exemptions to be aware of.
As well as the procedures of the Companies Act, before directors enter into any transaction, they should bear in mind their general duties to the company, notably their duties to promote the success of the company, to declare an interest in a proposed or existing transaction of the company and to avoid conflict of interest. The company’s articles of association may have an impact on a director’s ability to approve transactions which he or she is interested in so these do need to be checked in each case.
It can be difficult for directors of owner-managed businesses whose company has been successful as a result of that individual’s hard work to distinguish between their personal affairs and their company’s affairs. However if the protection of a limited liability company is to be preserved, it is important to keep that distinction in mind.