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As a company director, you should know the law places several restrictions on certain transactions. This includes restrictions on directors involved in substantial property transactions. The consequences of breaching these restrictions can be substantial. Hence, this article will:
- define substantial property transactions;
- look at the steps you can take to minimise liability; and
- consider what the consequences of non-compliance may be.
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What Are Substantial Property Transactions?
A substantial property transaction (SPT) is any transaction where your company either buys or sells a substantial non-cash asset from:
- a director of the company;
- a director of the company’s holding company;
- a person connected with a director of the company; or
- a person connected with a director of the company’s holding company.
In other words, an SPT is where the:
- company either buys or sells a non-cash asset;
- non-cash asset is of substantial value; and
- other party in the transaction must either be a company director or a connected person.
Before You Enter Into an SPT
If your company will enter into an SPT, the best option is almost always to obtain prior shareholder approval. The shareholders must vote on a resolution proposing the transaction to obtain shareholder approval.
As a director, you should ensure that the resolution is sufficiently detailed, which should include:
- the purchase or sale price of the asset (or an expected range);
- the nature of the asset with a description of any of its characteristics;
- any defects to the asset’s title that might affect its value; and
- an account of the nature of the relationship between the director or connected person with whom the company will transact.
However, as with all shareholder matters, you should review your company’s articles of association. Importantly, you will want to determine if SPTs require a special resolution rather than a mere ordinary resolution. Likewise, the articles may specify particular administrative or procedural requirements for SPTs.
Substantial Property Transactions Involving Subsidiary Companies
The law takes a different approach for SPTs involving subsidiary companies. A subsidiary company is any company with a shareholder owning most of its holding shares. For instance, suppose HoldCo Ltd owns all of the voting shares in SubCo Ltd. SubCo Ltd is a subsidiary of HoldCo Ltd. With this in mind, consider the following scenario involving HoldCo Ltd and SubCo Ltd.
However, where a subsidiary is not wholly owned, the shareholders of the subsidiary vote on it as if it were not a subsidiary. That is, if XYZ Ltd owns 51% of voting shares in SubCo2 Ltd and ABC Ltd owns 49%, SubCo2 Ltd’s directors must put the resolution to both companies.
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What Happens If I Do Not Obtain Shareholder Approval Prior To Substantial Property Transactions?
Suppose your company has already entered into an SPT without shareholder approval. In this instance, the law allows the company to approve the transfer retroactively. However, this requires the directors to put to the shareholders a resolution ratifying the transaction. If the resolution passes, the law treats the transaction as if the shareholders had approved it before it occurred.
However, the shareholders must approve the transaction within a reasonable period. Of course, what is reasonable depends on the circumstances. However, the law may only allow the company to ratify the transaction if the directors seek shareholder ratification within several weeks to a few months.
Voidability and Director Liability
Without ratification or shareholder approval, the company can void the transaction at either the shareholders’ insistence or the directors’. For a company to void the transaction, it must be possible to reverse it. This is possible if the company buys or sells the asset directly from the director. In this case, both parties just swap assets like the transaction never happened.
Where voidability is not possible, the company can order the director to account to the company for any gain the director obtained at the company’s expense. Likewise, it can order the director to reimburse the company for any loss, even if the director did not gain anything at the company’s expense.
Practical Considerations Following a Breach
As with all conflicts involving a director’s breach of their duties, the extent to which you may face liability as a director depends on the circumstances. The law restricting SPTs involving directors is designed to protect companies and their shareholders from abusing their powers; for instance, concealing facts about a transaction to induce the company into buying the asset for more than it is worth.
Therefore, there may be circumstances where you are in technical breach of this law. However, you will unlikely face any real liability if no shareholders are aggrieved. This is because the mechanism for enforcing the law rests with the company through the action of its shareholders. However, as a matter of best practice, you should avoid breaches of your duty in all instances.
Key Takeaways
The law restricts directors from entering transactions where the director’s company is either the purchaser or seller of substantial non-cash assets without shareholder approval. Nor can the non-cash asset transaction involve a connected person. Failure to obtain shareholder approval of the substantial property transaction means directors may face personal liability. The company, through its shareholders, can also insist that the transaction be voided. However, the company’s shareholders can also retroactively approve an SPT if they do so within a reasonable period.
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Frequently Asked Questions
A substantial property transaction is any transaction where your company either buys or sells a substantial non-cash asset from a director to certain connected third parties.
This includes close family members like children, spouses, civil partners, and parents. It also includes business partners and certain trustees of trusts.
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