Under S330 of the Companies Act, a company is prohibited (subject to certain limited exceptions) from making a loan to a director. The exceptions include loans of small amounts (an aggregate maximum of £5,000); loans by a subsidiary to a holding company; loans to directors to cover expenditure incurred in performing their roles, or in defending certain civil or criminal proceedings or where the ordinary business of the company is lending money. The Court of Appeal in Neville (as Administrator of Unigreg Ltd) and Another v Krikorian and Others [2006] EWCA Civ 943 has highlighted the dangers for a director who knows that his company is operating loans in breach of Section 330 in favour of another director.
Statutory Background
Any breach of s330(2) will render a director who has authorised the transaction liable under s341(2) of the 1985 Act :
- to account to the company for any gain which he has made directly or indirectly by the arrangement or transaction; and
- (jointly and severally with any other person liable under section 341(2) of the 1985 Act) to indemnify the company for any loss or damage resulting from the arrangement or transaction
The Facts
Mr Krikorian (A) and his son (K) were the only directors of Unigreg Ltd. Between 1996-1998 loan accounts were opened for both K and A. However during this period, A had become less active in the business and the annual accounts in which the loans appeared were only signed on behalf of the directors by K.
In 2002 the Krikorians petitioned for insolvency. The administrator then applied to the court claiming that A and K had contravened s330 of the 1995 Act by creating directors' loan accounts through which they borrowed money from the company and as a result they were jointly and severally liable for the amounts outstanding on the accounts.
A had accepted liability for the amount outstanding on his own account but the Court held that he was also liable for the debt on K's account. A appealed this decision on the grounds that he was unaware of the existence of K's loan account until 2001 and that he had not authorised the payments to K. The Court did not accept these arguments and as a result A was held liable for the difference between the amount that could have been repayable by the company in 1999 (the date A was taken to have known about the practice of lending to K) and the amount that was now available.
It is clear from the Court of Appeal judgement that:
- As a director A was still responsible for the company's accounts although he had not signed them.
- The existence of a practice whereby a director knowingly allows his company to make loans to a co-director in breach of Section 330 was viewed as equivalent to authorising the individual payments. This was the case even if the director has no knowledge of each individual payment at the time it was made.
- As soon as the existence of a loan in breach of Section 330 is discovered a director may be in breach of his duty if he fails to recoup any outstanding balance which is repayable on demand.
This decision draws attention to one of the dangers that can result from remaining as a director of a company without taking a proper interest in its affairs. The joint and several liability which can arise in respect of loans made to fellow directors will be of particular concern to individuals of sound financial standing in comparison to the borrower. As soon as a director becomes aware of this type of practice he has a duty to put a stop to it and to attempt to recover the outstanding balances.