Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties [1998] SLC 105(APPENDIX) (DP) (August 1998)

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Scottish Law Commission (Discussion Papers)

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URL: http://www.bailii.org/scot/other/SLC/DP/1998/105(APPENDIX).html
Cite as: [1998] SLC 105(APPENDIX) (DP)

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APPENDIX A

Draft clauses relating to directors' duties and draft statement of directors' duties

Draft section 309A (Duty of care, skill and diligence)
Draft section 309B (Statement relating to directors' duties)
[ON PAGE 310 FOLLOWED BY EXPLANATORY NOTES]
Draft statement relating to directors' duties to their companies [on pages 313-314]

DRAFT CLAUSES/SCHEDULES

Duty of care, skill and diligence

1. In the Companies Act 1985 this section is inserted after section 309- Duty of care, skill

and diligence.

"Duty of care, skill and diligence.

309A.-(1) A director of a company owes the company a duty to exercise the care, skill and diligence which would be exercised in the same circumstances by a reasonable person having both-
(a) the knowledge and experience that may reasonably be expected of a person in the same position as the director, and
(b) the knowledge and experience which the director has.
(2) This section has effect instead of the rules of law stating the duties of care, skill and diligence owed by a director of a company to the company.
(3) References in this section to a director include references to a shadow director."

Statement of duties

2. In the Companies Act 1985 this section is inserted after section Statement relating

309A- to director's duties.

"Statement relating to directors' duties.

309B.-(1) In prescribing a form of document falling within this subsection the Secretary of State may include in it a statement containing information about directors' duties; and these documents fall within this subsection-
(a) a statement referred to in section 10(2);
(b) a notification referred to in section 288(2) if it is a
notification of a person having become a director;
(c) a return referred to in section 363(2);
(d) an application referred to in section 680(1).

(2) Regulations under section 257 may require a document to include a prescribed statement containing information about directors' duties.
(3) The enactments and rules of law stating directors' duties are not affected by-
(a) anything in a statement including a document by
virtue of this section, or
(b) any acknowledgement by a person (by signing the
document) that he has read the statement."

EXPLANATORY NOTES ON DRAFT CLAUSES

Clause 1 inserts a new section 309A into the Companies Act 1985.

Subsection (1) sets out the minimum standard of care, skill and diligence which a director must show to his company. There is some doubt as to the current standard which is required at common law. Traditionally the cases have not required directors to exhibit a greater degree of skill than may reasonably be expected from a person with their knowledge and experience (a subjective test) (see paragraphs 12.3-12.7 of the consultation paper). More recently, the courts have been prepared to say that the common law standard now mirrors the tests laid down in section 214(4) of the Insolvency Act 1986, which includes an objective assessment of a director's conduct (see paragraphs 12.8-12.10 of the consultation paper). (Section 214 makes provision (in connection with proceedings under that section to obtain a contribution from a director to a company's losses) as to how a court is to assess the matters which a director ought to have known or concluded about the company's financial position and the steps which he ought to have taken to minimise the loss to creditors). Subsection (1) of section 309A replaces the common law standard of care, skill and diligence (see subsection (2) below) with a dual test which is itself modelled on section 214(4) of the Insolvency Act 1986.

Subsection (1) attributes to the director both the notional knowledge and experience which may reasonably be expected of a person in the same position as the director (subsection (1)(a) - an objective test) and the actual knowledge and experience which the director has (subsection (1)(b) - a subjective test). The court is then required to look at whether the director has exercised the care, skill and diligence which would have been exercised by a reasonable person in the same ciricumstances as the director having both types of knowledge and experience (ie objective and subjective). Subsection (1)(a) is intended to set a minimum standard required by law of all directors. However, where a director possesses particular knowledge or experience over and above that which might otherwise be reasonably expected of a person in his position, then he must meet the higher standard of care, skill and diligence appropriate to his knowledge and experience (in accordance with subsection (1)(b)). In considering whether the director has met the appropriate standard, the court must take account of the particular circumstances of the case ("in the same circumstances") and have regard to specific responsibilities that a director either has or has undertaken ("in the same position").

Subsection (2) confirms that the section replaces the common law standard of care, skill and diligence which must exercised by a director. But it does not affect other matters relating to the duty of care, such as remedies.

"Director" is defined in section 741(1) of the Companies Act 1985, and for these purposes is intended to include a de facto director (see the discussion on de facto directors in paragraphs 17.5-17.10 of the consultation paper). Subsection (3) provides that director also includes a "shadow director", as defined in section 741(2) of the Companies Act 1985. "Company" is defined in section 735(1) of the Companies Act 1985.

Clause 2 inserts a new section 309B into the Companies Act 1985.

Subsection (1) permits the Secretary of State to include in certain prescribed forms which must be delivered by a company for registration, a statement containing information about directors' duties. The forms concerned are: (a) the statement of first directors; (b) notice of change of a director; (c) the annual return; and (d) an application by a company not formed under the Companies Acts for registration under the Companies Act 1985.

Subsection (2) gives the Secretary of State power to make regulations under section 257 requiring a statement of directors' duties in prescribed form to be included in any document which is required to be prepared, laid before the company in general meeting or delivered to the Registrar of Companies under Part VII of the Companies Act 1985 (Accounts and Audit). So, for example, regulations could be made requiring the statement of duties to be included in the annual accounts.

The object of both provisions is to enable the relevant documents to be used as a means of bringing these duties to the attention of a company's officers (see the discussion on this point at paragraphs 14.32-14.40 of the consultation paper). The intention is that the statement should set out in simple language the principal duties of a director. A draft of the sort of statement which might be included is set out below and discussed at paragraphs 14.33-14.35 of the consultation paper.

Subsection (3) confirms that any statement included or required to be included in a document by virtue of this section will not have any effect on the duties imposed by law. The statement is for information purposes only. It also confirms that the fact that a director signs a document in which such a statement is included, acknowledging that he has read the statement, will not affect the duties he owes.

DRAFT STATEMENT RELATING TO DIRECTORS' DUTIES TO THEIR COMPANIES

General

(1) The law imposes duties on directors. If a person does not comply with his duties as a director he may be liable to civil or criminal proceedings and he may be disqualified from acting as a director.

(2) Set out below there is a summary of the main duties of a director to his company. It is not a complete statement of a director's duties, and the law may change anyway. If a person is not clear about his duties as a director in any situation he should seek advice.

Loyalty

(3) A director must act in good faith in what he considers to be the interests of the company.

Obedience

(4) A director must act in accordance with the company's constitution (such as the articles of association) and must exercise his powers only for the purposes allowed by law.

No secret profits

(5) A director must not use the company's property, information or opportunities for his own or anyone else's benefit unless he is allowed to by the company's constitution or the use has been disclosed to the company in general meeting and the company has consented to it.

Independence

(6) A director must not agree to restrict his power to exercise an independent judgment. But if he considers in good faith that it is in the interests of the company for a transaction to be entered into and carried into effect, he may restrict his power to exercise an independent judgment by agreeing to act in a particular way to achieve this.

Conflict of interest

(7) If there is a conflict between an interest or duty of a director and an interest of the company in any transaction, he must account to the company for any benefit he receives from the transaction. This applies whether or not the company sets aside the transaction. But he does not have to account for the benefit if he is allowed to have the interest or duty by the company's constitution or the interest or duty has been disclosed to and approved by the company in general meeting.

Care, skill and diligence

(8) A director owes the company a duty to exercise the care, skill and diligence which would be exercised in the same circumstances by a reasonable person having both-

(a) the knowledge and experience that may reasonably be expected of a person in the same position as the director, and

(b) the knowledge and experience which the director has.

Interests of employees etc

(9) A director must have regard to the interests of the company's employees in general and its members.

Fairness

(10) A director must act fairly as between different members.

Effect of this statement

(11) The law stating the duties of directors is not affected by this statement or by the fact that, by signing this document, a director acknowledges that he has read the statement.

APPENDIX B

Draft provisions on loans to directors

[ON PAGES 316-328 FOLLOWED BY EXPLANATORY NOTES]

DRAFT CLAUSES/SCHEDULES

SCHEDULE 13A

Loans to Directors etc

Part I

Index of Definitions

SCH. 13A

1.These expressions are defined or otherwise explained by the provisions indicated-

Conditional sale agreement
Credit transaction
Director
Guarantee
Money-lending company
Quasi-loan (and related expressions)
Relevant amounts
Relevant company
Services
Transaction or arrangement (for whom made)
Transaction or arrangement (value of)

paragraph 12
paragraph 12
paragraph 8
paragraph 11
paragraph 21(8)
paragraph 10
paragraph 22
paragraph 9
paragraph 12
paragraph 12
paragraph 24

Part II

Prohibitions

Prohibitions on all companies

(2) A company must not enter into a guarantee or provide security in connection with a loan made by any person to a director of the company or of its holding company.

Prohibitions on relevant companies

(2) A relevant company must not make a loan or a quasi-loan to a person connected with a director of the company or of its holding company.

(3) A relevant company must not enter into a guarantee or provide security in connection with a loan or quasi-loan by any person to a director of the company or of its holding company or to a person connected with such a director.

(4) A relevant company must not enter into a credit transaction as creditor for a director of the company or of its holding company or for a person connected with such a director.

(5) A relevant company must not enter into a guarantee or provide security in connection with a credit transaction made by any person for a director of the company or of its holding company or for a person connected with such a director.

Other prohibitions

(2) If an arrangement is made in breach of this paragraph, for the purposes of this Schedule the transaction is to be treated as having been entered into on the date of the arrangement.

(6) A company must not take part in an arrangement by which-

(a) another person enters into a transaction which would have broken paragraph 3, 4 or 5 if the company had entered into it, and

(b) the other person has obtained or is to obtain a benefit from the company or its holding company or a subsidiary of the company or its holding company.

Part III

Principal Definitions

Introduction

Directors

Relevant companies

(a) is a public company,

(b) is a subsidiary of a public company,

(c) is a subsidiary of a company which has a public company as another subsidiary, or

(d) has a subsidiary which is a public company.

Quasi-loans

(a) on terms that the borrower (or a person on his behalf) will reimburse the creditor, or

(b) in circumstances giving rise to a liability on the borrower to reimburse the creditor.

(2) A transaction is also a quasi-loan if a party (the creditor) agrees to reimburse, or reimburses otherwise than under an agreement, expenditure incurred by another for another (the borrower)-

(a) on terms that the borrower (or a person on his behalf) will reimburse the creditor, or

(b) in circumstances giving rise to a liability on the borrower to reimburse the creditor.

(3) A reference to the person to whom a quasi-loan is made is a reference to the borrower.

(4) The liabilities of a borrower under a quasi-loan include the liabilities of any person who has agreed to reimburse the creditor on behalf of the borrower.

Guarantees

Credit transactions etc

(a) supplies goods or sells land under a hire-purchase agreement or a conditional sale agreement,

(b) leases or hires land or goods in return for periodical payments, or

(c) otherwise disposes of land or supplies goods or services on the understanding that payment (whether in a lump sum or instalments or by way of periodical payments or otherwise) is to be deferred.

(2) "Conditional sale agreement" has the same meaning as in the Consumer 1974 c. 39.

Credit Act 1974.

(3) Services are anything other than goods or land.

Transactions or arrangements made for persons

(2) A loan or quasi-loan is made for a person if it is made to him.

(3) A credit transaction is made for a person if he is the person to whom goods or services are supplied, or land is sold or otherwise disposed of, under the transaction.

(4) A guarantee or security is made for a person if it is entered into or provided in connection with-

(a) a loan or quasi-loan made to him, or

(b) a credit transaction made for him.

(5) An arrangement within paragraph 5 or 6 is made for a person if the transaction to which the arrangement relates was made for him.

(6) Any other transaction or arrangement for the supply or transfer of (or of an interest in) goods or land or services is made for a person if he is the person to whom the goods or land or services (or the interest) is or are supplied or transferred.

Part IV

Exceptions

Small loans

Relevant companies: short-term quasi-loans

(2) The quasi-loan must require the director (or a person on his behalf) to reimburse the creditor its expenditure within 2 months of it being incurred.

(3) The aggregate of the amount of the quasi-loan and of the amount outstanding under each relevant quasi-loan must not exceed £5,000.

(4) A quasi-loan is relevant if it was made to the director under this paragraph by the creditor or its subsidiary or, if the director is a director of the creditor's holding company, any other subsidiary of that company.

(5) The amount outstanding is the amount of the outstanding liabilities of the person to whom the quasi-loan was made.

Relevant companies: loans in same group

(2) Paragraph 4(2) does not stop the company making a loan or quasi-loan to another member of the group, by reason only that a director of one member of the group is associated with another member of the group.

(3) Paragraph 4(3) does not stop the company entering into a guarantee or providing security in connection with a loan or quasi-loan made by any person to another member of the group, by reason only that a director of one member of the group is associated with another member of the group.

Relevant companies: minor transactions

Relevant companies: business transactions

(a) the transaction is entered into by the company in the ordinary course of its business,

(b) the value of the transaction is not greater (in respect of the person for whom it is made) than that which it is reasonable to expect the company to have offered to or in respect of a person of the same financial standing but unconnected with the company, and

(c) the terms on which the transaction is entered into are no more favourable (in respect of the person for whom it is made) than those which it is reasonable to expect the company to have offered to or in respect of a person of the same financial standing but unconnected with the company.

Transactions at request of holding company

(a) a loan or quasi-loan by a company to its holding company;

(b) a company entering into a guarantee or providing security in connection with a loan or quasi-loan made by any person to its holding company;

(c) a company entering into a credit transaction as creditor for its holding company;

(d) a company entering into a guarantee or providing security in connection with a credit transaction made by any person for its holding company.

Director's expenditure for company

(2) Part II does not stop a company doing anything to enable a director to avoid incurring expenditure for those purposes or that purpose.

(3) However, sub-paragraphs (1) and (2) are subject to sub-paragraphs (4) and (5).

(4) Sub-paragraphs (1) and (2) do not authorise a relevant company to enter into a transaction if the aggregate of the relevant amounts exceeds £20,000.

(5) Sub-paragraphs (1) and (2) apply only if one of these conditions is satisfied-

(a) the thing in question is done with prior approval of the company given at a general meeting at which all the matters mentioned in sub-paragraph (6) are disclosed;

(b) the thing in question is done on condition that, if the approval of the company is not so given at or before the next annual general meeting, the loan is to be repaid within 6 months from the conclusion of the meeting or any other liability arising under the transaction is to be discharged within that period.

(6) The matters to be disclosed are-

(a) the purpose of the expenditure incurred or to be incurred by the director, or which would otherwise be incurred by him;

(b) the amount of the funds to be provided by the company;

(c) the extent of the company's liability under any transaction which is connected with the thing in question.

Money-lending companies

(a) a loan or quasi-loan made by a money-lending company to any person;

(b) a money-lending company entering into a guarantee in connection with a loan or quasi-loan made otherwise than by the company.

(2) However, sub-paragraph (1) is subject to sub-paragraphs (3) to (5); but sub-paragraph (4) is itself subject to sub-paragraph (6).

(3) Sub-paragraph (1) does not authorise a relevant company (unless it is a banking company) to enter into a transaction if the aggregate of the relevant amounts exceeds £100,000; but in determining the aggregate a company which a director does not control is to be treated as not connected with him.

(4) Sub-paragraph (1)(a) applies only if these conditions are satisfied-

(a) the loan or quasi-loan is made by the company in the ordinary course of its business,

(b) the amount of the loan or quasi-loan is not greater (in the case of the person to whom it is made) than that which it is reasonable to expect the company to have offered to a person of the same financial standing but unconnected with the company, and

(c) the terms of the loan or quasi-loan are not more favourable (in the case of the person to whom it is made) than those which it is reasonable to expect the company to have offered to a person of the same financial standing but unconnected with the company.

(5) Sub-paragraph (1)(b) applies only if these conditions are satisfied-

(a) the company enters into the guarantee in the ordinary course of its business,

(b) the amount of the guarantee is not greater (in the case of the person in whose respect it is entered into) than that which it is reasonable to expect the company to have offered in respect of a person of the same financial standing but unconnected with the company, and

(c) the terms of the guarantee are not more favourable (in the case of the person in whose respect it is entered into) than those which it is reasonable to expect the company to have offered in respect of a person of the same financial standing but unconnected with the company.

(6) If sub-paragraph (7) is satisfied the conditions in sub-paragraph (4)(b) and (c) do not of themselves stop a company making a loan to a director of the company or of its holding company-

(a) for the purpose of facilitating the purchase, for use as the director's only or main residence, of all or part of a dwelling-house together with any land to be occupied and enjoyed with it;

(b) for the purpose of improving a dwelling-house (or part of one) so used or any land occupied and enjoyed with it;

(c) in substitution for a loan made by any person and falling within paragraph (a) or (b) above.

(7) This sub-paragraph is satisfied if-

(a) loans of any description mentioned in sub-paragraph (6) are ordinarily made by the company to its employees and on terms no less favourable than those on which the transaction in question is made, and

(b) the aggregate of the relevant amounts does not exceed £100,000.

(8) A money-lending company is a company whose ordinary business includes the making of loans or quasi-loans, or the giving of guarantees in connection with loans or quasi-loans.

Part V

Further Definitions

Relevant amounts

(2) In relation to a proposed transaction or arrangement and the question whether it falls within an exception under Part IV, for the purposes of this paragraph and paragraph 23 the relevant exception is that exception.

(3) Where the relevant exception is the one provided by paragraph 14 (small loans) references in this paragraph and paragraph 23 to a person connected with a director must be ignored.

(4) The relevant amounts in relation to a proposed transaction or arrangement are these-

A. The value of the proposed transaction or arrangement.

B. The value of any existing arrangement which-

(a) falls within paragraph 5 or 6,

(b) also falls within paragraph 23, and

(c) was entered into by virtue of the relevant exception by the company or by a subsidiary of the company or (where the proposed transaction or arrangement is to be made for a director of its holding company or a person connected with such a director) by that holding company or any of its subsidiaries.

C. The amount outstanding under any other transaction which-

(a) falls within paragraph 23,

(b) was made by virtue of the relevant exception, and

(c) was made by the company or by a subsidiary of the company or (where the proposed transaction or arrangement is to be made for a director of its holding company or a person connected with such a director) by that holding company or any of its subsidiaries.

(5) For the purposes of item C in sub-paragraph (4) the amount outstanding is the value of the transaction less any amount by which that value has been reduced.

(a) for the director for whom the proposed transaction or arrangement is to be made, or for a person connected with that director, or

(b) where the proposed transaction or arrangement is to be made for a person connected with a director of a company, for that director or any person connected with him.

An arrangement falls within this paragraph if it relates to a transaction which does so.

(2) However, sub-paragraph (1) has effect subject to sub-paragraphs (3) and (4).

(3) If the proposed transaction-

(a) falls within paragraph 21, and

(b) is one which a banking company proposes to enter into under paragraph 21(6) (housing loans etc),

any other transaction or arrangement which (apart from this sub-paragraph) would fall within this paragraph does not do so unless it was entered into in pursuance of paragraph 21(6).

(4) If-

(a) a transaction is entered into by a company which is (at the time the transaction is entered into) a subsidiary of the company which is to make the proposed transaction, or is a subsidiary of that company's holding company, and

(b) it is no longer such a subsidiary at the time when the question arises whether the proposed transaction or arrangement falls within any relevant exception,

the transaction first mentioned does not fall within this paragraph.

Value of transactions and arrangements

(2) The value of a loan is the amount of its principal.

(3) The value of a quasi-loan is the amount (or maximum amount) which the person to whom it is made is liable to reimburse the creditor.

(4) The value of a guarantee or security is the amount guaranteed or secured.

(5) The value of an arrangement to which paragraph 5 or 6 applies is value A minus amount B, where-

(a) value A is the value of the transaction to which the arrangement relates, and

(b) amount B is any amount by which the liabilities under the arrangement or transaction of the person for whom the transaction was made have been reduced.

(6) The value of a transaction or arrangement not falling within sub-paragraphs (2) to (5) is the price which it is reasonable to expect could be obtained for the goods or land or services to which the transaction or arrangement relates if they had been supplied (when the transaction or arrangement is entered into)-

(a) in the ordinary course of business, and

(b) on the same terms (apart from price) as those on which they have been supplied, or are to be supplied, under the transaction or arrangement in question.

(7) If the value of a transaction or arrangement is not capable of being expressed as a specific sum of money (because the amount of any liability arising under it is unascertainable, or for any other reason) its value is to be taken to exceed £100,000, whether or not any liability under it has been reduced.

Part VI

Sanctions

Civil remedies

(2) Sub-paragraph (1) does not apply if restitution of any money or any other asset which is the subject matter of the transaction or arrangement is no longer possible.

(3) Sub-paragraph (1) does not apply if the company has been indemnified under paragraph 26 for the loss or damage suffered by it.

(4) Sub-paragraph (1) does not apply if any rights acquired in good faith for value and without actual notice of the breach by a person other than the person for whom the transaction or arrangement was made would be affected by its avoidance.

(2) The director and the person so connected (where applicable) and any other director of the company who authorised the transaction or arrangement (whether or not it has been avoided under paragraph 25)-

(a) is liable to account to the company for any gain which he has made directly or indirectly by the transaction or arrangement, and

(b) is liable (jointly and severally with any other person liable under this paragraph) to indemnify the company for any loss or damage resulting from the transaction or arrangement.

(3) Sub-paragraph (2) is without prejudice to any liability imposed apart from it, but is subject to sub-paragraphs (4) and (5).

(4) If a transaction or arrangement is entered into by a company and a person connected with a director of the company or of its holding company in breach of Part II, the director is not liable under sub-paragraph (2) if he shows that he took all reasonable steps to secure the company's compliance with Part II.

(5) In any case-

(a) a person connected with a director of the company or of its holding company, and

(b) any other director of the company who authorised the transaction or arrangement,

is not liable under sub-paragraph (2) if he shows that, at the time the transaction or arrangement was entered into, he did not know the relevant circumstances constituting the breach.

Relevant companies: criminal penalties

(2) A relevant company is guilty of an offence if it enters into a transaction or arrangement for a director of the company or of its holding company in breach of Part II.

(3) Sub-paragraph (2) does not apply if the relevant company shows that, at the time the transaction or arrangement was entered into, it did not know the relevant circumstances.

(4) A person is guilty of an offence if he procures a relevant company to enter into a transaction or arrangement knowing or having reasonable cause to believe that the company was thereby breaking Part II.

(5) A person guilty of an offence under this paragraph is liable to imprisonment or a fine or both.

Part VII

Miscellaneous

Records

(a) has effect in the case of a company which is a banking company or is the holding company of a credit institution;

(b) has effect subject to the exceptions provided by paragraph 29.

(2) If the company takes advantage of paragraph 2 of Part IV of Schedule 9 in relation to a financial year it must keep a register containing-

(a) a copy of every transaction, arrangement or agreement which would (but for that paragraph) have to be disclosed in its accounts or group accounts for the financial year and for each financial year in the preceding 10 in relation to which it has taken advantage of that paragraph;

(b) a written memorandum setting out the terms of every such transaction, arrangement or agreement (in the case of a transaction, arrangement or agreement not in writing).

(3) If the company takes advantage of paragraph 2 of Part IV of Schedule 9 in relation to the last complete financial year preceding its annual general meeting, it must prepare a statement containing the particulars of every transaction, arrangement or agreement which would (but for that paragraph) have to be disclosed in its accounts or group accounts for the financial year.

(4) The company must make the statement available for inspection by its members-

(a) at its registered office for at least 15 days ending with the date of the meeting, and

(b) at the meeting.

(5) The company's auditors must-

(a) examine the statement before it is made available to the members;

(b) make a report to the members on it;

(c) say in the report whether in their opinion the statement contains the particulars required by sub-paragraph (3);

(d) if in their opinion it does not contain the particulars, set out the particulars in the report (so far as they are reasonably able to do so).

(6) The company must annex the auditors' report to the company's statement before it is made available to the members.

(7) If a company fails to comply with any provision of this paragraph every person who is a director of it at the time of the failure is guilty of an offence and liable to a fine.

(8) However-

(a) it is a defence for a person to prove that he took all reasonable steps to secure compliance with the provision concerned;

(b) a person is not guilty of the offence by virtue only of being a shadow director of the company.

(9) For the purposes of the application of this paragraph to loans and quasi-loans made by a company to persons connected with a person who at any time is a director of the company or of its holding company, a company which a person does not control is not connected with him.

(2) If the condition in sub-paragraph (3) below is satisfied paragraph 28 does not apply in relation to-

(a) a transaction or arrangement made or subsisting in a financial year, and made by a company or by a subsidiary of a company for a person who at any time in that year was a director of the company or of its holding company or was connected with such a director, or

(b) an agreement, made or subsisting in that year, for a transaction or arrangement which (if entered into or made) would fall within paragraph (a).

(3) The condition is satisfied if A minus B did not exceed £2,000 at any time in the financial year, where-

(a) A is the aggregate of the values of each transaction or arrangement made for the person, and of each agreement for such a transaction or arrangement, and

(b) B is the amount (if any) by which the value of those transactions, arrangements and agreements has been reduced.

(4) For the purposes of this paragraph-

(a) the value of a transaction or arrangement is to be determined in accordance with paragraph 24;

(b) the value of an agreement for a transaction or arrangement is whatever the value of the transaction or arrangement would be if it were entered into or made and paragraph 24 applied.

Foreign law

EXPLANATORY NOTES ON DRAFT SCHEDULE

SCHEDULE

This Schedule would constitute Schedule 13A to the Companies Act 1985 and replace sections 330-344 and part of section 347 of the Companies Act 1985. The sections have been reorganised and rewritten in simpler language (see paragraphs 9.34-40 of the consultation paper) so as to facilitate understanding of them. There have been no changes of substance, except that the definition of relevant amounts previously in section 339 has been applied for the purposes of another provision which uses the phrase (formerly section 338(6)(b)).

Paragraphs 1 and 2

The index of definitions is new and is intended to assist the reader in locating the definitions.

Paragraph 3

This sets out the basic prohibitions applying to all companies (as defined in section 735(1) of the Companies Act 1985). They may not make loans to their directors or directors of their holding companies, or give guarantees or provide security for any loan to any such director. The director involved and others may be guilty of a criminal offence if this prohibition is breached: see paragraph 27 of the Schedule.

Paragraph 4

Four additional prohibitions apply to relevant companies (defined in paragraph 9 of the Schedule). First, a relevant company may not make a quasi-loan to any of its directors (or any directors of its holding company) (paragraph 4(1)). Second, a relevant company may not enter into a credit transaction (as defined in paragraph 12 below) in favour of any of its directors (or any director of its holding company) or connected persons of such directors as defined in section 346 of the Companies Act 1985 (paragraph 4(4)). Third, there is a prohibition on a company making loans or quasi-loans to a connected person of the director (paragraph 4(2)). This mirrors the prohibition imposed in relation to directors by paragraph 3. "Connected persons" include specified family members and companies controlled by the director. Fourth, a relevant company is prohibited from giving any guarantee or providing any security in connection with a loan, quasi-loan or credit transaction entered into by anyone else in favour of the director or a connected person of a director (paragraph 4(3) and (5)).

Paragraphs 5 and 6

These contain anti-avoidance provisions. For instance, a company cannot circumvent a prohibition on making a loan by taking an assignment of the rights under a loan made by a third party (paragraph 5(1)). Likewise, a company (A) cannot avoid the prohibition by, for example, persuading another company (B) to give a loan to one of its (A's) directors on terms that A does the same for a director of B (see paragraph 6).

Paragraph 8

"Shadow directors" are persons (other than professional advisers giving professional advice and parent companies) in accordance with whose instructions directors are accustomed to act (section 741 of the Companies Act 1985). The reference to sections 330-346 in section 741(3) will be substituted, in part, by a reference to this Schedule.

Paragraph 9

This defines "relevant company", which broadly means any company which is a public company, or belongs to a group of companies which includes a public company, to which the additional prohibitions in paragraph 4 apply (and paragraphs 5 and 6 in so far as they relate to paragraph 4).

Paragraph 10

This defines "quasi-loan". The object is to catch transactions which fall outside the narrow legal definition of loan, meaning a transaction whereby a party is lent money for a time which he agrees to repay in money or money's worth: see Champagne Perrier-Jouet SA v HH Finch Ltd [1982] 1 WLR 1359. Thus a relevant company would make a quasi-loan if it paid a director's department store account direct to the store.

Paragraph 12

This defines "credit transaction". Under sub-paragraph (1)(a), a relevant company would enter into a credit transaction for a director if it sold him a car on hire purchase. Under sub-paragraph (1)(b), a relevant company would enter into a credit transaction if it gave a director a licence of a company flat, even at a commercial rent. (However it would not be a credit transaction if there was no rent). Under sub-paragraph (1)(c), a relevant company would also enter into a credit transaction for a director if it bought him a season ticket to travel to work and he paid the cost by instalments. A conditional sale agreement, as defined by the Consumer Credit Act 1974, involves a sale under which the price is payable by instalments but the seller retains the property in the goods even if the buyer obtains possession of them.

Paragraph 13

This provision is required in order to identify the person "for" whom a transaction of the kind described in the prohibitions was made. For example, under this paragraph a credit transaction consisting of the sale of a car to a director on hire purchase would be made "for" the director. Under paragraph 17, credit transactions made for a particular director can be added together, and if they fall below £10,000 they are permitted under an exception in that paragraph.

Paragraphs 14 to 21

These contain a series of exceptions from the prohibitions listed above. Many of the exceptions are linked to "relevant" amounts to be calculated in accordance with paragraph 22.

Paragraph 14 contains a "de minimis" exception, available for loans where the aggregate of the relevant amounts does not exceed £5,000.

Paragraph 15 contains an exception for short-term limited value quasi-loans, ie quasi-loans requiring reimbursement within 2 months, where the amount owed by the director at any time under that quasi-loan, and any other quasi-loan entered into under the same exception, does not exceed £5,000.

Paragraph 16 excepts intra-group loans, quasi-loans or the giving of guarantees or security in connection with intra-group loans or quasi-loans. (These might otherwise be prohibited if a director has a sufficient shareholding in the holding company to make that company and every company in the group a connected person of his).

Paragraph 17 contains a de minimis exception available for credit transactions where the aggregate of the relevant amounts does not exceed £10,000.

Paragraph 18 excepts credit transactions on normal commercial terms and in the ordinary course of business.

Paragraph 19 excepts transactions in favour of a holding company.

Paragraph 20 excepts transactions where a company wishes to give a director financial assistance to help him work for the company (for example, a bridging loan to help him relocate to a new area). This is permitted up to a limit (found by aggregating the relevant amounts) of £20,000, but must first either be approved by the company in general meeting (and specified conditions as to disclosure met), or be done on terms that if it is not so approved at or before the annual general meeting the loan will be repaid or the liability discharged within six months of the conclusion of the meeting.

Paragraph 21 contains exceptions for money-lending companies, that is companies whose ordinary business includes the making of loans and quasi-loans and the giving of guarantees in connection therewith. The limit on such transactions is £100,000 if the money-lending company is a relevant company. In addition the transaction must be on normal commercial terms and in the ordinary course of business (except where a special exception for "house purchase" loans applies - see paragraphs 21(6) and (7)).

Paragraphs 22 and 23

These explain how the aggregate of the relevant amounts is found. These are calculated on a per director basis, but where the company is a relevant company, transactions of a director's connected persons are aggregated with those of the director. The amounts to be added together are (a) the value (ascertained under paragraph 24) of the proposed transaction; (b) the value of existing arrangements for that director (or where relevant, his connected persons) falling within paragraphs 5 and 6 which have been entered into by virtue of the same exception; and (c) the amount outstanding under any other transaction or arrangement made by virtue of the same exception. For the purposes of (b) and (c), the transactions and arrangements in question are those which have been made by the company or a subsidiary, or (in the case of a transaction in favour of a holding company director) by the holding company or any subsidiary of its.

There are special provisions for the calculation of the relevant amounts where a house-purchase loan is made under paragraph 21(6) (paragraph 23 (3)).

Paragraph 24

This explains how the value of a transaction is ascertained. For example, the value of a guarantee is the amount guaranteed (paragraph 24(4)). If the transaction is not one of those specified in sub-paragraphs (2) to (5), the value is the price which could reasonably have been expected to have been obtained if the goods were supplied in the ordinary course of business and on normal commercial terms. If the value cannot be expressed as a specific sum of money, the value is automatically taken to exceed £100,000 (paragraph 24(7)).

Paragraphs 25 and 26

These deal with civil remedies. A transaction in breach of the prohibitions can be set aside by the company. Paragraph 25 makes provision as to the circumstances in which the right of rescission may be lost, and this includes the situation where the company has been fully indemnified against loss, for example, because a director who authorised the transaction has indemnified the company under paragraph 26(2)(b). A director who authorises a transaction, and a connected person of a director who is otherwise liable under paragraph 26, may be able to use the defence under paragraph 26(5) where they did not know of the relevant circumstances constituting the breach.

Paragraph 27

This deals with criminal penalties. These do not attach in the case of transactions by non-relevant companies.

Paragraphs 28 and 29

A banking company, or holding company of a credit institution, which takes advantage of the exemption (in paragraph 2 of Part IV of Schedule 9 to the Companies Act 1985) from disclosure of certain transactions in favour of directors, and others, in its annual accounts must keep and make available for inspection information in accordance with paragraph 28. Paragraph 29 contains exceptions from the obligation in paragraph 28.

Paragraph 30

This ensures that the prohibitions in the Schedule cannot be circumvented by contracting under some foreign law.

TABLE OF DERIVATIONS FOR THE SCHEDULE

Paragraph of Schedule Provision of Companies Act 1985

(Note: this Table is prepared for guidance only and does not form part of the Schedule)

APPENDIX C

Table of derivations

Companies Acts referred to by year in this table:

The Companies Act 1928

The Companies Act 1929 (consolidating the Companies Acts 1908 to 1928)

The Companies Act 1947

The Companies Act 1948 (consolidating the 1929 and 1947 Companies Acts)

The Companies Act 1967

The Companies Act 1976

The Companies Act 1980

The Companies Act 1985 (consolidating the Companies Acts 1948 to 1983)

Amending changes introduced by other Acts or statutory measures are referred to in the text of the footnotes.

1985	1980	1976	1967	1948	1947	1929	1928

311(1)				189(1)	34(1)
311(2)^[1]				189(2)	34(2)

312^[2]				191	36(1)
313(1)^[3]				192(1)		150(1)	82(1)
313(2)				192(2)		150(2)	82(1)

1985	1980	1976	1967	1948	1947	1929	1928

314(1)	80, Sch 2			193(1)		150(3)
314(1)(a)				193(1)		150(3)	82(2)
314(1)(b),(c)				193(1)	36(2)
314(1) (d)				193(1)	36(2)#	150(3)#	82(2), (3)#
314(2)				193(1)	36(2)#	150(3)	82(2)
314(3)				193(2)	36(4)^[4]	150(4), (4A),(4B)	82(3)

315(1)				193(3)	36(4)	150(4),(4A),(4B)	82(3)
315(1)(b)				193(3)	36(3),(4),(5)#	150(4),(4A),(4B)#	82(3)#
315(2)				193(4)	36(4)
315(3)				193(5)	36(4)

316(1)				194(1)	36(6)
316(2)				194(2)		150(5)	82(4)
316(3)^[5]				194(3)	36(7)
316(4)				194(4)		150(6)	82(5)

1985	1980	1976	1967	1948	1947	1929	1928

317(1)				199(1)		149(1)	81(1)
317(2)				199(2)		149(2)	81(2)
317(3)(a)				199(3)		149(3)	81(3)
317(3)(b)	Sch 3, para 25#			199(3)#		149(3)#	81(3)#
317(4)				199(3)	41(5)
317(5),(6)	60
317(7)	80, Sch 2			199(4)		149(4)	81(4)
317(8)	63(3)
317(9)				199(5)		149(5)	81(5)

318(1)(a),(b), (2)^[6]		s34,Sch 1	26(1)
318(1)(b)	61(1)#		26(1)
318(3)			26(2)-(3A)
318(4)	61(3)#		26(2)-(3A)
318(5)	61(2), (3)#		26(2)-(3A)
318(6)	63(4)

1985	1980	1976	1967	1948	1947	1929	1928

318(7)-(11)^[7]	61(3)#, 80,Sch 2		26(4)-(8)

319(1)^[8]	47(2)
319(2)	47(3)
319(3)	47(1)
319(4)	47(6)
319(5),(6)	47(4), (5)
319(7)	47(7), 63(1)

320(1)^[9]	48(1)^[10]
320(2)^[11]	48(2)
320(3)	63(1)

321^[12]	48(6)-(8)^[13]


1985	1980	1976	1967	1948	1947	1929	1928

322(1),(2)	48(3)^[14]
322(3),(4)	48(4)
322(5),(6)	48(5)

322A^[15]
322B^[16]

323(1),(2)^[17]	80(1), Sch 2	42(1), Sch 2	25(1)
323(3)-(5)			25(2)-(4)

324(1),(2)	80,Sch 2	Sch 2	27(1)
324(3)(a)			28(1)
324(4)			27(4)
324(5)			27(9)
324(6)			27(11), (13)


1985	1980	1976	1967	1948	1947	1929	1928

324 (7)			27(8)
324(8)^[18]			27(10)

325(1),(2)			29(1)^[19]
325(3),(4)			29(2)
325(6)			29(14)

326(2)-(5)	80,Sch 2		29(12)
326(6)			29(13)

327^[20]			30

328(1),(2)	80,Sch 2		31(1)
328(3),(5)		24, 25(2)	31(2)
328(6),(9)^[21]			31(3), (6)
1985	1980	1976	1967	1948	1947	1929	1928

329(1),(2)^[22]	80,Sch 2	25(1),(2)
329(3)^[23]		25(3),(4)

330(1)	49			190	35
330(2),(3)	49(1)
330(4)	49(2)
330(5)	63(1)
330(6),(7)	49(3), (4)

331	65, 87(1)^[24]
331(2),(5)^[25],(6)	65(1)
331(3),(4)	65(2)
331(7)	65(3)
331(9)	65(6)
332^[26]	50(2)

333	50(1)^[27]
1985	1980	1976	1967	1948	1947	1929	1928

334^[28]	50(2A)^[29]

335^[30]	50(3) (a),(b)

336^[31]	50(4) (a),(b)

337(1),(2)	50(4) (c)
337(3)	50(5)

338(1)	50(4) (d)
338(2)	65(1)
338(3),(5)^[32]	50(6)
338(6)^[33]	50(7)
339(1),(2)	51(1),(2)^[34]
339(3)	51(3)
1985	1980	1976	1967	1948	1947	1929	1928

339(4)^[35]	51(2A)
339(5),(6)	51(4), (5)
340	65(4)
340(2)-(6)	65(4)
340(7)^[36]	65(5)
341(1)	52(1)
341(2),(3)	52(2)
341(4),(5)	52(3)
342(1)-(3)	53(1)-(3)
342(4)	53(5)
342(5)	53(4)^[37]
343(1)^[38]	57(1)^[39]
343(4)	57(2)
343(6),(7)	57(3), (4)
343(8)^[40]	57(6), (7)
343(8)(b)	63(2)
343(9)	57(8)
1985	1980	1976	1967	1948	1947	1929	1928

344(1)^[41]	58(4)
344(2)^[42]	57(5)

345	62

346	64^[43]
346(2)	64(1)
346(3)	64(2)
346(4)-(6)	64(3)
346(7),(8)	64(4)
347	65(8)

The following sections and schedules of the Companies Act 1985 form part of the additional background to the review of Part X:

1985	1980	1976	1967	1948	1947	1929	1928

309(1),(2)	46, 63(1)

310	Sch 3, para 26			205	122(4), Sch VII, (1)(c) (d)	152	78(1), 86(5)

Sch 13			27-29#^[44]

Sch 6, Pt II	56, 64, 65^[45]

KEY

# Part of the section.

* Companies Acts (Pre-Consolidation Amendments) Order 1984 (SI 1984/134).

* * Companies Acts (Pre-Consolidation Amendments) (No 2) Order 1984 (SI 1984/1169).

APPENDIX D

Extracts from the Stock Exchange's Combined Code

THE COMBINED CODE

PRINCIPLES OF GOOD GOVERNANCE AND CODE OF BEST PRACTICE

Derived by the Committee on Corporate Governance from the Committee's Final Report and from the Cadbury and Greenbury Reports.

PART 1: PRINCIPLES OF GOOD GOVERNANCE

SECTION 1: COMPANIES

...

B. DIRECTORS' REMUNERATION

...

Disclosure

3. The company's annual report should contain a statement of remuneration policy and details of the remuneration of each director.

...

D. ACCOUNTABILITY AND AUDIT

Internal Control

2. The board should maintain a sound system of internal control to safeguard shareholders' investment and the company's assets.

...

PART 2: CODE OF BEST PRACTICE

SECTION 1: COMPANIES

A. DIRECTORS

A.1 The Board

...

Code Provisions

A.1.1 The board should meet regularly.

...

A.1.3 There should be a procedure agreed by the board for directors in the furtherance of their duties to take independent professional advice if necessary, at the company's expense.

...

A.1.5 All directors should bring an independent judgement to bear on issues of strategy, performance, resources (including key appointments) and standards of conduct.

A.1.6 Every director should receive appropriate training on the first occasion that he or she is appointed to the board of a listed company, and subsequently as necessary.

...

A.3 Board balance

...

A.3.2 The majority of non-executive directors should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. Non-executive directors considered by the board to be independent should be identified in the annual report.

A.4 Supply of Information

...

A.4.1 Management has an obligation to provide the board with appropriate and timely information, but information volunteered by management is unlikely to be enough in all circumstances and directors should make further enquiries where necessary. The chairman should ensure that all directors are properly briefed on issues arising at board meetings.

...

A.6 Re-election

...

A.6.1 Non-executive directors should be appointed for specified terms subject to re-election and to Companies Act provisions relating to the removal of a director, and reappointment should not be automatic.

A.6.2 All directors should be subject to election by shareholders at the first opportunity after their appointment, and to re-election thereafter at intervals of no more than three years. The names of directors submitted for election or re-election should be accompanied by sufficient biographical details to enable shareholders to take an informed decision on their election.

B. DIRECTORS' REMUNERATION

...

Remuneration policy

...

B.1.5 Executive share options should not be offered at a discount save as permitted by paragraphs 13.30 and 13.31 of the Listing Rules.

...

Service Contracts and Compensation

B.1.7 There is a strong case for setting notice or contract periods at, or reducing them to, one year or less. Boards should set this as an objective, but they should recognise that it may not be possible to achieve it immediately.

B.1.8 If it is necessary to offer longer notice or contract periods to new directors recruited from outside, such periods should reduce after the initial period.

B.1.9 Remuneration committees should consider what compensation commitments (including pension contributions) their directors' contracts of service, if any, would entail in the event of early termination. They should in particular consider the advantages of providing explicitly in the initial contract for such compensation commitments except in the case of removal for misconduct.

B.1.10 Where the initial contract does not explicitly provide for compensation commitments, remuneration committees should, within legal constraints, tailor their approach in individual early termination cases to the wide variety of circumstances. The board aim should be to avoid rewarding poor performance while dealing fairly with cases where departure is not due to poor performance and to take a robust line on reducing compensation to reflect departing directors' obligations to mitigate loss.

...

B.3 Disclosure

...

B.3.1 The board should report to the shareholders each year on remuneration. The report should form part of, or be annexed to, the company's annual report and accounts. It should be the main vehicle through which the company accounts to shareholders on directors' remuneration.

B.3.2 The report should set out the company's policy on executive directors' remuneration. It should draw attention to factors specific to the company.

B.3.3 In preparing the remuneration report, the board should follow the provisions in Schedule B to this Code.

B.3.4 Shareholders should be invited specifically to approve all new long-term incentive schemes (as defined in the Listing Rules) save in circumstances permitted by paragraph 13.13A of the Listing Rules.

B.3.5 The board's annual remuneration report to shareholders need not be a standard item of agenda for AGMs. But the board should consider each year whether the circumstances are such that the AGM should be invited to approve the policy set out in the report and should minute their conclusions.

C. RELATIONS WITH SHAREHOLDERS

...

C.2.4 Companies should arrange for the Notice of the AGM and related papers to be sent to shareholders at least 20 working days before the meeting.

D. ACCOUNTABILITY AND AUDIT

...

D.2 Internal Control

...

D.2.1 The directors should, at least annually, conduct a review the effectiveness of the group's system of internal controls and should report to shareholders that they have done so. This review should cover all controls, including financial, operational and compliance controls and risk management.

...

SCHEDULE B: PROVISIONS ON WHAT SHOULD BE INCLUDED IN THE REMUNERATION REPORT

1. The report should include full details of all elements in the remuneration package of each individual director by name, such as basic salary, benefits in kind, annual bonuses and long term incentive schemes including share options.

2. Information on share options, including SAYE options, should be given to each director in accordance with the recommendations of the Accounting Standards Board's Urgent Issues Task Force Abstract 10 and its successors.

3. If grants under executive share option or other long-term incentive schemes are awarded in one large block rather than phased, the report should explain and justify.

4. Also included in the report should be pension entitlements earned by each individual director during the year, disclosed on one of the alternative bases recommended by the Faculty of Actuaries and the Institute of Actuaries and included in the Stock Exchange Listing Rules. Companies may wish to make clear that the transfer value represents a liability of thecompany, not a sum paid or due to the individual.

5. If annual bonuses or benefits in kind are pensionable the report should explain and justify.

6. The amounts received by, and commitments made to, each director under 1, 2 and 4 above should be subject to audit.

7. Any service contracts which provide for, or imply, notice periods in excess of one year (or any provisions for predetermined compensation on termination which exceed one year's salary and benefits) should be disclosed and the reasons for the longer notice periods explained.

APPENDIX E

Extracts from the Listing Rules of The Stock Exchange

Rule 12.43A

Chapter 16

The Model Code (Appendix to Chapter 16)

Best practice provisions: Directors' remuneration

Section A: Remuneration Committees (annexed to the Listing Rules)

Best practice provisions: Directors' remuneration

Section B: Remuneration policy, service contracts and compensation (annexed to the Listing Rules)

RULE 12.43A

Chapter 12: Annual report and accounts

...

Corporate governance

12.43A In the case of a company incorporated in the United Kingdom, the following additional items must be included in its annual report and accounts:

(a) a narrative statement of how it has applied the principles set out in Section 1 of of the Combined Code appended to the listing Rules, providing sufficient explanation to enable its shareholders to evaluate properly how the principles have been applied;

(b) a statement as to whether or not it has complied throughout the accounting period with the provisions set out in Section 1 of Part 2 of the Combined Code. A company that has not complied with the provisions of the Combined Code, or complied with only some of the provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period, must specify the provisions with which it has not complied, and (where relevant) for what part of the period such non-compliance continued, and give reasons for any non-compliance; and

Directors' remuneration

(c) a report to the shareholders by the Board, which must contain:

(i) a statement of the company's policy on executive directors' remuneration;

(ii) the amount of each element in the remuneration package for the period under review of each director by bane, including, but not restricted to, basic salary and fees, the estimated money value of benefits in kind, annual bonuses, deferred bonuses, compensation for loss of office and payments for breach of contract or other termination payments, together with the total for each director for the period under review and for the corresponding prior period, and any significant payments made to former directors during the period under review; such details to be presented in tabular form, unless inappropriate, together with explanatory notes as necessary;

(iii) information on share options, including SAYE options, for each director by name in accordance with the recommendations of the Accounting Standards Board's Urgent Issues Task Force Abstract 10; such information to be presented in tabular form together with explanatory notes as necessary;

(iv) details of any long-term incentive schemes, other than share options details of which have been disclosed under (iii) above, including the interests of each director by name in the long-term incentive schemes at the start of the period under review; entitlements or awards granted and commitments made to each director under such schemes during the period, showing which crystallise either in the same year or subsequent years; the money value and number of shares, cash payments or other benefits received by each director under such schemes during the period; and the interests of each director in the long-term incentive schemes at the end of the period;

(v) explanation and justification of any element of remuneration, other than basic salary, which is pensionable;

(vi) details of any directors' service contract with a notice period in excess of one year or with provisions for pre-determined compensation on termination which exceeds one year's salary and benefits in kind, giving the reasons for such notice period;

(vii) the unexpired term of any directors' service contract of a director proposed for election or re-election at the forthcoming annual general meeting and, if any director proposed for election or re-election does not have a directors' service contract, a statement to the effect;

(viii) a statement of the company's policy on the granting of options or awards under its employees' share schemes and other long-term incentive schemes, explaining and justifying any departure from that policy in the period under review and any change in the policy from the preceding year;

(ix) for defined benefit schemes (as in Part 1 of Schedule 6 to the Companies Act 1985:

(a) details of the amount of the increase during the period under review (excluding inflation) and of the accumulated total amount at the end of the period in respect of the accrued benefit to which each director would be entitled on leaving service or is entitled having left service during the period under review;

(b) and either:

(i) the transfer value (less director's contributions) of the relevant increase in accrued benefit (to be calculated in accordance with Actuarial Guidance Note GN11 but making no deduction of any underfunding) as at the end of the period; or:

(ii) so much of the following information as is necessary to make a reasonable assessment of the transfer value in respect of each director:

(a) current age;

(b) normal retirement age;

(c) the amount of any contributions paid or payable by the director under the terms of the scheme during the period under review;

(d) details of spouse's and dependants' benefits;

(e) early retirement rights and options, expectations of pension increases after retirement (whether guaranteed or discretionary); and

(f) discretionary benefits for which allowance is made in transfer on leaving and any other relevant information which will significantly affect the value of the benefits.

Voluntary contributions and benefits should not be disclosed; and

(x) for money purchase schemes (as in Part 1 of Schedule 6 to the Companies Act 1985) details of the contribution or allowance payable or made by the company in respect of each director during the period under review.

Requirements of auditors

A company's statement under 12.43A must be reviewed by the auditors before publication only insofar as it relates to provisions A.2, A.3, A12, D1, D.3 and D.6 of the Combined Code. The scope of the auditors' report on the financial statements must cover the disclosures made pursuant to paragraph 12.43A(c)(ii), (iii), (iv) and (ix) and (x) above. The auditors must state in their report if in their opinion the company has not complied with any of the requirements of paragraph 12.43A(c), (iii), (iv), (ix) and (x) of the listing rules and, in such a case, must include in their report, so far as they are reasonably able to do so, a statement giving the required particulars.

CHAPTER 16

Directors

Scope of chapter

This chapter imposes obligations relating to directors, including rules as to the disclosures a company must make about its directors and about dealings in securities of the company by directors and persons connected with them. Chapter 11 sets out requirements for transactions between a company and any of its directors (and other related parties). The appendix to this chapter contains the Model Code for transactions in securities by directors certain employees and persons connected with them.

Failure by a director to accept and discharge his responsibilities for the company's compliance with the listing rules may lead the Exchange to take one or more of the steps set out in paragraph 1.10 with regard to that director.

Blank directors declaration forms (see paragraphs 16.3 to 16.6) should normally be obtained from a company's sponsor. Completed declarations must be sent to Regulatory Information, The Securities and Futures Authority Limited, Cottons Centre, Cottons Lane, London SE1 2QB who act as agents for the Exchange in this respect.

The main headings are:

16.1 directors' responsibilities

16.3 directors' declarations and board changes

16.9 directors' service contracts

16.13 notification of interests of directors and connected persons

16.18 the Model Code.

When notifying interests of directors and connected persons (see paragraphs 16.13 to 16.17) companies are recommended to use the form issued by the Exchange for this purpose (see Schedule 11).

Directors' responsibilities

16.1 Under the FSA, directors and proposed directors are personally responsible for information contained in listing particulars or supplementary listing particulars. In addition paragraph 5.2 requires a declaration by directors accepting responsibility for the information to be included in such particulars (see paragraph 6.A.3 or 6.H.3), and directors must provide the Exchange with an assurance in the terms set out in paragraph 5.5 where listing particulars are prepared.

16.2 A listed company must ensure that its directors accept full responsibility, collectively and individually, for the company's compliance with the listing rules.

Directors' declarations and board changes

Directors' declarations

16.3 A new applicant must submit to The Securities and Futures Authority Limited a formal declaration by each of its directors as to their business activities, past and present, in the form specified in Schedule 7 (a "director's declaration"). Such directors' declarations must be submitted at least 14 days prior to the intended date of publication of listing particulars.

16.4 A listed company must submit a director's declaration in respect of any new director to The Securities and Futures Authority Limited within 14 days of the appointment becoming effective.

16.5 A listed company which becomes aware of any changes to any of the details set out in paragraphs 3 to 12 inclusive of the director's declaration of any director must take reasonable steps to ensure that a new director's declaration in respect of that director is submitted to The Securities and Futures Authority Limited within 14 days of the company becoming aware of the changes unless a director's declaration in respect of that director giving details of the changes has already been submitted by another listed company.

16.6 A listed company must take reasonable steps to ensure that a new director's declaration in respect of each director is submitted to The Securities and Futures Authority Limited within 30 days of the third anniversary of the date when a declaration in respect of that director was last lodged (either by the company itself or by any other listed company) whether or not any of the details contained in that declaration have changed. In addition, the Exchange may at any time require a listed company to submit a director's declaration in respect of any director.

16. A Subject to the provisions of paragraphs 1.5 and 1.6, the Exchange reserves the right to require publication of any of the information contained in a director's declaration, either in the listing particulars of a new applicant or by notification to the Company Announcements Office in the case of a listed company.

Board changes

16.7 A company must notify the Company Announcements Office without delay (by the end of the business day following the decision) when:

(a) a new director is appointed;

(b) a director resigns or is removed; or

(c) any important functions or executive responsibilities of a director are changed.

16.8 The notification required by paragraph 16.7 must state the effective date of the change it if is not with immediate effect and, in the case of an appointment, whether the position is executive or non-executive and the nature of any specific function or responsibility.

Directors' service contracts

16.9 Copies of each directors' service contract must be made available for inspection by any person:

(a) at the registered office of the company, or in the case of an overseas company, at the offices of any paying agent in the United Kingdom during normal business hours on each business day; and

(b) at the place of the annual general meeting for at least 15 minutes prior to and during the meeting.

16.10 Where one directors' service contract covers both directors and executive officers, the company may make available for inspection in accordance with paragraph 16.9 a memorandum of the terms of the contract which relate to the directors only.

16.11 Directors' service contracts available for inspection must disclose or have attached to them the following information:

(a) the name of the employing company;

(b) the date of the contract, the unexpired term and details of any notice periods;

(c) full particulars of the director's remuneration including salary and other benefits;

(d) any commission or profit sharing arrangements;

(e) any provision for compensation payable upon early termination of the contract; and

(f) details of any other arrangements which are necessary to enable investors to estimate the possible liability of the company upon early termination of the contract.

16.12 Paragraph deleted - September 1997

Notification of interests of directors and connected persons

16.13 A company must notify the Company Announcements Office of the following information:

(a) any information relating to interests in securities that are, or are to be, listed which is disclosed to the company in accordance with section 324 (duty of director to disclose shareholdings in own company) as extended by section 328 (extension of section 324 to spouses and children) of the Companies Act 1985 or entered in the company's register in accordance with section 325(3) or (4) of that Act, together with:

(i) the date on which the disclosure was made to the company;

(ii) the date on which the transaction giving rise to the interest (or cessation of interest) was effected:

(iii) the price, amount and class of securities concerned;

(iv) the nature of the transaction; and

(v) the nature and extent of the director's interest in the transaction;

(b) information (unless notified under (a) above) relating to any interest of a connected person of a director in securities that are, or are to be, listed which, if the connected person were a director, would be required to be disclosed by him to the company or entered in the company's register as referred to in (a) above; the notification by the company must identify the director, the connected person and the nature of the connection between them, give the particulars specified in (a)(i) to (iv) above and state the nature and extent of the director's interest (if any) in the transaction; and

(c) details of (unless notified under (a) or (b) above):

(i) the grant to, or acceptance by, a director or a person connected with a director of any option (whether for the call or put or both) relating to securities of the company or of any other right or obligation, present or future, conditional or unconditional, to acquire or dispose of any securities in the company which are or will be listed or any interest of whatsoever nature in such securities; and

(ii) the acquisition, disposal, exercise or discharged of, or any dealing with, any such option, right or obligation by a director or a person connected with a director;

the notification by the company must identify the director and, where relevant, the connected person and the nature of the connection between them, give the particulars specified in (a)(i) to (iv) above and state the nature and extent of the directors' interest (if any) in the transaction.

16.14 Any notification required by paragraph 16.13 must be made without delay (by the end of the business day following the receipt of the information by the company).

16.15 A company not subject to the Companies Act 1985 must notify to the Company Announcements Office equivalent information to that required under paragraph 16.13 so far as such information is known to the company. Any notification under this paragraph must be made without delay following the company becoming aware of the relevant information.

16.16 In the case of a dealing during a close period in exceptional circumstances as permitted by paragraph 9 of the Model Code (set out in the appendix to this chapter), the information notified to the Company Announcements Office by the company) pursuant to paragraph 16.13 or 16.15 must also include a statement of the nature of the exceptional circumstances in the light of which dealing was permitted.

16.17 A company must require each of its directors to disclose to it all information which the company needs in order to comply with paragraph 16.13 or 16.15 (so far as that information is known to the director or could with reasonable diligence be ascertained by the director), as soon as possible and not later than the fifth business day following the day on which the existence of the interest to which the information relates comes to the director's knowledge. A company must require each of its directors at such times as it deems necessary or desirable to confirm that he has made all due enquiry of those persons who are connected with him. A company is not required to notify the Company Announcements Office information which, notwithstanding compliance by it with this paragraph, it does not have.

The Model Code

16.18 A company must require:

(a) its directors; and

(b) any employee of the company or director or employee of a subsidiary undertaking or parent undertaking of the company who, because of his office or employment in the company or subsidiary undertaking or parent undertaking, is likely to be in possession of unpublished price-sensitive information in relation to the company

to comply with a code of dealing in terms no less exacting than those of the Model Code (set out in the appendix to this chapter) and must take all proper and reasonable steps to secure such compliance.

16.19 Companies may impose more rigorous restrictions upon dealings by directors and employees if they so wish.

APPENDIX TO CHAPTER 16

The Model Code

Introduction (not forming part of the Model Code)

The freedom of directors and certain employees of listed companies to deal in their company's securities is restricted in a number of ways - by statute, by common law and by the requirement of the listing rules that listed companies adopt and apply a code of dealing based on the Model Code set out in this appendix. This requirement imposes restrictions beyond those that are imposed by law. Its purpose is to ensure that directors, certain employees and persons connected with them (within the meaning of section 346 of the Companies Act 1985) do not abuse, and do not place themselves under suspicion of abusing, price-sensitive information that they may have or be thought to have, especially in periods leading up to an announcement of results. Company directors, like other individuals, are prohibited from insider dealing by the Criminal Justice Act 1993. Under that Act it is a criminal offence for an individual who has information as an insider to deal on a regulated market, or through or as a professional intermediary, in securities whose price would be significantly affected if the insider information were made public. It is also an offence to encourage insider dealing and to disclose inside information with a view to others profiting from it.

The main headings of the Model Code for transactions in securities by directors, certain employees and persons connected with them are:

definitions

dealings by directors and relevant employees

- purpose of dealing

- dealing in close periods

- dealing in other circumstances

- dealing in another company's securities

- clearance to deal

- circumstances for refusal

- dealing in exceptional circumstances

- director acting as trustee

dealings by connected persons and investment managers

- special circumstances

- grant of options

- exercise of options

- personal equity plans

- savings schemes etc.

- guidance on other dealings

relevant employees.

Definitions

(1) In this code the following definitions, in addition to those contained in the listing rules, apply unless the context otherwise requires:

(a) "close period" means any of the periods when a director is prohibited from dealing as specified in paragraph 3 of this code;

(b) "dealing" includes any sale or purchase of, or agreement to sell or purchase, any securities of the company and the grant, acceptance, acquisition, disposal, exercise or discharge of any option (whether for the call, or put, or both) or other right or obligation, present or future, conditional or unconditional, to acquire or dispose of securities, or any interest in securities, of the company and "deal" shall be construed accordingly;

(c) "prohibited period" means any period to which paragraph 7 of this code applies;

(d) "relevant employee" means any employee of the listed company or director or employee of a subsidiary undertaking or parent undertaking of the listed company who, because of his office or employment in the listed company or subsidiary undertaking or parent undertaking, is likely to be in possession of unpublished price-sensitive information in relation to the listed company;

(e) "securities" means any listed securities and, where relevant, securities which have been listed in a member state or admitted to dealing on, or have their prices quoted on or under the rules of, any regulated market;

(f) "unpublished price-sensitive information" means information which:

(i) relates to particular securities or to a particular issuer or to particular issuers of securities and not to securities generally or issuers of securities generally (and, for these purposes, information shall be treated as relating to an issuer of securities which is a company not only where it is about the company but also where it may affect the company's business prospects);

(ii) is specific or precise;

(iii) has not been made public within the meaning of section 58 of the Criminal Justice Act 1993; and

(iv) if it were made public would be likely to have a significant effect in the price or value of any securities

and, without prejudice to the generality of the above, it should be considered whether any unpublished information regarding transactions required to be notified to the Company Announcements Office in accordance with chapter 10 or chapter 11 of the listing rules and unpublished information of the kind referred to in the paragraphs of the listing rules set out below is price-sensitive:

Paragraph

9.1 general obligation of disclosure

9. (a) alterations to capital structure

9. and 9.12 notification of major interests in shares

15. . 15.9. 15.13

and 15.15 purchase of own securities

16. and 16.15 notification of directors' interests; and

(g) "regulated market" means any regulated market defined as such in the Insider Dealing (Securities and Regulated Markets) Order 1994, as amended or supplemented by any further order made under section 60(1) of the Criminal Justice Act 1993.

Dealings by directors and relevant employees

Purpose of dealing

(2) A director must not deal in any securities of the listed company on considerations of a short term nature.

Dealing in close periods

(3) A director must not deal in any securities of the listed company during a "close period". A close period is:

(a) the period of two months immediately preceding the preliminary announcement of the company's annual results or, if shorter, the period from the relevant financial year end up to and including the time of the announcement; and

(b) if the company reports on a half-yearly basis, the period of two months immediately preceding the publication of the half-yearly report in accordance with paragraph 12.49 of the listing rules or, if shorter, the period from the relevant financial period end up to and including the time of such publication; or

(c) if the company reports on a quarterly basis, the period of one month immediately preceding the announcement of the quarterly results or, if shorter, the period from the relevant financial period end up to and including the time of the announcement (save that for the final quarter paragraph 3(a) of this code applies).

(4) A director must not deal in any securities of the listed company at any time when he is in possession of unpublished price-sensitive information in relation to those securities, or otherwise where clearance to deal is not given under paragraph 7 of this code.

(5) Paragraph deleted - July 1994

Clearance to deal

(6) A director must not deal in any securities of the listed company without advising the chairman (or one or more other directors designated for this purpose) in advance and receiving clearance. In his own case, the chairman, or other designated director, must advise the board in advance at a board meeting, or advise another designated director, and receive clearance from the board or designated director, as appropriate.

Circumstances for refusal

(7) A director must not be given clearance (as required by paragraph 6 of this code) to deal in any securities of the listed company during a prohibited period. A "prohibited period" means:

(a) any close period;

(b) any period when there exists any matter which constitutes unpublished price sensitive information in relation to the company's securities (whether or not the director has knowledge of such matter) and the proposed dealing would (if permitted) take place after the time when it has become reasonably probable that an announcement will be required in relation to that matter; or

(c) any period when the person responsible for the clearance otherwise has reason to believe that the proposed dealing is in breach of this code.

(8) A written record must be maintained by the company of the receipt of any advice received from a director pursuant to paragraph 6 of this code and of any clearance given. Written confirmation from the company that such advice and clearance (if any) have been recorded must be given to the director concerned.

Dealing in exceptional circumstances

(9) In exceptional circumstances where it is the only reasonable course of action available to a director, clearance may be given for the director to sell (but not to purchase) securities when he would otherwise be prohibited from doing so. An example of the type of circumstance which may be considered exceptional for these purposes would be a pressing financial commitment on the part of the director that cannot otherwise be satisfied. The determination of whether circumstances are exceptional for this purpose must be made by the person responsible for the clearance.

Director acting as trustee

(10) Where a director is a sole trustee (other than a bare trustee), the provisions of this code will apply, as if he were dealing on his own account. Where a director is a co-trustee (other than a bare trustee), he must advise his co-trustees of the name of the listed company of which he is a director. If the director is not a beneficiary, a dealing in his company's securities undertaken by that trust will not be regarded as a dealing by the director for the purposes of this code, where the decision to deal is taken by the other trustees acting independently of the director or by investment managers on behalf of the trustees. The other trustees or the investment managers will be assumed to have acted independently of the director for this purpose where they:

(a) have taken the decision to deal without consultation with, or other involvement of, the director concerned; or

(b) if they have delegated the decision making to a committee of which the director is not a member.

Dealings by connected persons and investment managers

(11) A director must (so far as is consistent with his duties of confidentiality to his company) seek to prohibit (by taking the steps set out in paragraph 12 of this code) any dealing in securities of the listed company during a close period or at a time when the director is in possession of unpublished price sensitive information in relation to those securities and would be prohibited from dealing under paragraph 7(b) of this code:

(a) by or on behalf of any person connected with him (within the meaning of section 346 of the Companies Act 1985); or

(b) by an investment manager on his behalf or on behalf of any person connected with him where either he or any person connected with him has funds under management with that investment manager, whether or not discretionary (save as provided in paragraphs 10 and 16 of this code).

(12) For the purposes of paragraph 11 of this code, a director must advise all such connected persons and investment managers:

(a) of the name of the listed company of which he is a director;

(b) of the close period during which they cannot deal in the company's securities;

(c) of any other periods when the director knows he is not himself free to deal in securities of the company under the provisions of this code unless his duty of confidentiality to the company prohibits him from disclosing such periods; and

(d) that they must advise him immediately after they have dealt in securities of the company (save as provided in paragraphs 10 and 16 of this code).

Special circumstances

Grant of options

(13) The grant of options by the board of directors under an employee share scheme to individuals who are not directors or relevant employees may be permitted during a prohibited period if such grant could not reasonably be made at another time and failure to make the grant would indicate that the company was in a prohibited dealing period.

Exercise of options

(14) The chairman or other designated director may allow the exercise of an option or right under an employees' share scheme, or the conversion of a convertible security, where the final date for the exercise of such option or right, or conversion of such security, falls during any prohibited period and the director could not reasonably have been expected to exercise it at an earlier time when he was free to deal (see also paragraph 20(h)).

(15) Where an exercise or conversion is permitted pursuant to paragraph 14 or 20(h) of this code, the chairman or other designated director may not, however, give clearance for the sale of securities acquired pursuant to such exercise or conversion.

Personal equity plans and authorised unit trusts

(16) A director may enter into a discretionary personal equity plan or deal in units of an authorised unit trust without regard to the provisions of this code. In the case of a personal equity plan investing only in securities of the listed company the provisions of paragraph 17 of this code apply.

(17) A director may enter into a personal equity plan which involves regular payments by standing order or direct debit of sums which are to be invested only in securities of the listed company if the following provisions are complied with:

(a) he does not enter into the plan to carry out the first purchase of the securities of the listed company within the plan during a prohibited period;

(b) he does not cancel or vary the terms of his participation, or carry out sales of the securities of the listed company within the plan during a prohibited period; and

(c) before entering into the plan or cancelling the plan or varying the terms of his participation or carrying out sales of the securities of the listed company within the plan, he obtains clearance under paragraph 6 of this code.

Savings schemes etc

(18) A director may enter into a scheme under which securities of the listed company:

(a) are purchased pursuant to a regular standing order or direct debit arrangement; or

(b) are acquired by way of a standing election to reinvest dividends or other distributions received:

if the provisions set out in paragraph 17 of this code in relation to personal equity plans investing only in the securities of the listed company are complied with.

Guidance on other dealings

(19) For the avoidance of doubt, the following constitute dealings for the purposes of this code and are consequently subject to the provisions of this code:

(a) dealings between directors and/or relevant employees of the company;

(b) off-market dealings; and

(c) transfers for no consideration by a director other than transfers where the director retains a beneficial interest under the Companies Act 1985.

(20) For the avoidance of doubt, and notwithstanding the definition of dealing contained in paragraph 1(b) of this code, the following dealings are not subject to the provisions of this code:

(a) undertakings or elections to take up entitlements under a rights issue or other offer (including an offer of shares in lieu of a cash dividend);

(b) the take up of entitlements under a rights issue or other offer (including an offer of shares in lieu of a cash dividend);

(c) allowing entitlements to lapse under a rights issue or other offer (including an offer of shares in lieu of a cash dividend);

(d) the sale of sufficient entitlements nil-paid to allow take up of the balance of the entitlements under a rights issue;

(e) undertakings to accept, or the acceptance of, a takeover offer;

(f) dealing by a director with a person whose interest in securities is to be treated by virtue of section 328 of the Companies Act (extension of section 324 to spouses and children) as the director's interest;

(g) transfers of shares arising out of the operation of an employees' share scheme into a personal equity plan investing only in securities of the listed company within ninety days of:

(i) the date of exercise of an option under a savings related share option scheme; or

(ii) the date of release of shares from a profit sharing scheme;

(h) with the exception of a disposal of securities received by a director as a participant, dealings in connection with an Inland Revenue approved "Save-as-you-earn" share option scheme, or any other employees' share scheme under which participation is extended, on similar terms to those contained in an Inland Revenue approved "Save-as-you-earn" share option scheme, to all or most employees of the participating companies in that scheme;

(i) with the exception of a disposal of securities received by a director as a participant, dealings in connection with an Inland Revenue approved profit share scheme, or any similar profit share scheme under which participation is extended, on similar terms to those contained in an Inland Revenue approved profit share scheme, to all or most employees of the participating companies in the scheme;

(j) arrangements which involve a sale of securities in the listed company with the intention of making a matched purchase of such securities on the next business day ("bed and breakfast" dealings);

(k) transfers of shares already held into a personal equity plan by means of a matched sale and purchase;

(l) the cancellation or surrender of an option under an employees' share scheme.

Relevant employees

(21) Relevant employees must comply with the terms of this code as though they were directors.

BEST PRACTICE PROVISIONS: DIRECTORS' REMUNERATION

SECTION A: REMUNERATION COMMITTEES

These provisions do not form part of the listing rules. Under paragraph 12.43(w) of the listing rules, a company must include a statement in its annual report and accounts as to whether or not it has complied with these provisions and must explain and justify any areas of non-compliance.

1. Boards of directors should set up remuneration committees to determine, within agreed terms of reference, the company's policy on executive directors' remuneration and specific remuneration packages for each of the executive directors, including pension rights and any compensation payments.

2. Remuneration committees should consist exclusively of non-executive directors with no personal financial interest other than as shareholders in the matters to be decided, no potential conflicts of interest arising from cross-directorships and no day-to-day involvement in running the business.

3. Remuneration committee chairmen should report to the shareholders through means specified in the listing rules.

4. The members of the remuneration committee should be listed each year in the committee's report to shareholders. When they stand for election or re-election, the proxy cards should indicate their membership of the committee.

5. The Board itself, or, where required by the Articles of Association, the shareholders, should determine the remuneration of all non-executive directors, within the limits set out in the Articles of Association.

6. Remuneration committees should consult the company chairman and/or chief executive about their proposals relating to the remuneration of other executive directors and have access to professional advice inside and outside the company.

7. The remuneration committee chairman, or other member of the remuneration committee, should attend the company's annual general meeting to answer shareholders' questions about directors' remuneration.

8. The committee's annual report to shareholders need not be a standard item of agenda for annual general meetings, but the committee should consider each year whether the circumstances are such that the annual general meeting should be invited to approve the policy set out in its report and should minute its conclusions.

BEST PRACTICE PROVISIONS: DIRECTORS' REMUNERATION

SECTION B: REMUNERATION POLICY, SERVICE CONTRACTS AND

COMPENSATION

These provisions do not form part of the listing rules. Under paragraph 12.43(x)(ii) of the listing rules a statement must be made in the report by the remuneration committee or by the Board if there is no remuneration committee included in the annual report and accounts that the remuneration committee has given full consideration to these provisions in framing its remuneration policy. There is no requirement to explain or justify any areas of non-compliance.

Remuneration policy

1. Remuneration committees should provide the packages need to attract, retain and motivate directors of the quality required but should avoid paying more than is necessary for this purpose.

2. Remuneration committees should judge where to position the company relative to other companies. They should be aware what comparable companies are paying and should take account of relative performance.

3. Remuneration committees should be sensitive to the wider scheme, including pay and employment conditions elsewhere in the group, especially when determining annual salary increases.

4. The performance-related elements of remuneration should be designed to align the interests of directors and shareholders and to give directors keen incentives to perform at the highest levels.

5. Remuneration committees should consider whether the directors should be eligible for annual bonuses. If so, performance conditions should be relevant, stretching and designed to enhance the business. Upper limits should always be considered. There may be a case for part-payment in shares to be held for a significant period.

6. Remuneration committees should consider whether the directors should be eligible for benefits under long-term incentive schemes. Traditional share option schemes should be weighed against other kinds of long-term incentive scheme. In normal circumstances, shares granted or other forms of deferred remuneration should not vest, and options should not be exercisable, in under three years. Directors should be encouraged to hold their shares for a further period after vesting or exercise subject to the need to finance any costs of acquisition and associated tax liability.

7. Any new long-term incentive schemes which are proposed should be approved by shareholders and should preferably replace existing schemes or at least form part of a well-considered overall plan, incorporating existing schemes. The total rewards potentially available should not be excessive.

8. Payouts or grants under all incentive schemes, including new grants under existing share option schemes, should be subject to challenging performance criteria reflecting the company's objectives. Consideration should be given to criteria which reflect the company's performance relative to a group of comparator companies in some key variables such as total shareholder return.

9. Grants under executive share option and other long-term incentive schemes should normally be phased rather than awarded in one large block.

10. Remuneration committees should consider the pension consequences and associated costs to the company of basic salary increases and other changes in remuneration, especially for directors close to retirement.

11. In general, neither annual bonuses nor benefits in kind should be pensionable.

Service contracts and compensation

12. Remuneration committees should consider what compensation commitments (including pension contributions) the directors' contracts of service, if any, would entail in the event of early termination, particularly for unsatisfactory performance.

13. There is a strong case for setting notice or contract periods at, or reducing them to, one year or less. Remuneration committees should, however, be sensitive and flexible, especially over time. In some cases notice or contract periods of up to two years may be acceptable. Longer periods should be avoided wherever possible.

14. If it is necessary to offer longer notice or contract periods, such as three years, to new directors recruited from outside, such periods should reduce after the initial period.

15. Within the legal constraints, remuneration committees should tailor their approach in individual early termination cases to the wide variety of circumstances. The broad aim should be to avoid rewarding poor performance while dealing fairly with cases where departure is not due to poor performance and to take a robust line on reducing compensation to reflect departing directors' obligations to mitigate damages.

16. Where appropriate, and in particular where notice or contract periods exceed one year, companies should consider paying all or part of compensation in instalments rather than one lump sum and reducing or stopping payment when the former director takes on new employment.

APPENDIX F

Cadbury Code of Best Practice

1 The Board of Directors 1.1 The board should meet regularly, retain full and effective control over the company and monitor the executive management.

1.2 There should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision. Where the chairman is also the chief executive, it is essential that there should be a strong and independent element on the board, with a recognised senior member.

1.3 The board should include non-executive directors of sufficient calibre and number for their views to carry significant weight in the board's decisions. (Note 1)

1.4 The board should have a formal Schedule of matters specifically reserved to it for decision to ensure that the direction and control of the company is firmly in its hands. (Note 2)

1.5 There should be an agreed procedure for directors in the furtherance of their duties to take independent professional advice if necessary, at the company's expense. (Note 3)

1.6 All directors should have access to the advice and services of the company secretary, who is responsible to the board for ensuring that board procedures are followed and that applicable rules and regulations are complied with. Any question of the removal of the company secretary should be a matter for the board as a whole.

2 Non-Executive Directors 2.1 Non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct.

2.2 The majority should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement, apart from their fees and shareholding. Their fees should reflect the time which they commit to the company. (Notes 4 and 5)

2.3 Non-executive directors should be appointed for specified terms and reappointment should not be automatic. (Note 6)

2.4 Non-executive directors should be selected through a formal process and both this process and their appointment should be a matter for the board as a whole. (Note 7)

3 Executive Directors 3. .1 Directors' service contracts should not exceed three years without shareholders' approval. (Note 8)

3.2 There should be full and clear disclosure of directors' total emoluments and those of the chairman and highest-paid UK director, including pension contributions and stock options. Separate figures should be given for salary and performance-related elements and the basis on which performance is measured should be explained.

3.3 Executive directors' pay should be subject to the recommendations of a remuneration committee made up wholly or mainly of non-executive directors. (Note 9)

4 Reporting and Controls 4.1 It is the board's duty to present a balanced and understandable assessment of the company's position. (Note 10)

4.2 The board should ensure that an objective and professional relationship is maintained with the auditors.

4.3 The board should establish an audit committee of at least 3 non-executive directors with written terms of reference which deal clearly with its authority and duties. (Note 1 1)

4.4 The directors should explain their responsibility for preparing the accounts next to a statement by the auditors about their reporting responsibilities. (Note 12)

4.5 The directors should report on the effectiveness of the company's system of internal control. (Note 13)

4.6 The directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. (Note 13).

APPENDIX G

Cadbury Statement of Directors' Responsibilities ^[46]

STATEMENT OF DIRECTORS' RESPONSIBILITIES

Company law requires the directors to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the company and the group and of the profit or loss of the group for that period. In preparing those financial statements, the directors are required to -

select suitable accounting policies and then apply them consistently

make judgements and estimates that are reasonable and prudent

state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements^[47]

prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business^[48]

The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the company and of the group and to enable them to ensure that the financial statements comply with the Companies Act 1985. They are also responsible for safeguarding the assets of the company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

APPENDIX H

Extracts from Australian Corporations Law

DUTY AND LIABILITY OF OFFICER OF CORPORATION

Section 232

(1) In this section:

"officer", in relation to a corporation, means:

(a) director, secretary or executive officer of the corporation;

...

(2) [Act honestly] An officer of a corporation shall at all times act honestly in the exercise of his or her powers and the discharge of the duties of his or her office.

(3) [repealed]

(4) In the exercise of his or her powers and the discharge of his or her duties, an officer of a corporation must exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation's circumstances.

(4A) [......]

(5) An officer or employee of a corporation, or a former officer or employee of a corporation, must not, in relevant circumstances, make improper use of information acquired by virtue of his or her position as such an officer or employee to gain, directly or indirectly, an advantage for himself or herself or for any other person or to cause detriment to the corporation.

(6) An officer or employee of a corporation must not, in relevant circumstances, make improper use of his or her position as such an officer or employee, to gain, directly or indirectly, an advantage for himself or herself or for any other person or to cause detriment to the corporation.

(6A)-(10) [......]

(11) This section has effect in addition to, and not in derogation of, any rule of law relating to the duty or liability of a person by reason of the person's office or employment in relation to a corporation and does not prevent the institution of any civil proceedings in respect of a breach of such a duty or in respect of such a liability.

APPENDIX I

Extracts from New Zealand Companies Act 1993

The following sections of the New Zealand Companies Act 1993 are set out below: 130 to 131, 133 to 134, and 137 to 146

DELEGATION OF POWERS

Section 130

130....(1) Subject to any restrictions in the constitution of the company, the board of a company may delegate to a committee of directors, a director or employee of the company, or any other person, any one or more of its powers other than its powers under any of the sections of this Act set out in the Second Schedule to this Act.

(2) A board that delegates a power under subsection (1) of this section is responsible for the exercise of the power by the delegate as if the power had been exercised by the board, unless the board-

(a) believed on reasonable grounds at all times before the exercise of the power that the delegate would exercise the power in conformity with the duties imposed on directors of the company by this Act and the company's constitution; and

(b) has monitored, by means of reasonable methods properly used, the exercise of the power by the delegate.

DUTY OF DIRECTORS TO ACT IN GOOD FAITH AND IN BEST INTERESTS OF COMPANY

Section 131

131....(1) Subject to this section, a director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.

(2) A director of a company that is a wholly-owned subsidiary may, when exercising powers or performing duties as a director, if expressly permitted to do so by the constitution of the company, act in a manner which he or she believes is in the best interests of that company's holding company even though it may not be in the best interests of the company.

(3) A director of a company that is a subsidiary (but not a wholly-owned subsidiary) may, when exercising powers or performing duties as a director, if expressly permitted to do so by the constitution of the company and with the prior agreement of the shareholders (other than its holding company), act in a manner which he or she believes is in the best interest of that company's holding company even though it may not be in the best interests of the company.

(4) A director of a company incorporated to carry out a joint venture between the shareholders may, when exercising powers or performing duties as a director in connection with the carrying out of the joint venture, if expressly permitted to do so by the constitution of the company, act in a manner which he or she believes is in the best interests of a shareholder or shareholders, even though it may not be in the best interests of the company.

POWERS TO BE EXERCISED FOR PROPER PURPOSE

Section 133

133. A director must exercise a power for a proper purpose.

DIRECTORS TO COMPLY WITH ACT AND CONSTITUTION

Section 134

134. A director of a company must not act, or agree to the company acting, in a manner that contravenes this Act or the constitution of the company.

DIRECTOR'S DUTY OF CARE

Section 137

137. A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account but without limitation,...

(a) The nature of the company; and

(b) The position of the director and the nature of the responsibilities undertaken by him or her.

USE OF INFORMATION AND ADVICE

Section 138

138.( (1) Subject to subsection (2) of this section, a director of a company, when exercising powers of performing duties as a director, may rely on reports, statements and financial data and other information prepared or supplied and on professional or expert advice given, by any of the following persons:

(a) An employee of the company whom the director believes on reasonable grounds to be reliable and competent in relation to the matters concerned;

(b) A professional adviser or expert in relation to matters which the director believes on reasonable grounds to be within the person's professional or expert competence;

(c) Any other director or committee of directors upon which the director did not serve in relation to matters within the director's or committee's designated authority.

(2) Subsection (1) of this section applies to a director only if the director...

(a) Acts in good faith; and

(b) Makes proper inquiry where the need for inquiry is indicated by the circumstances; and

(c) Has no knowledge that such reliance is unwarranted.

Transactions Involving Self-interest

MEANING OF "INTERESTED"

Section 139

139....(1) Subject to subsection (2) of this section, for the purposes of this Act, a director of a company is interested in a transaction to which the company is a party if, and only if, the director(

(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 person who will or may derive a material financial benefit from, the transaction, not being a party or person that is...

(i) The company's holding company being a holding company of which the company is a wholly-owned subsidiary; or

(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 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.

(2) For the purposes of this Act, a director of a company is not interested in a transaction to which the company is a party if 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 in whole or in part under a guarantee, indemnity, or by the deposit of a security.

DISCLOSURE OF INTEREST

Section 140

140....(1) A director of a company must, forthwith after becoming aware of the fact that he or she is interested in a transaction or proposed transaction with the company, cause to be entered in the interests register, and, if the company has more than one director, disclose to the board of the company(

(a) If the monetary value of the director's interest is able to be quantified, the nature and monetary value of that interest; or

(b) If the monetary value of the director's interest cannot be quantified, the nature and extent of that interest.

(2) For the purposes of subsection (1) of this section, 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 of interest in relation to that transaction.

(3) A failure by a director to comply with subsection (1) of this section does not affect the validity of a transaction entered into by the company or the director.

(4) Every director who fails to comply with subsection (1) of this section commits an offence and is liable on conviction to the penalty set out in section 373(2) of this Act.

Cf 1995, No 63, s 199

AVOIDANCE OF TRANSACTIONS

Section 141

141.... (1) A transaction entered into by the company in which a director of the company is interested may be avoided by the company at any time before the expiration of 3 months after the transaction is disclosed to all the shareholders (whether by means of the company's annual report or otherwise).

(2) A transaction cannot be avoided if the company receives fair value under it.

(3) For the purposes of subsection (2) of this section, the question whether a company receives fair value under a transaction is to be determined on the basis of the information known to the company and to the interest director at the time the transaction is entered into.

(4) If a transaction is entered into by the company in the ordinary course of its business and on usual terms and conditions, the company is presumed to receive fair value under the transaction.

(5) For the purposes of this section...

(a) A person seeking to uphold a transaction and who knew or ought to have known of the director's interest at the time the transaction was entered into has the onus of establishing fair value; and

(b) In any other case, the company has the onus of establishing that it did not receive fair value.

(6) A transaction in which a director is interested can only be avoided on the ground of the director's interest in accordance with this section or the company's constitution.

EFFECT ON THIRD PARTIES

Section 142

142....The avoidance of a transaction under section 141 of this Act does not affect the title or interest of a person in or to property which that person has acquired if the property was acquired(

(a) From a person other than the company; and

(b) For valuable consideration; and

(c) Without knowledge of the circumstances of the transaction under which the person referred to in paragraph (a) of this section acquired the property from the company.

APPLICATION OF SECTIONS 140 AND 141 IN CERTAIN CASES

Section 143

143. Nothing in section 140 and section 141 of this Act applies in relation to-

(a) Remuneration or any other benefit given to a director in accordance with section 161 of this Act; or

(b) An indemnity given or insurance provided in accordance with section 162 of this Act.

INTERESTED DIRECTOR MAY VOTE

Section 144

144....Subject to the constitution of the company, a director of a company who is interested in a transaction entered into, or to be entered into, by the company, may(

(a) Vote on a matter relating to the transaction; and

(b) Attend a meeting of directors at which a matter relating to the transaction arises and be included among the directors present at the meeting for the purpose of a quorum; and

(c) Sign a document relating to the transaction on behalf of the company; and

(d) Do any other thing in his or her capacity as a director in relation to the transaction...

as if the director were not interested in the transaction.

USE OF COMPANY INFORMATION

Section 145

145.... (1) a director of a company who has information in his or her capacity as a director or employee of the company, being information that would not otherwise be available to him or her, must not disclose that information to any person, or make use of or act on the information, except(

(a) For the purposes of the company; or

(b) As required by law; or

(c) In accordance with subsection (2) or subsection (3) of this section; or

(d) In complying with section 140 of this Act.

(2) A director of a company may, unless prohibited by the board, disclose information to...

(a) A person whose interests the director represents; or

(b) A person in accordance with whose directions or instructions the director may be required or is accustomed to act in relation to the director's powers and duties and, if the director discloses the information the name of the person to whom it is disclosed must be entered in the interests register.

(3) A director of a company may disclose, make use of, or act on the information if...

(a) Particulars of the disclosure, use, or the act in question are entered in the interests register; and

(b) The director is first authorised to do so by the board; and

(c) The disclosure, use, or act in question will not, or will not be likely to, prejudice the company.

APPENDIX J

Extracts from the Canadian Business Corporations Act 1985

122. ...(1) Every director and officer of a corporation in exercising his powers and discharging his duties shall ...

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

Reliance on statements

123. ...(4) A director is not liable under section...122 [the skill and care requirement] if he relies in good faith on

(a) financial statements of the corporation represented to him by an officer of the corporation or in a written report of the auditor of the corporation fairly to reflect the financial condition of the corporation; or

(b) a report of a lawyer, accountant, engineer, appraiser or other person whose profession lends credibility to him.

APPENDIX K

Article 93 of the German Stock Corporation Act

ARTICLE 93

Duty of Care and Responsibility of Members of the Management Board

(1) In conducting business the members of the management board shall employ the care of a diligent and conscientious manager. They shall not disclose confidential information and secrets of the company, in particular trade and business secrets, which have become known to them as a result of their service on the management board.

(2) Members of the management board who violate their duties shall be jointly and severally liable to the company for any resulting damage. They shall bear the burden of proof in the event of a dispute as to whether or not they have employed the care of a diligent and conscientious manager.

(3) The members of the management board shall in particular be liable for damages if, contrary to this act:

1. contributions are repaid to shareholders;

2. shareholders are paid interest or dividends;

3. company shares or shares of another company are subscribed, acquired, taken as a pledge or redeemed;

4. share certificates are issued before the par value or the higher issue price has been fully paid;

5. assets of the company are distributed;

6. payments are made after the company has become insolvent or over indebted [sic];

7. remuneration is paid to members of the supervisory board;

8. credit is extended;

9. in connection with a conditional capital increase, new shares are issued other than for the specified purpose or prior to full payment of the consideration.

(4) The members of the management board shall not be liable to the company for damages if they acted pursuant to a lawful resolution of the shareholders' meeting. However, liability for damages shall not be precluded by the fact that the supervisory board has consented to the act. The company may waive or compromise a claim for damages upon the expiry of three years after the claim has arisen, provided that the shareholders' meeting consents thereto and no minority whose aggregate holding equals or exceeds one tenth of the share capital records an objection in the minutes. The foregoing period of time shall not apply if the person liable for damages is insolvent and enters into a composition with his creditors to avoid or terminate bankruptcy proceedings.^[49]

(5) The claim of the company for damages may also be asserted by the company's creditors if they are unable to obtain satisfaction from the company. However, in cases other than those set out in subsection (3) the foregoing shall apply only if the members of the management board have grossly violated the duty of care of a diligent and conscientious manager; subsection (2) sentence 2 shall apply analogously. Liability for damages to the creditors shall be extinguished neither by a waiver nor by a compromise of the company nor by the fact that the act which caused the damage was based on a resolution of the shareholders' meeting. If bankruptcy proceedings have been instituted over the company's assets, the receiver in bankruptcy shall exercise the rights of the creditors against the members of the management board during the course of such proceedings.^[50]

(6) Claims under the foregoing provisions shall be barred after the expiration of a period of five years.

APPENDIX L

Extracts from the Review of the Hong Kong Companies Ordinance - Consultancy Report (March 1997)

6.13 RECOMMENDATION

Statutory statement of directors' duties:

There should be a statutory statement of directors' duties to act honestly and in the best interests of the company and to exercise the care, diligence and skill that a reasonably prudent person would. These duties should also be made applicable to those corporate officers appointed by the board.

Current Ordinance

There is no statutory statement of the directors' and officers' duties to act honestly and in the best interests of the company and to exercise the care, diligence and skill that a reasonably prudent person would.

COMMENTARY

A statutory statement of directors' duties would have the beneficial effect of clearly setting out the standard against which actions by directors would be measured. As in other jurisdictions, there is no doubt that the long history in the case law would continue to inform the statutory language, but the statutory standard would prevail. The duties incumbent upon company directors are the product of a long evolution at common law; their development was also influenced by certain equitable notions. Directors' duties may be classified into two categories: fiduciary duties and the duty of care and skill. Directors' fiduciary duties represent Equity's most significant contribution to company law; they place the directors under a fiduciary obligation to act in the best interests of the company, not to abuse or fetter their powers, and not to place themselves in situations of conflict of interest.

At common law, the duty of care incumbent upon directors was anything but onerous; in Re Brazilian Rubber Plantations and Estates Ltd., Neville J. said the following:

A director's duty has been laid down as requiring him to act with such care as is reasonably to be expected from him, having regard to his knowledge and experience. He is, I think, not bound to bring any special qualifications to his office. He may undertake the management of a rubber company in complete ignorance of everything connected with rubber, without incurring responsibility for the mistakes which may result from such ignorance; while if he is acquainted with the rubber business he must give the company the advantage of his knowledge when transacting the company's business. He is not, I think bound to take any definite part in the conduct of the company's business, but so far as he does undertake it he must use reasonable care in its despatch.

Such reasonable care must, I think, be measured by the care an ordinary man might be expected to take in the same circumstances on his own behalf. His is clearly, I think, not responsible for damages occasioned by errors in judgment... (Re Brazilian Rubber Plantations and Estates, [1911] Ch. 425 (C.A. at 437).

The duty of care as it has evolved in the case law is derived from a gross negligence standard.

In counterbalance to this very low standard of care (and partly due to the historical development of the company where directors were originally seen as true "trustees" or fiduciaries), fiduciary duties have been imposed on directors. Initially the fiduciary duties imposed by the courts were quite strict, in keeping with the view that directors were in fact trustees. With time, and in the interests of the promotion of commerce and risk-taking enterprises, these strict fiduciary duties were relaxed by the courts. A more modern view of these new fiduciary-like duties would include some of all of the following:

to act in good faith

not to fetter their discretion (such as agreeing to vote in a certain way in future)

to avoid conflicts of interest (such as interested director transactions)

not to misuse corporate property, information, or opportunities

not to compete with the company

There are various statutory formulations of directors' duties but all are derived from the standard of care (essentially a negligence standard) and the fiduciary duty attributed to directors by the courts. Such formulations have become the accepted norm in company statutes. Delaware is a notable exception, relying instead on its highly specialised judiciary to formulate the standards. Until recently, it seemed that the United Kingdom was moving in the direction of statutory standards. According to the U.K. Department of Trade and Industry working group on Directors Duties, there was "support emerging for the codification of directors' duties similar to the approach adopted in other Commonwealth countries. The DTI favours a reduced Part X coupled with a 'statement' of directors' duties" (Great Britain, Department of Trade and Industry, DTI's Programme for the Reform of Company Law - Progress Report (London: Department of Trade and Industry, 11 June 1996)). A subsequent Progress Report (October 1996) indicates, however, that such an initiative has been again derailed.

The U.K. Jenkins Committee, in 1962, considered that a general statement of the basic principles underlying the fiduciary relationship of directors towards their companies would be useful to directors and others concerned with company management. The Second Report in Hong Kong in 1973 agreed and so recommended. The SCCLR has also so recommended. Efforts were made to develop a statutory formulation of directors' fiduciary duties in Hong Kong, the most recent being the Companies (Amendment) Bill 1991. The Bill was not enacted due to objections expressed in particular by the Law Society. The Law Society was of the view (among other things) that any attempt to draft a statutory formulation of directors' fiduciary duties would be incomplete and that it was better to continue with the present system where a director should consult his professional advisors whenever a question involving his fiduciary duties to the company arose. When the Bill was withdrawn the Government encouraged the private sector to draft guidelines to better inform directors of their duties. In 1995 the Hong Kong branch of the Institute of Directors published Guidelines for Directors which was, in part, intended to be responsive to the need for some private sector guidelines. Of special interest in this area is the SEHK Listing Rules' formulation of directors' duties, which demonstrates its affinity to modem statutory formulations. This is a measure which is long overdue and upon which there was considerable consensus in the working party.

There are several issues associated with the statutory formulation of directors' duties. Under the "negligence" branch (the duty to act with care, diligence and skill), the issues are primarily the level of diligence required and the degree of objectivity of the test. There appears to be a fairly general consensus that the "gross negligence" standard of the common law is too low and that the test should be an objective one, to this extent displacing the case law. On the other hand, setting too high a standard has been resisted on several grounds: commercial expediency and the ability to attract good business people to fill directorships. So that although serious consideration has been given to setting a "professional" standard and in fact encouraging the development of a professional class of directors, these efforts have not materialised. The MBCA rejects the notion of raising the standard to that of professional expertise.

The reference to 'ordinarily prudent person' embodies long traditions of the common law, in contrast to suggested standards that might call for some undefined degree of expertise, like 'ordinarily prudent businessman'. The phrase recognises the need for innovation, essential to profit orientation, and focuses on the basic director attributes of common sense, practical wisdom, and informed judgment (MBCA, Official Comment, s.8.30 (a)).

As for the "fiduciary" branch of directors' duties, the main issues are the breadth of the duty owed, by whom and to whom it is owed (e.g. does it encompass individual or groups of shareholders). There is little quarrel with requiring directors to act honestly, in good faith and in the best interests of the company. Obvious issues of conflict of interests (which under traditional fiduciary standards are dealt with strictly) or duties to a third person may be addressed separately in the legislation. Although it does appear in the New Zealand legislation, care should be taken not to import the "proper purpose" test into the standards. The "proper purpose" test was not recommended by the New Zealand Law Commission but included in the resulting legislation at the behest of Parliament. The Law Commission in New Zealand correctly noted that the "concept of proper purpose was originally derived from the case law on powers and today arguably there is a lack of underpinning objects against which powers could be assessed. On the other hand, recent cases seem to use 'proper purpose' to impose an objective standard where the good faith of directors is accepted" (NZLRC 9, at 119). A proper purpose test is unnecessary given the statutory statement of directors duties proposed.

Corporate officers are included in the U.S. and Canadian formulation of both branches of the duties, in recognition of the commercial reality of managerial responsibilities. The MBCA makes the duties applicable to, corporate officers with "discretionary authority". This recommendation suggests applying the standards to those corporate officers appointed directly by the board of directors. Where most executive officers are also directors, as is often the case in Hong Kong, there would, in fact, be no extension of duties and liabilities.

In connection with the statutory formulation of directors duties in the United States, there has been a recent flurry of so-called "stakeholder," or "constituency" statutes. These statutes widen the range of factors directors may consider in making decisions to include interests such as those of employees, suppliers, customers, the community in which the corporation is situated, and, in some cases, all other "pertinent factors". By 1995, twenty-nine states had enacted such provisions. However, of these, only one, Connecticut, had made these considerations mandatory, the others were worded in a permissive fashion.

The stakeholder statutes were not designed to widen the range of persons to whom directors owe fiduciary duties; none permit any of the mentioned classes to take action if boards fail to consider their interests. Rather than to cause a sea of change in corporate decision-making, these statutes were actually intended, as transcripts from state legislatures reveal, to be anti-takeover defences; in the event that none of the other legislative or corporate anti-takeover defences prevail, directors can always cite constituency concerns as reason for rejecting a hostile bid. They may also have reduced directors' potential fiduciary liability. There has been little litigation over these provisions and their effect on American corporate law has been non-existent for all practical purposes. For these reasons, stakeholder, or constituency provisions are not being recommended; they are not relevant or appropriate in the Hong Kong context.^[51]

6.14 RECOMMENDATION

Reliance on reports:

Directors and executive officers should be able to rely in good faith on financial statements and other reports prepared by officers and employees as well as the professional advice of lawyers, accountants, etc.

Current Ordinance

There are no provisions which allow directors and officers to rely in good faith on financial statements and other reports prepared by officers and employees as well as the professional advice of lawyers, accountants, etc.

COMMENTARY

The reliance defence reflects commercial reality and should be coterminous with the statutory duties. In the United States, under the MBCA it is available to officers who are subject to statutory duties as well as directors. However, an officer's "ability to rely on information, reports, or statements, may, depending upon the circumstances of the particular case, be more limited than in the case of a director in view of the greater obligation he may have to be familiar with the affairs of the corporation [...] Nondirector officers with more limited discretionary authority may be judged by a narrower standard, though every corporate officer or agent owes duties of fidelity, honesty, good faith, and fair dealing to the corporation" (MBCA, Official Comment, s.8.42).

This reliance defence was previously narrower in Canada; financial statements were the only reports which could be relied upon. However, the CBCA was amended in June 1995 and brought into line with MBCA. Now directors in Canada can rely on reports prepared by other professionals (s. 123(4)(b)).^[52]

6.15 RECOMMENDATION

Business judgment rule:

There should be no need of a statutory formulation of the 'business judgment rule'.

Current Ordinance

There is no statutory formulation of the 'business judgment rule'.

COMMENTARY

The business judgment rule is a feature of U.S. corporate law that has no direct Commonwealth equivalent, although Australia has been considering introducing it (see J.H. Farrar, "Corporate Governance, Business Judgment and the Professionalism of Directors" (1993) 6 Corp. and Bus. L.J. 365). It is a jurisprudential rule; none of the U.S. states have attempted to codify it, leaving its formulation up to the courts. It is characterised as the presumption that in any given business decision the board "acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interest of the company" (Smith v. Van Gorkom, 488 A 2d 858 at 872 (Del. S.C. 1985)). Thus, plaintiffs must demonstrate by preponderance of evidence that the board was not in fact acting in such a way before the courts will substitute their judgment for that of the board in relation to the decision being reviewed.

The American Law Institute, after numerous failed attempts, finally produced a codification of the business judgment rule in its Principles of Corporate Governance: Analysis and Recommendations.

A director or officer who makes a business judgment in good faith fulfils the duty under this Section if the director or officer: (1) is not interested [...] in the subject of the business judgment; (2) is informed with respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances; and (3) rationally believes that the business judgment is in the best interest of the corporation (s. 4.01(c)).

Essentially, the business judgment rule is the jurisprudential expression of the unwillingness of U.S. courts to indulge in ex post facto review of the merits of business judgments. It is based on the argument that a greater likelihood of judicial review of business decisions will lead boards to choose overly conservative courses of action instead of making decisions with regard to optimal results, thereby damaging corporate performance.

Another argument is that judicial and business decision-making are different processes taking place in different environments: it is doubtful whether judges, who may lack the business expertise required to appreciate all the factors involved in a complex business decision, and whose methods of analysis are legal rather than commercial, will be able to make a decision superior or even equal to the one made by the board. Even if this were not the case, the fairness of allowing review of business decisions on the basis of perfect judicial hindsight is questionable. It must be noted that much of the U.S. case law in this area has dealt with takeover situations, so that the major issue in these cases has been entrenchment of management by the adoption of certain plans of action such as sales of crown jewels, where the board authorises the sale of the asset or division that is motivating the takeover bidder.

It has been argued that courts in Commonwealth jurisdictions implicitly apply similar reasoning in duty-of-care judgments. Certainly, Commonwealth courts are reticent to review business judgments where gross negligence or self interest are not to be found, and will not find directors liable for mere errors of judgment (see, e.g. Re City Equitable Fire Insurance Co. Ltd. [1925] 1 Ch. 407). Professor Ziegel states that:

To a large extent, Anglo-Canadian courts have given implicit recognition to the concerns expressed by [the business judgment rule] in their duty of care judgments. For instance, Lord Wilberforce, in Howard Smith Ltd v. Ampol Petroleum Ltd., [1974] AC 821 at 832, stated that:

There is no appeal on merits from management decisions to courts of law; nor will courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at.

In this respect, rather than being articulated as a clearly identifiable doctrinal rule, the considerations underlying the business judgment rule have simply been imported into the formulation of the final standard of care that governs directorial conduct. Viewed in this way, the integration of the business judgment rule into the relevant standard of care takes Anglo-Canadian courts to the same endpoint as their American counterparts (J.S. Ziegel et al., Cases and Materials on Partnerships and Canadian Business Corporations, 3rd ed. (Toronto: Carswell, 1994) at 478).

Recently, there have been suggestions that Australia enact a statutory equivalent to the business judgment rule. The Australian Government has so far been unwilling to do so for the following reasons: 1) the wisdom of importing an American common law rule into the Australian Corporations Law is questionable (compatibility problems might arise); 2) codification of the business judgment rule had, at the date the objections were made, proved impossible; 3) Australian common law contains a rule, which although expressed differently and occurring as part of the standard of care, produces similar results; 4) the Corporations Law allowed the court to excuse directors from liability where they had acted honestly and ought fairly to be excused; and 5) the precise objective of enacting the business judgment rule was unclear. However, following the recent election in Australia, it would appear that the new government is once again considering the adoption of the business judgment rule (see Hon. Brian Gibson, "The Government's View on the Corporations Law" (speech delivered in Sydney, 14 May 1996)).

6.16 RECOMMENDATION

Indemnifying directors:

Companies should be permitted to indemnify directors and officers in specific circumstances; companies should be required to indemnify directors and officers in specific circumstances.

Current Ordinance

Under the Ordinance a contract indemnifying directors for breach of duty is void, as is any provision to such effect in the company's articles (s. 165). However, a company may indemnify directors for costs incurred while successfully defending themselves against a civil or criminal action (s. 165, art. 137). Furthermore, a court, "having regard to all the circumstances of case", may grant relief to a director who has acted "honestly and reasonably" even though held liable for "negligence, default, breach of duty or breach of trust" (s.358, art. 137).

COMMENTARY

Where a director has behaved properly and faithfully, there should be a claim to indemnification from the company. However, blanket indemnification is undesirable. Indemnification where a director has acted in breach of fiduciary duties would effectively involve a waiver of such duties. The factors to be balanced are the need to recruit qualified directors against the use of corporate funds - by directors to avoid the costs imposed on them for certain forms of misconduct. Indemnification should be permissible where it furthers "sound corporate policies" and should be prohibited where it would "protect or encourage wrongful or improper conduct", according to the MBCA. The CBCA indemnification provisions, upon which this recommendation is based, are quite liberal.

The indemnification provisions should be broadened. Indemnification should be permissible where 1) the liability was reasonably incurred in a proceeding in which the manager was involved by virtue of his position, 2) the manager was not in breach of his fiduciary duty to the company and 3) where there is a monetary penalty, reasonably believed his conduct to be lawful. Where the company itself is the plaintiff in the proceeding, different considerations prevail; judicial approval may be required.

Indemnification should be mandatory where the manager has been substantially successful on the merits of a defence (see CBCA, s. 124).^[53]

6.17 RECOMMENDATION

Insuring directors:

Companies should be permitted to insure directors and officers except for a failure to act honestly and in good faith with a view to the best interests of the company.

Current Ordinance

Under the Ordinance a company cannot purchase insurance on behalf of directors (s. 165) although the directors themselves may do so. This is comparable to the position taken in the United Kingdom prior to recent amendments to the U.K. Companies Act.

COMMENTARY

The current prohibition on companies purchasing directors' and officers' liability insurance directly is easily circumvented as was the case in the U.K. prior to recent reforms. Companies increased directorial compensation to cover insurance premiums. This was not an ideal state of affairs, however. The CBCA provisions with respect to insurance are, again, quite liberal, essentially permitting the market to decide what risks will be insurable. The only limitation is with respect to acts which are not done honestly and in good faith with a view to the best interests of the company.

Apart from breach of fiduciary duty, the company should be able to purchase directors' and officers' insurance for any risks which the market is prepared to insure. The Dickerson Committee wrote in 1971: "Until experience shows that this broad power to obtain indemnity insurance from commercial carriers has been abused by directors and officers, there appears no reason to limit the insurance coverage that may be obtained" (Dickerson Report at para. 250).^[54]

6.18 RECOMMENDATION

Disqualification of directors:

Disqualification of directors provisions should be eliminated for company law purposes. Those existing provisions relating to securities, insolvency or criminal activity should be re-enacted in appropriate legislation.

Current Ordinance

The provisions governing disqualification orders are long and complex (ss. 168C-S, sch. 15). There are four principal grounds on which a court may make a disqualification order-

conviction of an indictable offence in connection with the promotion, formation, management, receivership or liquidation of a company or any other indictable offence which involves a finding that he acted fraudulently or dishonestly (s. 168E(l));

persistent default in relation to filing requirements of the Ordinance requiring any return, account, or other document to be delivered to the Registrar (s. 168F(l));

fraud in the course of winding up a company or the appearance of guilt for fraudulent trading even if the director has not been convicted (s. 275); and

unfitness - the court is required to consider the conduct of a person who has been or is a director of an insolvent company (s. 168H).

COMMENTARY

In general, the existing disqualification of directors provisions (drawn from the Company Directors Disqualification Act 1986 in the United Kingdom) are overbroad, for the purposes of core company law. Those provisions dealing with insolvency, capital markets and criminal fraud should be left to other specialised regulatory and enforcement agencies. In addition, the use of director disqualification as an enforcement mechanism for rather mundane administrative offences (such as failure to keep a register of members) may be too draconian. In a new Ordinance, with its simplified structure and emphasis on self-enforcement, there should be fewer administrative offences to police.

The real question is the necessity for broad director disqualification provisions at all. There have been mixed experiences in the jurisdictions which have enacted the U.K. - style provisions.

It is difficult to reach firm conclusions as to whether disqualification has proved to be an effective device or sanction. Whether disqualification of bankrupt or dishonest persons, of directors whose companies fail to comply with reporting obligations, or those whose companies go into insolvent liquidation has achieved significant protection of the public interest cannot be conclusively ascertained. All one can say is that disqualification probably has added usefully to the other sanctions and devices enacted by legislation in the public interest (A. Hicks, "Disqualification of Directors - Forty Years On" (1988) J. Bus. L. 27 at 47).

If dishonest or incapable directors are dealt with in the context of insolvency, securities and criminal legislation, is there a need for further more generalised sanction under company law? There may be a certain amount of political expediency behind the U.K. legislation, a public response to perceived abuses in the corporate world in the 1980s. Certainly, there is a strong argument for leaving whatever other situations which might arise to shareholders themselves to police, especially if shareholders possess a broad unfairly prejudicial remedy as part of their arsenal. This would be consistent with the objective of creating a self-enforcing regime for companies.

The CBCA (which preceded the UK director disqualification legislation) does not contain director disqualification provisions, although they do appear in some provincial securities laws and the new Quebec Civil Code. The CBCA, however, does create a very broad statutory duty on directors and officers to act in compliance with the statute and the company constitution. It also provides shareholders with a broad assortment of remedies, including an extremely open ended oppression or unfairly prejudicial remedy.

The MBCA, on the other hand, does provide a form of director disqualification at s. 8.09, "Removal of Directors by Judicial Proceeding". These provisions are much narrower than those in the United Kingdom; a director may be barred from re-election for a period of time, but only to the board of that corporation. The director must have engaged in fraudulent or dishonest conduct or gross abuse of authority or discretion, with respect to the corporation. Removal must be in the best interest of the corporation. Unlike the United Kingdom, where shareholders do not have standing to initiate most forms of disqualification proceedings, the action may be taken by the corporation or shareholders holding at least 10% of the shares. A derivative action for removal may be commenced by a shareholder with less than a 10% share.

The elements of a derivative action are clearly discernible in s.8.09 but the MBCA sees the court ordered removal as being quicker and simpler.

The purpose of section 8.09 is to permit the prompt and efficient elimination of dishonest directors. It is not intended to permit judicial resolution of internal corporate struggles for control except in those cases in which a court finds that the director has been guilty of wrongful conduct of the type described (MBCA, Official Comment, s.8.09).

New York's variation of the MBCA also permits the state Attorney General (the public official responsible for enforcing corporations legislation) to take an action. Disqualification can thus be seen to be an exceptional recourse.

In the context of the current recommendations, the broad statutory unfairly prejudicial remedy or derivative action should provide the means of removing rogue directors without recourse to specific disqualification provisions.^[55]

6.19 RECOMMENDATION

Conflicts of interest:

Consideration should be given to placing directors and executive officers (i.e. those appointed directly by the board) under a duty of fair dealing with respect to transactions they enter into with the company.

Current Ordinance

Not applicable. There is no statutory mechanism through which interested transactions may be upheld. However, a company may provide a procedure by which interested transactions become non-voidable and directors are not liable for any profit realized from such a transaction (Table A, art. 86). In general, companies do not adopt Table A. It is customary for articles to provide for general notice as being sufficient, to require no specific disclosure and to permit interested directors to vote.

COMMENTARY

In the United Kingdom in particular, this is a very unsatisfactory area of the law; there are numerous sections dealing with different varieties of interested director contracts assorted with various sanctions, some of which are criminal. This state of affairs is an indication of the lack of unifying conceptual basis underlying the statutory treatment. At common law, in the mid-nineteenth century, directors were subject to the strict rules of trust law with regards to conflicts of interest such as interested transactions between themselves and their companies. As a result, interested transactions were voidable at the option of the company and the director was accountable for any profit derived from the transaction.

To this day, under trust law, trustees have a fiduciary duty not to place themselves in a conflict of interest in which their personal interests could potentially conflict with their duties as trustees. These rules aim to prevent trustees from misappropriating trust property for their own personal profit instead of managing the property in the best interest of the trust's beneficiaries. The same rules were applied by analogy to directors in order to protect companies from directors who would divert company assets and business opportunities from the company for personal benefit.

The application of this strict trust standard to directors of companies received its clearest expression in Aberdeen Railway v. Blaikie ...1854) 1 Macq. H. L. 461 (H. L. S. C.). In that case, a contract between the company and a partnership, of which one of the directors was a partner, was made voidable at the instance of the company notwithstanding that its terms were fair and reasonable. Lord Cranworth L.C. said on that occasion:

[I]t is a rule of universal application, that no one, having [fiduciary] duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect. So strictly is this principle adhered to, that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into.

The imposition of the trust standard on directors stems in large part from the history of joint stock companies, which were originally created by trust instruments called deeds of settlement. The use of deeds of settlement finds its origins in the Bubble Act which was enacted in the early 18th century. The Bubble Act aimed to stamp out the outbreak of speculation in freely transferable shares in the 1720's. It took direct aim at unincorporated companies which had freely transferable shares (the objects of speculation). Accordingly, the Act made it very difficult for unincorporated associations to obtain corporate status and enjoy the advantages of incorporation (Gower's at 29-30). Despite the Bubble Act, deeds of settlement enabled unincorporated associations to operate with many of the advantages of incorporation. Under such deeds, company members would agree to be associated in an enterprise with a prescribed joint stock divided into a specified number of shares; management would be delegated to a committee of directors; and the company's property would be vested in a separate body of trustees, some of whom would often also be directors (ibid.).

Under the first Joint Stock Companies Act of 1844, the deed of settlement was recognised to be the joint stock company's constitution; it had to be filed with the Registrar of Companies in order for the company to become incorporated. It was only after the passage of the Joint Stock Companies Act 1856, the first modern Companies Act, that deeds of settlement were superseded by the modern memorandum and articles of association (Gower's at 45). Thus, at the time Aberdeen was decided, in 1854, many company directors were in effect true trustees, hence the apparently logical conclusion of imposing a trust standard upon them for conflicts of interest.

These fiduciary duties imported directly from the law of trusts came to be seen as increasingly inappropriate and impractical for corporate directors working in a commercial context. For instance, it became more common for directors to serve on the boards of several companies. This was particularly the case where a company was member of a group of related companies or associated with other companies by means of interlocking directorates. Problems arose because directors owed fiduciary duties to each company of which they were directors and not the group as a whole. It was often in the interests of all companies in a group that they deal with one another (P. Lipton, "Has the 'Interested-Director Cloud' been Lifted? -- A Comparison between the U.S. and Australian Approaches" (1994) 4 Australian Journal of Corporate Law 239 at 242).

As early as the turn of the century, the appropriateness of the trust standard was questioned by Lord Herschell of the Privy Council in Bray v. Ford, [1896] A C 44 at 51-52:

It is an inflexible [......] rule of a Court of Equity that a person in a fiduciary position is not entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. It has [...] been deemed expedient to lay down this positive rule. But I am satisfied that it might be departed from in many cases, without any breach of morality, without any wrong inflicted, and without any consciousness of wrongdoing [emphasis added].

Uncertainty is the bane of commercial existence and any rule which renders a commercial transaction "voidable" creates undesirable uncertainty.

As noted in the Official Comment to the MBCA, a conflict of interest is not in itself a crime or a tort or necessarily injurious to the company. A "conflict of interest" is not something a director is 'guilty of'; it is simply a state of affairs. It is a state of affairs which can potentially, but not necessarily, lead to an abusive situation. Indeed, in many situations, a company and its shareholders may secure major benefits from a transaction despite the presence of a director's conflicting interest (MBCA, Introductory Comment, s. 8.60).

Given that the imposition of the trust standard was commercially impractical, draftspeople took advantage of the fact that the common law recognised that there was no legal limitation upon what the members of a company could agree to in the articles of association. As a consequence, articles were drafted so that interested transactions would be upheld so long as interested directors disclosed their interest to the board and did not vote. In other cases, articles were widened to such an extent that directors were not required to disclose their interests, were permitted to vote and were absolved altogether of any duty to account for profits derived from an interested transaction.

Such wide articles had become so widespread before 1929 that the Companies Act was amended that year to include what is now section 317 of the U.K. Companies Act 1985. Section 317 of the U.K. Companies Act 1985 and section 162 of the current Ordinance require directors to divulge the nature of their interest in any contract, transaction, or arrangement involving the company to the board of directors. Criminal sanctions apply to non-disclosure, even in the context of one director companies.

Over the last thirty years or so, Commonwealth and U.S. legislatures have come up with various statutory mechanisms through which an interested director or officer transaction may be upheld so as to increase predictability and enhance the practical administration of interested transactions. Third parties and directors cannot function effectively in an environment where companies can challenge and subject interested transactions to ex post facto court review years later. To use the language found in the MBCA, these mechanisms have the advantage of providing "safe harbours" and "bright lines" for companies and directors involved in interested transactions; that is to say, they provide clear procedures and criteria by which directors can insulate interested transactions from court review (PE Kay, "Director Conflicts of Interest Under the Model Business Corporation Act: A Model For All States?" (1994) 69 Washington L Rev 207 at 210).

These statutory mechanisms are based on procedural and/or substantive requirements of fairness. In terms of procedural fairness, they often resemble the articles of association drawn up to uphold interested transactions, in that they usually include two requirements. The first requirement is transparency through disclosure - directors in a conflict of interest must disclose both the nature and the extent of their material interest in the transaction. Moreover, directors are generally required to also disclose any material interest they may have in a person who is, or proposes, to be a party to a contract with the company. A material interest is generally defined as an interest that an outside observer would reasonably expect to influence a director's judgment. This objective standard does not require the existence of actual influence upon the director, but only an interest that may be reasonably expected to affect a director's actions (Kay, supra at 218). The second requirement is disinterested decision making - the director in a conflict of interest is not allowed to take part in the board's decision making on matters relating to his conflict of interest.

All Commonwealth statutes, the MBCA and s.5.02 of the American Law Institute's (ALI) Principles of Corporate Governance require directors to disclose their interests. The MBCA, in subchapter F (ss. 8.60-8.63), requires disinterested decision making at the board level. The New Zealand Companies Act 1993 at s.144 does not require disinterested decision making.

In addition to the requirement of procedural fairness, several jurisdictions have added a requirement of substantive fairness: from an objective standpoint the interested transaction must be reasonable and fair to the corporation. For a transaction to be substantively fair, it must not only have a fair price but also be in the best interests of the corporation. However, in considering the fairness of a transaction, the court will in addition be required to look at not only the price but also whether the transaction provided a benefit to the corporation.(MBCA, Official Comment, s.8.61). The CBCA, the New Zealand Companies Act 1993, the MBCA and s.5.02 of the Principles of Corporate Governance all have tests that require interested transactions to be reasonable and fair to the corporation.

It is important to understand the underlying rationales of these requirements. Obviously, the requirement of disclosure aims to make a company board aware that a conflict of interest exists; this allows the company to protect itself against directors acting in their personal interest. For example, they might exclude the interested director from the decision making process, or at least filter the interested directors' pronouncements in light of their personal bias, before arriving at a decision.

Disinterested decision making generally goes hand in hand with the requirement of disclosure, but not necessarily so. The rationale for excluding interested directors is again rather obvious: it allows the board to take a decision without theoretically having the interested director's personal interest coming into play and biasing the board's final decision in his or her favour.

The requirement of substantive fairness is in some ways a final safety net. Although all the requirements of procedural fairness may be respected in terms of disclosure and decision making, the board might still come to a decision that is substantively unfair to the company for various informal reasons -- the interested director is an important and respected director or a personal friend of the other directors, the interested director is the majority shareholder of the corporation, etc. Accordingly, the requirement of substantive fairness is a last stop measure to protect the corporation and its shareholders from a board entering into transactions that are grossly unfair to the corporation.

Absent the constraints of fiduciary duty [substantive fairness], the majority rule represents a spoils system in which the party that obtains working or numerical voting control has unbundled opportunities for its own self-aggrandisement (D. M. Branson, "Assault on Another Citadel: Attempts to Curtail the Fiduciary Standard of Loyalty Applicable to Corporate Directors" (1988) 57 Fordham L.R. 375 at 394).

The concepts of procedural and substantive fairness are not alien to Hong Kong company and securities law. As noted above, the requirement of disclosure is already a part of the current Ordinance. In terms of disinterested decision making and substantive fairness, companies incorporated under the Ordinance can choose to include such requirements in their articles of association; they are, however, under no obligation to do so. As a matter of practice, articles of Hong Kong companies often provide that interested directors may vote on interested transactions and need not account.

It is noteworthy that Chapter 14 of the SEHK's Listing Rules for "connected transactions" (the SEHK's term for interested transactions) already require disinterested decision making and substantive fairness. For example, Rule 14.26 lays out the circumstances where certain connected transactions are subject to disclosure and disinterested shareholder consent (ie. contrary to Beatty, a director cannot vote qua shareholder to uphold an interested transaction). It is also noteworthy that Rule 14.31 states that the primary objective of the circular sent to shareholders should be to demonstrate the reasonableness and fairness of the proposed connected transaction.

Moreover, Rule 14.23(2) gives the Exchange the power to grant a waiver from the requirement to obtain shareholders' approval; instead, the Exchange may require a letter from the company's auditors or financial advisors stating that in their opinion the transaction is fair and reasonable so far as the shareholders of the company are concerned ("fairness" opinions are found in other jurisdictions as well). However, one should take note that these rules do not apply to public companies that are not listed.

At present, the current Ordinance contains only the requirement of disclosure. The other important procedures governing interested transactions are found in the articles of association and case law, which in many important respects, is in an unsatisfactory state. As noted above, much of the case law supposedly applicable to interested transactions and directors' conflict of interest is drawn from a now inappropriate line of trust law cases. Modern directors are not trustees and the role of a corporate manager is not the same as that of a trustee. The trustee's role of preserving the trust capital while investing conservatively to produce income is fundamentally at odds with the risk-taking required of corporate directors and officers in search of profit maximisation (see Welling at 379).

A statutory mechanism that allows interested transactions to be upheld not only enhances predictability and practical administration of interested transactions but is more in keeping with the commercial context in which directors function. Generally speaking, the standard governing commercial relations is one based on good faith and fair dealing. The fiduciary standard for directors has evolved more toward this commercial standard based on honesty and fair dealing; it has been reflected in the CBCA's statutory formulation of directors' duties at s. 122(l): "Every director and officer of a corporation in exercising his powers and discharging his duties shall (a) act honestly and in good faith with a view to the best interests of the corporation ...".

The recommendation made here that directors and officers be placed under a duty of fair dealing with respect to interested transactions flows logically from the duty found at s. 122(l) CBCA, but is a further refinement of it. The s. 122(l) statutory formulation of directors' duties has been heavily interpreted in light of the fiduciary duty line of cases (which obviously import variations on the trust standard). The specific duty of fair dealing in interested director transactions finds its source in the 1994 ALI Principles of Corporate Governance at s. 5.02. It is a statutory expression of the commercial, standard which has in fact evolved in this area, away from the commercially impracticable trust standard. The imposition of an impracticable standard prompted the search for a means of validating commercially reasonable transactions. By stating a duty of fair dealing, the commercial nature of the standard should be made readily apparent and distinguished from stricter fiduciary duties.

The ALI Principles explain the evolution of this duty of fair dealing in the United States.

Many states have "safe harbour" statutes relating to transactions between directors and the corporation. These statutes have generally approached conflict-of-interest transactions in terms of the voidability of transactions and the effect of approval by disinterested directors or shareholders, rather than imposing an affirmative duty of fair dealing. This may reflect the evolution of the law in this area from a rule that originally permitted all transactions with directors to be set aside without regard to fairness, and a tendency to leave the development of affirmative duties of fair dealing to the case law (Comment, s 5.02).

The creation of a statutory duty of fair dealing in interested transactions is a new approach but one which is consistent with the underlying principles in the case law in this area. Further research and careful consideration should be given to introducing this concept.

It is also consistent with concerns expressed by many working party members that shareholders in Hong Kong required greater statutory protections, especially minority shareholders.^[56]

6.20 RECOMMENDATION

Qualification of interested transactions:

Interested transactions should be upheld if (i) directors disclose to the board their material interest in the transaction; (ii) do not vote as a director on any resolution to approve the transaction; and (iii) the transaction was reasonable and fair to the corporation at the time it was approved. In the alternative, such transactions could also be approved by unanimous shareholder consent.

Current Ordinance

Article 86 of Table A allows a company to provide a procedure by which interested transactions can be upheld and directors are not liable for any profit realized from such a transaction. Under this procedure a director must 1) disclose the nature of their interest in accordance with s.162 of the Ordinance - the company's articles of association cannot eliminate the s. 162 disclosure requirement: and 2) not vote on the interested transaction nor be counted in the quorum present at the meeting that considers the transaction (art. 86).

COMMENTARY

The CBCA requires that an interested transaction be both procedurally and substantively fair while the MBCA requires such transaction to be either procedurally or substantively fair. There has been some debate in the literature as to the value of a disjunctive or conjunctive scheme. In particular, the MBCA's disjunctive approach has been criticised as being too lax, in that it may allow directors to engage in substantively unfair transactions by simply following the MBCA's requirements of procedural fairness (see generally M.A. Eisenberg, "Self-Interested Transactions in Corporate Law" (1988) Journal of Corporation Law 997; Kay, supra).

However, the difference between a disjunctive test and conjunctive test is arguably more one of form than substance. Commenting on the "reasonable and fair" branch of their draft act which eventually became the CBCA, the Dickerson Report underlined that this branch served only to give content and substance to the directors' general duty to act in the corporation's best interest.

Particularly noteworthy is the overriding criterion that the contract be "reasonable and fair to the corporation", which is necessary to preclude mutual 'back-scratching" by directors who might otherwise tacitly agree to approve one another's contracts with the corporation. Of course directors who indulge in such conduct will be liable under the general provisions of s. 9.19 [the draft act's provision laying out the directors' general duty to act in the corporation's best interest] in any event [...] The 'reasonable and fair' standard set out in subsection (3)(c) serves only to underline the director's specific duties in the circumstances [emphasis added] (Dickerson Report at para. 228).

Likewise, the Official Commentary to the MBCA in discussing its safe harbour procedures (disclosure and disinterested decision making) made a similar- observation:

... neither the transaction nor the director is legally vulnerable if the procedures of section 8.62 [disclosure and disinterested decision making] have been properly followed. Subsection (b)(1) is, however, subject to a critically important predicate condition... The condition -- an obvious one-- is that the board's action must comply with the care, best interests and good faith criteria prescribed in section 8.30(a)for all directors' actions [emphasis added] (MBCA, Official Comment s. 8.61).

Working party members were generally in favour of tightening the rules in this area provided there was a manner by which transactions could be upheld by shareholder approval (see Recommendation 6.21). The working party members thus supported the conjunctive test which, on balance, is being recommended here.

Professor Sealy noted that the disclosure and disinterested voting procedures were too formalistic for many private companies and suggested the approach adopted in the New Zealand Companies Act 1993 at s. 107(3). If all "entitled persons", essentially shareholders, agree to or concur in a company entering into a transaction in which a director is interested, no further formalities would be required.^[57]

6.21 RECOMMENDATION

Shareholder approval of interested transactions:

Shareholders should be able to vote to uphold a transaction by special resolution in certain circumstances.

Current Ordinance

There is no statutory mechanism through which disinterested shareholders may vote to uphold an interested transaction.

COMMENTARY

This recommendation aims to provide another mechanism by which interested transactions, may be upheld. Under s.242 of the CBCA, shareholder ratification serves only an evidentiary purpose and not a curative one. Under this provision, a legal action (such as an oppression or unfairly prejudicial action) cannot be stayed or dismissed by reason only that an alleged breach of the director's fiduciary duty has been approved by the shareholders; however, evidence of shareholder approval may be taken - into account - by the court in making an order under the CBCA'S oppression remedy or derivative action. Commenting on this provision, the Dickerson Committee stated:

... we think it better to characterise shareholder ratification or waiver as an evidentiary issue, which in effect compels the court to go behind the constitutional structure of the corporation and examine the real issues. If, for example, the alleged misconduct was ratified by majority shareholders who were also the directors whose conduct is attacked, evidence of shareholder ratification would carry little or no weight. If, however, the alleged misconduct was ratified by a majority of disinterested shareholders after full disclosure of the facts, that evidence would carry much more weight indicating that the majority of disinterested shareholders condoned the act or dismissed it as a mere error of business judgment... By giving the court wide discretion to consider the pertinent facts and by barring the court from following a simplistic path such as applying the shareholder ratification rule, we in effect compel the court to adjudge the issue on its merits (Dickerson Report at para. 487).

Although the approach taken in the CBCA definitely has its merits, the Ontario Business Corporations Act (OBCA) and Alberta Business Corporations Act (ABCA), which are in many ways more modern updates of the current CBCA, allow for shareholder ratification by special resolution of interested transactions upon disclosure at sections 132(8) and 115(7), respectively. There was general support for this approach in the working party; in some circumstances, a director may inadvertently fail to make proper disclosure. This defect could be cured by special resolution.^[58]

6.22 RECOMMENDATION

Loans to directors:

Transactions involving loans to directors should continue to be prohibited subject to certain exceptions.

Current Ordinance

The Ordinance lays down a general prohibition on loans to directors subject to certain exceptions (s. 157H).

COMMENTARY

At present, s. 157H of the Ordinance lays down a general prohibition of loans to directors. This general prohibition is subject to certain exceptions such as: shareholder approved loans in private companies; loans made by a company whose ordinary course of business includes lending money and giving guarantees; or loans for house purchases, etc; transactions for the purposes of the company; and transactions within a group of companies. There is a cap on the aggregate of some of these exceptions.

The MBCA treats loans to directors no differently from any other interested director transaction. Therefore, loans, guarantees, pledges, or other forms of assistance to directors are permitted and enforceable so long as the disclosure and disinterested approval requirements are observed and the solvency requirements pertaining to a "distribution" are met. This approach is similar to the SEHK's rules for listed companies in Hong Kong; Rule 14.26(6) requires financial assistance to connected persons which is not upon normal commercial terms in the ordinary and usual course of business to be disclosed and approved by a disinterested shareholder vote.

Although this approach was discussed in the working party meetings, loans to directors were viewed as particularly open to abuse in Hong Kong. "Why should companies be providing their directors with loans in the first place?" was the comment of one working member. For this reason, the working party was inclined to retain the existing prohibition and narrow the exceptions somewhat. An issue to be resolved is whether private companies should be able to provide such loans with shareholder approval. Some jurisdictions (such as Singapore) provide for this while others (such as the U.K., in following a recommendation of the Jenkins Committee) do not.

Unfortunately, retention of the prohibition and exceptions will add complexity to the drafting and, in the opinion of Professor Sealy, risks being ineffective. Directors and their counsel can show great ingenuity in structuring transactions to avoid the prohibition.^[59]

6.23 RECOMMENDATION: Use of Corporate Information and Opportunity. Directors and officers should not disclose or use for their benefit a corporate opportunity or information that they obtain by reason of their position or employment except (i) with consent of disinterested board members, (ii) where disclosure is required by law or otherwise or (iii) where it is reasonable to assume that the disclosure or use of the information or opportunity will not be likely to prejudice the corporation.

Current Ordinance

There is no statutory scheme to deal with the use of corporate information or the diversion of corporate opportunity.

COMMENTARY

At present, Hong Kong has no statutory scheme to deal with the acquisition or diversion of "corporate opportunities" by directors. As a consequence, this area is governed by the same strict trust standard that governs interested transactions. The general rule established in Regal (Hastings) v Gulliver, that any party acting in a fiduciary capacity may not enter into any engagement in which he might have an interest conflicting with that of the beneficiary, and this irrespective of the absence of bad faith, has been accepted in much of the Commonwealth. The law is somewhat different in Canada because of the leading Canadian case of Peso Silver Mines Ltd v Cropper [1966] SCR 673. Canadian courts are unwilling to find a director in breach of his or her duties where both good faith is shown, and where no special or privileged information was delivered from the Position as a director.

Both Australia and New Zealand have innovated in this area by introducing statutory provisions to deal with the problem of corporate opportunities by way of rules regulating the use of company information. Under section 232(5)-(6) of the Australian Corporations Law, directors must not make improper use of their position, or information acquired by virtue of their position, to gain, directly or indirectly, an advantage for themselves or for any other person, or to cause detriment to the corporation. Section 232 is in addition to, and not in derogation of, any other law relating to the duty of a director (eg under the common law a director is liable to account even where he has not improperly used the position of director).

However, New Zealand has gone one step further than Australia. At s.145 of the Companies Act 1993, directors may disclose or make use of information obtained in course of their employment, if they disclose to, as well as receive consent from, the board and the disclosure or use of the information will not prejudice the company. Disclosure is also recorded in an "interest register" which is available to shareholders. The emphasis on disclosure in New Zealand is based on pragmatic considerations. There is greater tolerance of situations of potential conflict of interest given the commercial reality of a small, close-knit business community with a high degree of cross-shareholdings in a small number of large companies.

The better approach to yet another register is simply to note the disclosure in the minutes of meeting.^[60]

APPENDIX M

Extracts from the City Code on Takeovers and Mergers

THE CITY CODE ON TAKEOVERS AND MERGERS

The City Code on Takeovers and Mergers is issued by the Panel on Takeovers and Mergers. The following extracts are taken from the Code updated on 23rd July 1998.

INTRODUCTION

1 The Code

...

(c) Enforcement of the Code

The Code has not, and does not seek to have the force of law. It has, however, been acknowledged by both government and other regulatory authorities that those who seek to take advantage of the facilities of the securities markets in the United Kingdom should conduct themselves in matters relating to takeovers in accordance with best business standards and so according to the Code.

...those who do not so conduct themselves may find that, by way of sanction, the facilities of those markets are withheld.

...

3 The Code in Practice

(a) General Principles and Rules

The Code is based upon a number of General Principles, which are essentially statements of good standards of commercial behaviour. These General Principles apply to all transactions with which the Code is concerned ... They are applied by the Panel in accordance with their spirit to achieve their underlying purpose, the Panel may modify or relax the effect of their precise wording accordingly.

In addition ... the Code contains a series of Rules ... their spirit must be observed as well as their letter and the Panel may modify or relax the application of a Rule...

...

(d) Disciplinary proceedings

If the Panel finds that there has been a breach of the Code, it may have recourse to:

(i) private reprimand;

(ii) public censure;

(iii) reporting the offender's conduct to another regulatory authority (eg the Department of Trade and Industry, the Stock Exchange, FSA or the relevant SRO or RPB);

(iv) taking action for the purpose of the requirements of FSA, relevant SROs and certain RPBs which oblige their members not to act for the offender in a takeover or in certain other transactions; and/or

(v) requiring further action to be taken as the Panel thinks fit.

GENERAL PRINCIPLES

...

9. Directors of an offeror and the offeree company must always, in advising their shareholders, act only in their capacity as directors and not have regard to their personal or family shareholdings or to their personal relationships with the companies. It is the shareholders' interests taken as a whole, together with those of employees and creditors, which should be considered when the directors are giving advice to shareholders. Directors of the offeree company should give careful consideration before they enter into any commitment with an offeror (or anyone else) which would restrict their freedom to advise their shareholders in the future. Such commitments may give rise to conflicts of interest or result in a breach of the directors' fiduciary duties.

...

RULE 21:

Restrictions on frustrating action

During the course of an offer, or even before the date of the offer if the board of the offeree company has reason to believe that a bona fide offer might be imminent, the board must not, except in pursuance of a contract entered into earlier, without the approval of the shareholders in general meeting:–

(a) issue any authorised but unissued shares;

(b) issue or grant options in respect of any unissued shares;

(c) create or issue, or permit the creation or issue of, any securities carrying rights of conversion into or subscription for shares;

(d) sell, dispose of or acquire, or agree to sell, dispose of or acquire, assets of a material amount; or

(e) enter into contracts otherwise than in the ordinary course of business.

The notice convening such a meeting of shareholders must include information about the offer or anticipated offer.

Where it is felt that an obligation or other special circumstance exists, although a formal contract has not been entered into, the Panel must be consulted and its consent to proceed without a shareholders' meeting obtained.

Notes on Rule 21

1. Consent by the offeror.

Where the Rule would otherwise apply, it will nonetheless normally be waived by the Panel if this is acceptable to the offeror.

2. "Material amount"

For the purpose of determining whether a disposal or acquisition is of "a material amount" the Panel will, in general, have regard to the following:–

(a) the value of the assets to be disposed of or acquired compared with the assets of the offeree company;

(b) where appropriate, the aggregate value of the consideration to be received or given compared with the assets of the offeree company; and

(c) where appropriate, net profits (after deducting all charges except taxation and excluding extraordinary items) attributable to the assets to be disposed of or acquired compared with those of the offeree company.

For these purposes, the term "assets" will normally mean fixed assets plus current assets less current liabilities.

Subject to Note 4, the Panel will normally consider relative values of 10% or more as being of a material amount, although relative values lower than 10% may be considered material if the asset is of particular significance.

If several transactions relevant to this Rule, but not individually material, occur or are intended, the Panel will aggregate such transactions to determine whether the requirements of this Rule are applicable to any of them.

The Panel should be consulted in advance where there may be any doubt as to the application of the above.

...

6. Service contracts

The Panel will regard amending or entering into a service contract with, or creating or varying the terms of employment of, a director as entering into a contract "otherwise than in the ordinary course of business" for the purpose of this Rule if the new or amended contract or terms constitute an abnormal increase in the emoluments or a significant improvement in the terms of service.

This will not prevent any such increase or improvement which results from a genuine promotion or new appointment but the Panel must be consulted in advance in such cases.

...

RULE 25. OFFEREE BOARD CIRCULARS

25.4 Directors' service contracts

(a) The first major circular from the offeree board advising shareholders on an offer (whether recommending acceptance or rejection of the offer) must contain particulars of all service contracts of any director or proposed director of the offeree company with the company or any of its subsidiaries where such contracts have more than 12 months to run. If there are none, this should be stated.

(b) If such contracts have been entered into or amended within 6 months of the date of the document, particulars must be given in respect of the earlier contracts (if any) which have been replaced or amended as well as in respect of the current contracts. If there have been none, this should be stated.

Notes on Rule 25.4

1. Particulars to be disclosed

The particulars required in respect of existing service contracts and, where appropriate under Rule 25.4(b), earlier contracts are:–

(a) the name of the director under contract;

(b) the expiry date of the contract;

(c) the amount of fixed remuneration payable under the contract (irrespective of whether received as a director or for management, but excluding arrangements for company payments in respect of a pension or similar scheme); and

(d) the amount of any variable remuneration payable under the contract (eg commission on profits) with details of the formula for calculating such remuneration.

Where there is more than one contract, a statement of the aggregate remuneration payable is normally regarded as fulfilling the requirements under (c) above, except to the extent that this method would conceal material anomalies which ought to be disclosed (eg because one director is remunerated at a very much higher rate than the others). In cases where contracts have been replaced or amended, however, the particulars of remuneration payable under both the existing and the earlier contracts must relate to each individual separately.

It is not acceptable to refer to the latest annual report, indicating that information regarding service contracts may be found there, or to state that the contracts are open for inspection at a specified place.

2. Recent increases in remuneration

The Panel will regard as the amendment of a service contract under this Rule any case where the remuneration of an offeree company director (with a service contract with more than 12 months to run) is increased within 6 months of the date of the document. Therefore, any such increase must be disclosed in the document and the current and previous levels of remuneration stated.

APPENDIX N

Financial Reporting Standard 8 (Related party disclosures) (FRS 8)

The following note appears in a preamble to FRS 8:^[61]

Financial Reporting Standard 8 is set out in paragraphs 1-7.

The Statement of Standard Accounting Practice set out in paragraphs 3-7 should be read in the context of the Objective as stated in paragraph 1 and the definitions set out in paragraph 2 and also of the Foreword to Accounting Standards and the Statement of Principles for Financial Reporting currently in issue.

The Explanation set out in paragraphs 8-23 shall be regarded as part of the Statement of Standard Accounting Practice insofar as it assists in interpreting that statement ...

OBJECTIVE

The objective of this FRS is to ensure that financial statements contain the disclosures necessary to draw attention to the possibility that the reported financial position and results may have been affected by the existence of related parties and by material transactions with them.

DEFINITIONS

The following definitions shall apply in this FRS and in particular in the Statement of Standard Accounting Practice set out in paragraphs 3-7.

2.1 Close family:-

Close members of the family of an individual are those family members, or members of the same household, who may be expected to influence, or be influenced by, that person in their dealings with the reporting entity.

2.2 Control:-

The ability to direct the financial and operating policies of an entity with a view to gaining economic benefits from its activities.

2.3 Key management:-

Those persons in senior positions having authority or responsibility for directing or controlling the major activities and resources of the reporting entity.

2.4 Persons acting in concert:-

Persons who, pursuant to an agreement or understanding (whether formal or informal), actively co-operate, whether by the ownership by any of them of shares in an undertaking or otherwise, to exercise control or influence^[62] over that undertaking.

2.5 Related parties:-

(a) Two or more parties are related parties when at any time during the financial period:

(i) one party has direct or indirect control of the other party; or

(ii) the parties are subject to common control from the same source; or

(iii) one party has influence over the financial and operating policies of the other party to an extent that that other party might be inhibited from pursuing at all times its own separate interests; or

(iv) the parties, in entering a transaction, are subject to influence from the same source to such an extent that one of the parties to the transaction has subordinated its own separate interests.

(b) For the avoidance of doubt, the following are related parties of the reporting entity:

(i) its ultimate and intermediate parent undertakings, subsidiary undertakings, and fellow subsidiary undertakings;

(ii) its associates and joint ventures;

(iii) the investor or venturer in respect of which the reporting entity is an associate or a joint venture;

(iv) directors^[63] of the reporting entity and the directors of its ultimate and intermediate parent undertakings; and

(v) pension funds for the benefit of employees of the reporting entity or of any entity that is a related party of the reporting entity;

(c) and the following are presumed to be related parties of the reporting entity unless it can be demonstrated that neither party has influenced the financial and operating policies of the other in such a way as to inhibit the pursuit of separate interests:

(i) the key management of the reporting entity and the key management of its parent undertaking or undertakings;

(ii) a person owning or able to exercise control over 20 per cent or more of the voting rights of the reporting entity, whether directly or through nominees;

(iii) each person acting in concert in such a way as to be able to exercise control or influence^[64] over the reporting entity; and

(iv) an entity managing or managed by the reporting entity under a management contract.

(d) Additionally, because of their relationship with certain parties that are, or are presumed to be, related parties of the reporting entity, the following are also presumed to be related parties of the reporting entity:

(i) members of the close family of any individual falling under parties mentioned in (a)-(c) above; and

(ii) partnerships, companies, trusts or other entities in which any individual or member of the family in (a)-(c) above had a controlling interest.

Sub-paragraphs (b), (c) and (d) are not intended to be an exhaustive list of related parties.

2.6 Related party transaction:-

The transfer of assets or liabilities or the performance of services by, to or for a related party irrespective of whether a price is charged.

STATEMENT OF STANDARD ACCOUNTING PRACTICE

Scope

Financial Reporting Standard 8 applies to all financial statements that are intended to give a true and fair view of a reporting entity's financial position and profit or loss (or income and expenditure) for a period. The FRS does not, however, require disclosure:

(a) in consolidated financial statements, of any transactions or balances between group entities that have been eliminated on consolidation;

(b) in a parent's own financial statements when those statements are presented together with its consolidated financial statements;

(c) in the financial statements of subsidiary undertakings, 90 per cent or more of whose voting rights are controlled within the group, of transactions with entities that are part of the group or investees of the group qualifying as related parties, provided that the consolidated financial statements in which that subsidiary is included are publicly available;

(d) of pension contributions paid to a pension fund; and

(e) of emoluments in respect of services as an employee of the reporting entity.

Reporting entities taking advantage of the exemption in (c) above are required to state that fact.

The FRS does not require disclosure of the relationship and transactions between the reporting entity and the parties listed in (a)-(d) below simply as a result of their role as:

(a) providers of finance in the course of their business in that regard;

(b) utility companies;

(c) government departments and their sponsored bodies,

even though they may circumscribe the freedom of action of an entity or participate in its decision making process; and

(d) a customer, supplier, franchiser, distributor or general agent with whom an entity transacts a significant volume of business.

Disclosure of control

When the reporting entity is controlled by another party, there should be disclosure of the related party relationship and the name of that party and, if different that of the ultimate controlling party. If the controlling party or ultimate controlling party of the reporting entity is not known, that fact should be disclosed. The information should be disclosed irrespective of whether any transactions have taken place between the controlling parties and the reporting entity.

Disclosure of transactions and balances

Financial statements should disclose material transactions undertaken by the reporting entity with a related party. Disclosure should be made irrespective of whether a price is charged. The disclosure should include:

(a) the names of the transacting related parties;

(b) a description of the relationship between the parties;

(c) a description of the transactions;

(d) the amounts involved;

(e) any other elements of the transactions necessary for an understanding of the financial statements;

(f) the amounts due to or from related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and

(g) amounts written off in the period in respect of debts due to or from parties.

Transactions with related parties may be disclosed on an aggregated basis (aggregation of similar transactions by type of related party) unless disclosure of an individual transaction, or connected transactions, is necessary for an understanding of the impact of the transactions on the financial statements of the reporting entity or is required by law.

Date from which effective

The accounting practices set out in the FRS should be regarded as standard in respect of financial statements relating to accounting periods commencing on or after 23 December 1995. Earlier adoption is encouraged but not required.

EXPLANATION

The effect of related parties

In the absence of information to the contrary, it is assumed that a reporting entity has independent discretionary power over its resources and transactions and pursues its activities independently of the interests of its individual owners, manages and others. Transactions are presumed to have been undertaken on an arm's length basis, ie on terms such as could have obtained in a transaction with an external party, in which each side bargained knowledgeably and freely, unaffected by any relationship between them.

These assumptions may not be justified when related party relationships exist, because the requisite conditions for competitive, free market dealings may not be present. Whilst the parties may endeavour to achieve arm's length bargaining the very nature of the relationship may preclude this occurring. Sometimes the nature of the relationship between the parties is such that the disclosure of the relationship alone will be sufficient to make users aware of the possible implications of related party transactions. For this reason, transactions between subsidiary undertaking, 90 per cent or more of whose voting rights are controlled within the group, and other members and investees of the same group are not required to be disclosed in the separate financial statements of the subsidiary undertaking.

Even when terms are arm's length, the reporting of material related party transactions is useful information, because the terms of future transactions are more susceptible to alteration as a result of the nature of the relationship than they would be in transactions with an unrelated party. Although the existence of a related party relationship sometimes precludes arm's length transactions, non-independent parties can deal with each other at arm's length, as in the situation where a parent undertaking places no restrictions on two subsidiaries, giving them complete freedom in deciding whether to deal with each other and on what terms. However, assertions in financial statements about transactions with related parties should not imply that the related party transactions were effected on terms equivalent to those that prevail in arm's length transactions unless the parties have conducted the transactions in an independent manner.

Applying the definition of 'related party'

Party

The definition of a related party encompasses both an individual or an entity, such as a company or unincorporated business, and a group of individuals or entities acting in concert. Groups of individuals or entities are include in this definition because although a single individual or entity (having, for example only a small shareholding) might not be able to divert a particular reporting entity from pursuing its own separate interests, this could be achieved by the individual or entity acting in concert with others.

Relationship

The definition is limited to parties having a relationship with a reporting entity that affects the pursuit of separate interests of either the reporting entity or the other party, since transactions with such parties could have a significant effect on the financial position and operating results of the reporting entity. Consequently, subsidiary undertakings and associates are related parties of the investor. The reporting entity and a major customer or supplier are not related parties by virtue of that connection alone because the reporting entity still retains the freedom to make decisions in its own separate interests.

Common control

Entities subject to common control are included in the definition of a related party because the controlling entity could cause such entities to transact particular terms. The relationship could therefore have a material effect on the performance and financial position of the reporting entity. Common control is deemed to exist when both parties are subject to control from boards having a controlling nucleus of directors in common.

Common influence

The difference between control and influence is that control brings with it the ability to cause the controlled party to subordinate its separate interests whereas the outcome of the exercise of influence is less certain. Two related parties of a third entity are not necessarily related parties of each other. For example:

(a) entities are not related parties by reason only of their being associated companies of the same investor. The parties are subject only to influence rather than common control, hence the relationship between them is normally too tenuous to justify their being treated as related parties of each other;

(b) similarly when one party is subject to control and another party is subject to influence from the same source, those two parties are not necessarily related parties of each other. Since one of the parties is subject only to influence rather than control, the relationship between them would not normally justify their being treated as related parties of each other; and

(c) two entities are not related parties simply because they have a director in common.

In all circumstances, however, it will be appropriate to consider whether one or both transacting parties, subject to control and influence from the same source or common influence, have subordinated their own separate interests in entering into that transaction.

Pension funds

The fact that certain pension funds are related parties of the reporting entity is not intended to call into question the independence of the trustees with regard to their fiduciary obligations to the members of the pension scheme. Transactions between the reporting entity and the pension fund may be in the interest of members but nevertheless need to be reported in the accounts of the reporting entity.

Scope

Related party disclosure provisions do not apply in circumstances where to comply with them conflicts with the reporting entity's duties of confidentiality arising by operation of law (although operation of law would not include the effects of terms stipulated in a contract). For example, banks are obliged by law to observe a strict duty of confidentiality in respect of their customers' affairs and the FRS would not override the obligation to preserve the confidentiality of customers' dealings.

Exempt subsidiary undertakings

The FRS grants certain exemptions to subsidiary undertakings 90 per cent or more of whose voting rights are controlled within the group. These subsidiaries do not have to disclose transactions with other group companies and investees of the group qualifying as related parties. The latter includes associates and joint ventures of other group companies with whom the reporting subsidiary has transacted in circumstances falling under paragraph 2.5(a)(iv). Disclosure would, however, be required of transactions with related parties of the reporting subsidiary other than those that are excluded by the exemption.

Disclosure of control

If the reporting entity is controlled by another party, that fact is relevant information, irrespective of whether transactions have taken place with that party, because the control relationship prevents the reporting entity from being independent in the sense described in paragraph 8. Indeed, the existence and identity of the controlling party may sometimes be at least as relevant in appraising an entity's prospects as are the performance and financial position presented in its financial statements. The controlling party may establish the entity's credit standing, determine the source and price of its raw materials, determine the products it sells, to whom and at what price, and may affect the source, calibre and even the primary concern and allegiance of its management.

Disclosure of transactions

Transactions

Disclosure is required of all material related party transactions. As transactions include donations to or by the entity, related party transactions are required to be disclosed whether or not a price is charged. The following are examples of related party transactions that require disclosure by a reporting entity in the period in which they occur:

- purchases or sales of goods (finished or unfinished);

- purchases or sales of property and other assets;

- rendering or receiving of services;

- agency arrangements;

- leasing arrangements;

- transfer of research and development;

- licence agreements;

- provision of finance (including loans and equity contributions in cash or in kind);

- guarantees and the provision of collateral security; and

- management contracts.

Materiality

Transactions are material when their disclosure might reasonably be expected to influence decisions made by the users of general purpose financial statements. The materiality of related party transactions is to be judged, not only in terms of their significance to the reporting entity, but also in relation to the other related party when that party is:

(a) a director, key manager or other individual in a position to influence, or accountable for stewardship of, the reporting entity; or

(b) a member of the close family of any individual mentioned in (a) above; or

(c) an entity controlled by any individual mentioned in (a) or (b) above.

Aggregation

Disclosure of details of particular transactions with individual related parties would frequently be too voluminous to be easily understood. Accordingly, similar transactions may be aggregated by type of related party. For example, in the individual accounts of a group company, purchases or sales with other group companies can be aggregated and described as such. However, this should not be done in such a way as to obscure the importance of significant transactions. Hence purchases or sales of goods should not be aggregated with purchases or sales of fixed assets. Nor should a material related party transaction with an individual be concealed in an aggregated disclosure.

Other elements of the transaction

Paragraph 6(e) requires disclosure of 'any other elements of the [related party] transactions necessary for an understanding of the financial statements'. An example falling within this requirement would be the need to give an indication that the transfer of a major asset had taken place at an amount materially different from that obtainable on normal commercial terms.

Relationship with statutory and London Stock Exchange requirements

There are extensive statutory and London Stock Exchange requirements and reliefs regarding disclosure of related party transactions and relationships. In certain instances, the FRS will extend existing disclosure requirements; in other instances, the statutory and London Stock Exchange disclosure requirements go beyond those of the FRS. The location of the principal statutory and London Stock Exchange requirements is given in Appendices I and II respectively.

APPENDIX O

List of Individuals and Organisations who have assisted with the project

The Accounting Standards Board

John Aldis, KPMG

Mark Ashworth, Assistant Company Secretary, NatWest Group plc

The Association of British Insurers

The Australian Law Commission

Robert Ayling, Chief Executive, British Airways plc

Colin Bamford, Financial Law Panel

Alan Barr, Burges Salmon

Jonathan Bates, The British Petroleum Company plc

Martin Beagley, ABI

Beaufort Management Consultants Ltd

Robert Bertram, Edinburgh and Heroit-Watt Universities

The Board of Directors, British Airways plc

R E Brown & Others, Syndicate 702 at Lloyd's

Anthony Carey, The Institute of Chartered Accountants in England & Wales

The Centre for Tomorrow's Company

Martin Chester, Theodore Goddard

Alastair Clark, Executive Director, Bank of England

Brian Cleave CB, Solicitor for the Inland Revenue

Allan Cook, Accounting Standards Board

Companies House

Confederation of British Industry

Harriet Creamer, Freshfields

The Crown Office in Scotland

Professor Paul Davies, Balliol College, University of Oxford

Andrew Davison, Eversheds

Dr Simon Deakin, The ESRC Centre for Business Research and Peterhouse College, University of Cambridge

Department of Trade and Industry

Clive Edrupt, CBI

The ESRC Centre for Business Research, University of Cambridge

Financial Law Panel

Financial Services Authority

The Federation of Small Businesses

Ronald D Fox, Fox Williams

The General Council of the Bar, Law Reform Committee

The Hon Mr Justice Girvan

Peter Graham, Norton Rose

Philip Goldenberg, S J Berwin & Co

David Gould, NAPF

Anthony Hammond CB QC, HM Procurator General and Treasury Solicitor

Sir Ronald Hampel, Chairman, ICI plc

Ian Hanford, Federation of Small Businesses

John Harper, Institute of Directors

David Harris, Lovell White Durrant

Neil Harvey, Clifford Chance

John Healey, The Stock Exchange and the Hampel Committee

Giles Henderson CBE, Slaughter & May

Andrew Hicks, University of Exeter

Peter Holgate, Coopers & Lybrand

The Home Office, Research and Statistics Directorate

Dean Horton, Chubb Insurance

Alan Hughes, The ESRC Centre, University of Cambridge

Tim Humphreys, ABI

Rodney Insall, Controller, Company Secretary's Office, British Petroleum Company plc

The Insolvency Service

The Institute of Chartered Accountants in England and Wales

The Institute of Chartered Secretaries and Administrators

Institute of Directors

John Jackson, ICSA

Barry Johnson, Coopers & Lybrand

Helen Jones, Company Secretary, Kingfisher plc

Martyn Jones, Deloitte & Touche

Alan Keat, Travers, Smith Braithwaite

The Law Reform Advisory Committee for Northern Ireland

The Law Society, Company Law Committee

The London Stock Exchange

John Lowry, Brunel University

Kelly Lyles, AIG Europe (UK) Limited

Roger Lyons, TUC and General Secretary of the MSF

Lord Marshall, Chairman, British Airways plc

Michael McKersie, ABI

Adrian J Mezzetti, Gregory, Rowcliffe & Milners

Robin Michaelson, ABI

The National Association of Pension Funds Ltd, Investment Committee

The National Audit Office

Maureen Nolan, ICSA

Richard Nolan, St John's College, University of Cambridge

The Occupational Pensions Regulatory Authority

Stephen Page, Barclays Bank and British Bankers' Association

The Panel on Takeovers and Mergers

The Hon Mr Justice Park

Caroline Phillips, ICSA

Tom Preece, Federation of Small Businesses

Professor Dan Prentice, Erskine Chambers and Pembroke College, University of Oxford

John Quarrell, the NAPF and Nabarro Nathanson

Gail Redwood, Company Secretary, British Airways plc

Jonathan Rickford, Project Director, The Company Law Review (DTI)

Jane Ridley, Financial Services Authority

Ken Rushton, Company Secretary, ICI Plc

The Serious Fraud Office

Isobel N Sharp, Arthur Andersen

The Society of Practitioners of Insolvency

Sir Thomas Stockdale Bt., Erskine Chambers

John Thirlwell, British Bankers' Association

Mia Thomas, CBI

The Trades Union Congress

Treasury Solicitor's Office

HM Treasury & Cabinet Office, Library and Information Service

Mark Watson, Institute of Directors

Ian West, R E Brown & Others, Syndicate 702 at Lloyd's

Ken Wild, Deloitte & Touche

Janet Williamson, TUC

Giles Wintle, ICA

Malcom Woodford, Price Waterhouse

Professor F Wooldridge, Notre Dame University in London

Robert Wright QC, Erskine Chambers

Note 1   See also the Companies Consolidation (Consequential Provisions) Act 1985, s 15 (see further s 189(3) of the 1948 Act and s 34(3) of the 1947 Act).    [Back]

Note 2   See also the Friendly Societies Act 1992, s 27, Sched 11, para 8(1); and in relation to a company which is a charity, the Charities Act 1993, s 66.    [Back]

Note 3   See also the Charities Act 1993, s 66.    [Back]

Note 4   Section 36(4) of the 1947 Act inserted subsections (4A) and (4B) into s 150(4) of the 1929 Act.    [Back]

Note 5   See, in relation to this subsection, the Friendly Societies Act 1992, s 27, Sched 11, para 8(1).    [Back]

Note 6   Section as amended by s 110, Companies Act 1981.    [Back]

Note 7   Subsection (7) amended by Companies Act 1989, ss 143(7), 212, Sched 24.    [Back]

Note 8   See further, in relation to a company which is a charity, Charities Act 1993, s 66.    [Back]

Note 9   See also s 66 of the Charities Act 1993. Sections in the 1980 Act as amended by s 110(2), Companies Act 1981.    [Back]

Note 10   As amended by SI 1984/134, art 46*.    [Back]

Note 11   As amended by the Companies (Fair Dealing by Directors) (Increase in Financial Limits) Order, SI 1990/1393, art 2.    [Back]

Note 12   Subsection (4) added by the Companies Act 1989, s 145, Sched 19, para 8.    [Back]

Note 13   As amended by s 110(3) of the Companies Act 1981.    [Back]

Note 14   As amended by SI 1984/134, art 47*.    [Back]

Note 15   Added by s 109(1) of the Companies Act 1989.    [Back]

Note 16   Inserted by the Companies (Single Member Private Limited Companies) Regulations 1992, SI 1992/1699, reg 2(b), Sched, para 3(1), pursuant to art 5 of the 12th Company Law Directive [1989] OJ L395/40.    [Back]

Note 17   Section as amended by Sched 3, para 28 of the Companies Act 1981.    [Back]

Note 18   See also s 732, Companies Act 1985.    [Back]

Note 19   Sections amended by s 119, Sched 3, para 28, Companies Act 1981.    [Back]

Note 20   Subsection (2) as amended by the Age of Legal Capacity (Scotland) Act 1991, s 10, Sched 1, para 39.    [Back]

Note 21   Subsection (8) as amended by the Age of Legal Capacity (Scotland) Act 1991, s 10, Sched 1, para 39.    [Back]

Note 22   Section as amended by the Financial Services Act 1986, s 212(2), Sched 16, para 20.    [Back]

Note 23   See also s 732 Companies Act 1985.    [Back]

Note 24   Sections as amended by s 119, Sched 3, para 56 of the Companies Act 1981.    [Back]

Note 25   Subsection (5) repealed by the Bankruptcy Act 1987, s 108(2), Sched 7, Pt I.     [Back]

Note 26   Subsection (1)(b) as amended by the Companies Act 1989, s 138.    [Back]

Note 27   As amended by the Companies Act 1981, s 119, Sched 3, para 49.    [Back]

Note 28   As amended by the Companies Act 1989, s 138.    [Back]

Note 29   As amended by the Companies Act 1981, s 111(1).    [Back]

Note 30   Subsection (1) amended by SI 1990/1393, art 2.    [Back]

Note 31   Subsection (3) amended by SI 1990/1393, art 2. See also, for companies which are also a charity, s 66, Charities Act 1993.    [Back]

Note 32   Subsection (4) amended by the Companies Act 1989, s 138 and s 23, Sched 10, Pt I, para 10.    [Back]

Note 33   Subsection amended by s 138, Companies Act 1989.    [Back]

Note 34   Sections as amended by s 111(2) and s 119 and Sched 3, para 50 of the Companies Act 1981.    [Back]

Note 35   Subsection amended by Companies Act 1989, s 23, Sched 10, Pt I, para 10.    [Back]

Note 36   Subsection amended by SI 1990/1393, art 2.    [Back]

Note 37   As amended by SI 1984/1169, art 6.**    [Back]

Note 38   Subsection amended by SI 1994/223, reg 6(2). Subsections (2)-(4) substituted by SI 1994/223, reg 6(3) and (4).    [Back]

Note 39   Sections amended by SI 1984/134, art 49.*    [Back]

Note 40   Excluding sub-subsection (b).    [Back]

Note 41   Subsection amended by SI 1990/1393, art 2.    [Back]

Note 42   Subsection amended by s 23, Sched 10, Pt I, para 10, Companies Act 1989.    [Back]

Note 43   Section as amended by the Companies Act 1981, s 119, Sched 3, paras 54 and 55 and SI 1984/1169, art 7, (paragraph 64(1)(e) inserted by SI 1984/1169).**    [Back]

Note 44   As amended by Sched 3, paras 28, 29 of the Companies Act 1981.    [Back]

Note 45   As amended by Sched 3, para 52 of the Companies Act 1981.    [Back]

Note 46   The APB's SAS 600 - Auditors' report on financial statements - May 1993 ( based on the Cadbury Code of Best Practice).    [Back]

Note 47   Large companies only.    [Back]

Note 48   If no separate statement of the business as a going concern is made by the directors.    [Back]

Note 49   Effective as of 1 January 1999 ( 93(4) sentence 4 will read as follows: The foregoing period of time shall not apply if the person liable for damages is insolvent and enters into a composition with his creditors to avoid insolvency proceedings or if the liability for damages is subject to an insolvency plan.    [Back]

Note 50   Effective as of 1 January 1999 ( 93(5) sentence 4 will read: If insolvency proceedings have been instituted over the company's assets, the receiver or the trustee, as the case may be, shall exercise the rights of the creditors against the members of the management board during the course of such proceedings.    [Back]

Note 51   DR: paras. 236-242, Draft Act s.9.19. CBCA: s.122. OBCA: S.134. MBCA: .30(a). NZLC R9: paras. 184-195,497,504520, Draft Act ss. 100(2),101-107. NZLC R16: para. 55, Draft Acts. 101.    [Back]

Note 52   DR: Draft Act s.9.16(9). CBCA: s.123(4). OBCA: S.135(4). MBCA: .30(b). NZLC R9: paras. 520-522. NZLC R16: Draft Act s. 107.    [Back]

Note 53   DR: paras. 243-246, Draft Act s.9.20(l)-(3),(5)-(7). CBCA: s.124. OBCA: s.136. MBCA: .50-8.51. NZLC R9: paras. 88,560-563, Draft Acts. 125. NZLC R16 : para. 58, Draft Act s 125. UK Companies Act l985: ss. 310(3),144,727.    [Back]

Note 54   DR: paras. 249-251, Draft Acts. 9.20(4). CBCA: s. 124(4). OBCA: s.136(4). MBCA: .57. NZLC R9: paras. 88,560-563, Draft Act s.125. NZLC R16: para. 58, Draft Act s.125. UK Companies Act 1985: s.310. UK Companies Act 1989: s. 137(l).    [Back]

Note 55   MBCA: s..09.    [Back]

Note 56   DR: para. 228, Draft Act s.9.17(3)(c). OBCA: s.13.2(7). MBCA: S .60-8.63. NZLC R9: paras. 193, 523-542, Draft Act ss. 108-113.    [Back]

Note 57   DR: paras. 226-32, Draft Act s.9.17. CBCA: s.120(7). OBCA: s.132(7). MBCA s.8.61. NZLC R9: paras. 193,523-542, Draft Act ss. 108-113 (but note voting by interested directors is permitted).    [Back]

Note 58   OBCA: s.132(8). MBCA: s..63.    [Back]

Note 59   DR: Draft Acts s 5.16(2). CBCA: s 44. OBCA: s 20. MBCA: ss..60-8.63. NZLC R9: see generally Draft Act ss 108-113.    [Back]

Note 60   MBCA: ss .60-8.63. NZLC R9: paras. 92,536-539, Draft Act s.112.    [Back]

Note 61   Issued by the Accounting Standards Board in October 1995.    [Back]

Note 62   In terms of para 2.5(a)(iii).    [Back]

Note 63   Directors include shadow directors, which are defined in companies legislation as persons in accordance with whose directions or instructions the directors of the company are accustomed to act.    [Back]

Note 64   In terms of paragraph 2.5(a)(iii).    [Back]

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	Scottish Law Commission (Discussion Papers)
You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Discussion Papers) >> Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties [1998] SLC 105(APPENDIX) (DP) (August 1998) URL: http://www.bailii.org/scot/other/SLC/DP/1998/105(APPENDIX).html Cite as: [1998] SLC 105(APPENDIX) (DP)