Companies Act Section 151: the nightmare is nearly over
4 November 2002
23 June 1998
24 July 2006
11 June 2001
19 November 2001
27 October 2008
Lawyers can be remarkably magnanimous when it comes to fees. Rather than charge clients tens of thousands of pounds to wrestle with a draconian, but unfortunately necessary, piece of company law, the City's finest are saying they would prefer to see Section 151 of the Companies Act 1985 scrapped.
If only it were that simple. This cumbersome piece of legislation, which outlines the rules on financial assistance by a company for the acquisition of its own shares, has been a veritable hornet's nest for a number of years.
Back in 1998 when Margaret Beckett, then the Secretary of State for Trade and Industry, launched the Company Law Review, she commented that the business community spent around £20m a year grappling with Section 151.
And much of this £20m, it was argued, ended up in lawyers' pockets.
Although, given the speed at which the Department of Trade and Industry (DTI) has moved on trying to rectify Section 151, you have to question whether it really takes the cost to the business community seriously anyway.
Commenting on this legislation, most City lawyers estimate that, when dealing with a management buyout (MBO) for example, clients can spend between £10,000 and £40,000 in both legal and accountancy fees in attempting to wind their way around this legislation.
For those practising in the City, especially at the magic circle firms, it is a lot easier to turn around and say they would be happy to forfeit this payment in return for a smoother process when dealing with an MBO.
Certainly, billings on dealing with Section 151 are a mere drop in the ocean when you consider that lawyers can earn between £500,000 and £750,000 in fees for acting on, say, a £500m MBO or leveraged buyout.
But for smaller or regional firms, £40,000 is a lot of money, so it would be slightly more difficult for these outfits to be so blasé.
However, looking at Section 151 in detail, it is hard not to see the merits of scrapping it, since it would certainly be advantageous to clients' bank balances.
First, some basic facts. Section 151 predominantly affects private companies, since public businesses are strictly prohibited from aiding the purchase of their own shares. And most importantly, it is there to protect the creditors.
But for private companies, while a prohibition exists lawyers can employ what is commonly known as a 'whitewash' protocol, which was introduced in the early 1980s to circumvent Section 151.
So if, for example, a newco is granted a loan to buy a business but needs to prove it can make repayments, the target company will use its own assets as security.
At that stage the directors need to make a statutory declaration to prove that the company will be solvent for 12 months. This is supported by a letter from its auditors to confirm that the business is not going to go belly-up any time soon.
So far so good. But this is where all the problems start.
First of all, lawyers have to determine if financial assistance is being given, and although the Companies Act provides some definitions, hours of navel-gazing inevitably follow.
It is true that most experienced lawyers should be more than qualified to identify whether a deal includes some element of financial assistance, but this is an area where mistakes can be made.
But if there are elements of financial assistance lawyers can simply whitewash their way out of the problem.
But it is so hideously time consuming. One partner spoke of a situation where he had to hire out a room at London's Barbican just to have the space to deal with hundreds of documents. Another said that he had to muck around with the procedure just to get paid, because his legal fees were being sourced from the target company.
Then there is the small matter that breaching Section 151 is one of a very few areas of the Companies Act that could actually constitute a criminal offence, ending up with a two-year spell in prison and unlimited fines.
It is worth pointing out, though, that no director of a private company has ever been sent to jail for breaching this section. And the scant examples of public companies allegedly breaching the clause - for example Ernest Saunders in the Guinness debacle - have never been stood up.
Besides, it would be nigh on impossible for an insolvency expert to prove that the clause was breached when a director could turn round and argue that they had been acting under the best advice of their lawyers and accountants.
However, the mere sniff of criminal proceedings is enough to scare the hell out of directors.
One partner chuckles about the legion of fond memories he has of directors discussing the declaration of solvency and the potential criminal element and often behaving like "rabbits in a headlight".
Better still, directors will refuse to accept the liability, state that the new management should take the flack and sign the declaration; then they walk out.
Okay, so Section 151 is a nightmare. And from a client's point of view, getting rid of or simplifying it would save money, despite hitting smaller law firms where it hurts.
The DTI, however, has been dithering over Section 151 for four years without even a whiff of a conclusion on the horizon.
The white paper published in response to the 1998 Company Law Review in July put forward such suggestions as removing unlimited companies from the scope of the prohibition, subject to certain safeguards.
Things are really moving fast then. There was not even a sniff of draft legislation on this point in the white paper.
If you have a situation where (most) lawyers are willing to give up a chunk of fees to get rid of this irritating section, then should not the DTI pull its collective finger out?
Lawyers suggest that there are a number of other areas in the Companies Act that protect creditors, but the DTI seems intent on tiptoeing around the issue without searching for any real resolution.
The hope is that a 'modernised' Companies Act will be in place by 2004, although given the DTI's quibbling over such a small but important issue, and one that is crying out for change, lawyers should not risk holding their breath and waiting for a solution.