This guide is based on UK law as at 1st February 2010, unless otherwise stated.
If a company’s shares are traded on the main market of the London Stock Exchange there is a further set of requirements before directors can contract with their own company. (See other relevant guides under Directors' duties)
Chapter 11 of the Listing Rules stipulates that where a transaction is proposed between a listed company or any of its subsidiaries and a ‘related party’, two things must happen: the company must send a circular to its shareholders explaining and valuing the transaction; and shareholders must formally approve the deal.
For these purposes, a related party includes:
- a director of the company (including a shadow director);
- a director of another company in the same group;
- a holder of 10 per cent of the shares in the company or another company in the same group, or someone able to control 10 per cent of the votes attaching to those shares;
- someone who is no longer such a director or shareholder but who was in the previous 12 months;
- someone who exercises a significant influence over the company;
- anyone connected with any of the above, such as immediate family, trustees or a related company.
Exemptions from the requirement for a circular and shareholder vote apply in a number of circumstances, including those listed below.
- The transaction has a revenue nature, rather than capital, and is ‘in the ordinary course of business’. (Thus, shareholder approval would potentially be needed for a director buying a fixed asset from a listed company for £500,000, but not for the director to be paid an annual bonus of £500,000 if the bonus scheme could be said to be in the ordinary course of business.)
- The director or 10 per cent shareholder qualifies as a related party only by virtue of being a director or shareholder of an ‘insignificant subsidiary’ – that is, a subsidiary that has contributed less than 10 per
cent of profits and represents less than 10 per cent of assets of the listed group in the past three financial years.
- The proposed transaction is a ‘small transaction’ – that is, one where various ratios detailed in the Listing Rules (for example, the amount to be paid under the transaction relative to the market capitalisation of the listed company) are no more than 0.25 per cent.
- The proposed transaction is outside the definition of small because one or more of the ratios detailed in the Listing Rules is above 0.25 per cent but all of them are still below five per cent. In this case, a company will be exempt from the normal requirements, but will have to obtain from an appropriate adviser confirmation that the terms of the proposed transaction are fair and reasonable so far as the shareholders are concerned. (Similar ratios apply to AIM companies. If any of them are five per cent or more, an AIM company must announce the transaction with the related party, disclosing certain specified details about it, and the board must confirm that, having consulted the company’s nominated adviser, it considers the transaction to be fair and reasonable.)