The importance of corporate governance cannot be overemphasized. Corporate governance plays the role of preserving corporate assets, promoting accountability and ensuring that those entrusted with management powers do not exploit their position for personal benefit.
Directors control the company’s affairs. They influence financial decisions and have access to company’ resources. To curb excesses, section 305 (1) of the Companies and Allied Matters Act, 2020 (“CAMA”) makes it clear that a director of a company stands in a fiduciary relationship with the company and most ensure that all actions taken with respect to the company are done in utmost good faith. Section 305 (3) further provides that at all times, a director must act in what is said to be the best interests of the company as a whole so as to preserve its assets, further its business and promote the purpose for which it was formed.
Without safeguards, the line between fiduciary duty and self-interest can be blurry. It is for this reason that the law has provided protective mechanisms to prevent conflict of interest and misuse of corporate funds. One of such protection is the statutory prohibition on loans to directors under Section 296 CAMA.
THE LEGAL FRAMEWORK
Section 296 of CAMA provides as follows:
“it is not lawful for a company to make a loan to any person who is a director or a director of its holding company, or enter into any guarantee or provide any security in connection with a loan made to such a person as earlier mentioned by any other person”.
The above provision achieves the following:
- Ensures that Company’s Funds are not Treated as the Personal Property of the Directors: It is a foundational principle of corporate law that upon incorporation, company becomes a distinct legal entity separate from its directors and shareholders. This principle is established in the locus classicus case of Salomon vs. Salomon & Co Ltd. (1897) AC 22 where the House of Lords upheld the doctrine of corporate personality. Sections 42 and 43 CAMA further establishes this principle by supporting the provision that companies have the powers of natural persons and have the power to own property.
The implication of the above is that any property purchased in the name of the company, belongs to the company and no member of the company or directors is permitted to apply the company’s properties and assets for their personal use. By limiting a company’s ability to advance funds to directors, the law reinforces the separation between corporate property and personal benefit.
- To Prevent Conflict of Interest Situation: Allowing directors to borrow from a company could compromise their decision-making. By prohibiting loans to directors, CAMA establishes a clear legal boundary and minimises the risks of decisions being driven by personal financial considerations rather than the welfare of the company. Where there is no conflict of interest, the integrity of directors is upheld.
- To Protect Shareholders and Creditors: The actions of Directors, directly affects the financial position of a company and shareholders rely on the management to act in the best interest of the business. If directors were allowed to borrow freely from the company, it could jeopardize the assets available to shareholders and creditors. The prohibition under CAMA serves as a protective function in this regard.
- To Prevent the Misuse and Diversion of Funds: One of the main objectives of corporate structure is to prevent the improper use or the diversion of company’s assets. The restriction imposed by section 296 CAMA functions as a preventative guard. By limiting instances under which company’s funds may be advanced to directors, the law reduces opportunity for abuse.
WHAT IS THE SCOPE OF THE RESTRICTION PROVIDED BY SECTION 296 CAMA?
Section 296 CAMA does not only prohibit straight forward lending mechanisms, it also places restrictions on indirect mechanisms through which loans may be obtained. The scope of the restriction is further explained below:
- Direct Loans: Any advancement of money from the company to a director falls within the scope of the section, regardless of whether the loan is interest-free or granted on commercial terms.
- Indirect Financial Assistance: This provision of CAMA also prohibits the company from guaranteeing or securing a loan granted to a director by another person. This prevents circumvention of the law.
- Restriction on Advancement to Directors of Holding Companies: To prevent group structures from being used as a medium to circumvent the law, Section 296 CAMA further places a restriction on financial advancement to directors of a holding company.
ARE THERE EXCEPTIONS TO THE RULE IN SECTION 296 CAMA?
The prohibition on loans to directors under Section 296 CAMA is stated in clear terms. However, the law recognises that there may be some circumstances where the rule will not apply. These circumstances are regarded as exceptions. The exceptions accommodate commercial and practical realities. It is only within these exceptions that the rule prohibiting loans to directors may be circumvented.
The exceptions as stated in section 296 (a) are as follows:
- Advancement for Company’s Purpose
A company may advance funds to a director to meet expenditure incurred or to be incurred for the company’s business or to enable the director properly discharge his duties. This exception is conditional as the company may only make such financial advancement upon the approval of the company given at a general meeting at which the purposes of the expenditure, the amount of the loan, the extent of the guarantee or security are disclosed.
The section further provides that, in the event that the approval is not given at or before the next annual general meeting, the loan shall be repaid or the guarantee or security shall be discharged within six months.
- Money Lending in the Ordinary Course of the Business
Section 296 (1) (b)states that loans to directors may be permitted if granted where lending forms part of the company’s business such as in the case of a money lending company or a finance company.
However, this exception does not encourage preferential treatment or insider dealings. Loans to directors under this exception shall be advanced under equal conditions as any other loan applicant.
WHAT ARE THE LEGAL CONSEQUENCES OF NON-COMPLIANCE?
The breach of Section 296 CAMA carries serious implications. Some of them are as follows:
- Personal Liability: Directors who authorise an unlawful loan may be held jointly and severally liable to indemnify the company against any loss that may arise from approving the grant of such loan.
- Breach of Fiduciary Duty: Such act may amount to the breach of directors’ fiduciary duty to the company which may expose the director to further civil consequences.
- Regulatory Exposure: Where the company in question is a regulated entity, non-compliance with the provision of Section 296 CAMA may expose the company to scrutiny from supervisory authorities which may lead to the imposition of fines and penalties on the company.
The above positions are established in the case of Neville and another v. Krikorian and others (2007) 1BCLC 1 where the England & Wales Court of Appeal (Civil Division) on July 4th 2006 upheld the position of the High Court, Chancery Division and held that both directors of the company are jointly and severally liable for being in contravention of the provisions of section 330 Companies Act, 1985 now section 197 Companies Act, 2006 by authorising the issuance of loans to the directors of the company.
From the above, it is clear that the risk associated with violating the provisions of Section 296 CAMA is not merely a compliance requirement. It carries financial and reputational consequences.
The prohibition of directors’ loans under CAMA 2020 is a deliberate safeguard provided by the law. To protect company’s assets and reinforce accountability within organisations.
