Director and NED agreements

Working with either the business or the individual directors to solve issues

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Director and NED agreements

Directors and NEDs run the risk of unforeseen personal liabilities. With the correct legal contracts the risks can be managed.  We draft tailored directors’ service agreements designed to avoid disputes.  

We act for companies of all sizes with a focus on the private sector.  We work within a wide range of sectors from professional services, media and emerging technology companies applying our problem solving expertise.

Responsibilities of directors

The common law is deficient in the regulation of directors. A bespoke director service agreement plugs the gaps. Directors carry several roles:

  • Office holder director recorded at Companies House;
  • An executive serving the business in the performance of duties; and
  • Often, there can be a third role – that of shareholder.

There is often confusion between the roles.  However, they do carry distinct responsibilities.

Problems commonly solved

We find solutions for a variety of problems.  The most commonly seen problems revolve around:

  • The role and duty of a director;
  • What to do if a conflict arises;
  • How to handle a difficult director;
  • How to balance the role of director with being a shareholder; and
  • Preventing damage to the business.

Voting

The board’s demographics and voting rights can change the course of the business without your control. Unless specifically stated, all directors have one vote. There are alternatives. It is possible to confer a director with a casting vote.  The use of a casting vote prevents a deadlock at board meetings.

External appointments

Without specific restrictions in the director service agreement, a director can hold multiple appointments. Multiple appointments are common amongst NEDs.  The service agreement can restrict the director or non-executive director’s activities.

Pay and bonuses

The director’s service agreement should deal with pay and bonus provisions.  The permutations are wide.  Based on our experience key areas to consider are:

  • Bonuses: will the bonus be discretionary or contractual and what are the targets?  This is a choice for the board to make.
  • If targets are not met, will there be an opportunity for the company to  claw back? Claw backs and malus provisions are becoming increasingly common, especially with public companies with institutional shareholders.  A claw back acts as a deterrent to matters such as manipulation of profits to achieve a bonus which is not really due.
  • How will leavers be dealt with?
  • Is a phantom option scheme which is akin to a cash bonus suitable?
  • Other benefits to be provided to the director?

Fiduciary duties

The director does have various fiduciary duties which are implied into any director or non-executive director’s service agreement.  The problem is the implied terms are limited.  There are duties set out under the Companies Act but they are difficult to enforce in practice.

  • Our solution is to bolster the implied terms and statutory responsibilities under the director’s service agreement. The director’s service agreement should link back to robust articles and shareholders’ agreement.  Our aim is to cut down on disputes.

Sensitive information

The duty of confidentiality is not implied by law.  Special protection is usually required under the  director’s service agreement.

The intellectual property used in the business

To protect the intellectual property in matters such as: the database, clients, products, designs and copyright specific contractual agreements are necessary.  The director’s of a company who do not protect the intellectual property will be criticised. The company’s exit will be jeopardized if directors’ do not have suitably drafted agreements with IP clauses.

Anti-competition provisions

There is a balance to be drawn between the right of a director to earn a living and the right of the employer to protect itself from unfair competition when the director leaves. Employment documentation clauses which do not hit the fine balance may be unenforceable. We are up to-date with this fast moving area of employment law.

Notice periods

The general rule is: the longer the notice period, the longer the director can be kept out of the market following termination. However, this increases dismissal costs.

Depending upon seniority, notice periods of 6-12 months are not uncommon. The risk is the director claims a breach of contract, which would make the post termination restrictions unenforceable.

  • A solution we consider is the use of so called garden leave clauses – these enable the employer to keep the director out of the office without running the risk of breaching the service contract.

Power of attorney

We recommend the company reserves a power to sign on behalf of a director. We draft these powers into the director’s service agreement and explain when you use them.  A power of attorney is particularly helpful in cases where there is a forced transfer of shares following resignation.

  • In practice, the person who controls the bank controls the company. No-one considers this issue when everything is going well. However, after a “falling-out”, the company may find that the hostile director controls the bank mandate. This can be covered off in the directors’ service agreement.

Directors using a personal services company

Sometimes directors will prefer that their salary and/or directors’ fees are paid to a limited company, or personal service company. This is common for:

  • Non-resident directors of UK companies;
  • Directors and NEDs with more than one appointment;
  • Director-shareholders who want to receive the dividends from the business through a personal services company, often located abroad.

Using a personal services company as a director IR35 issues

UK director shareholders often receive a mix of a low salary and a big dividend payment to maximise the tax efficiency. Foreign director shareholders however, may prefer to invoice their dividend entitlement to a company from their foreign personal services company if the income tax is lower in the home jurisdiction.  This is likely to attract HMRC scrutiny.

The problem with personal services companies

Directors’ appointments are personal even if performed abroad. If a director performs UK duties for the company it is likely that IR35 applies.  There are exceptions where UK duties are minimal. The anti avoidance legislation can tax directors living outside of the UK.

If HMRC investigates, it will want to recover any tax underpaid by the director from the company.

Solutions for companies

The companies can protect themselves by:

  • Implementing suitable employment agreements recording UK and foreign duties;
  • Amending the articles of association and shareholders’ agreement to record the differences in how different director-shareholders are remunerated; and
  • Obtaining an indemnity from the director for any tax costs in case of IR35 assessment by HMRC.

Equity incentives

There are no legal restrictions on the award of shares to directors.  There are complex tax considerations.  The tax treatment of share awards varies depending upon the nature of the award:

  • Gift of shares
    A director who receives shares in the employer company will be treated as if he received income from employment and taxed at the highest rate of income tax. There are ways to minimise the tax exposure.
  • Grant of share options
    A director can receive either HMRC approved options such as EMI or CSOP or unapproved share options. Directors are employees so they usually qualify for approved share schemes. The growth in the value of shares under an approved share option scheme is usually taxed as capital if qualifying conditions are met. Hence regarded as tax efficient. NEDs do not qualify for approved share schemes so their option gain would be taxed to income.

In many companies it will be necessary to seek shareholder approval for the dilution of shares – an area on which we frequently advise.

Implementation of equity incentives

We deal with:

Resignation of a director

If a director resigns, there can be the following issues:

  • Ex-directors can remain as employees, unless the director’s service agreement says otherwise. This may not be what is intended.
  • The director cannot be forced to sell any shares held upon resignation, unless the right to force a sale is set out in the articles or shareholders’ agreement.

There are two broad situations: voluntary and forced resignation.

Special considerations for non-executive directors

Non-executive directors (NEDs), a common fixture of PLC and listed companies, now become increasingly popular with private companies. As a NED you have the same responsibilities as the executive directors but your risks are higher. Your personal wealth and reputation are at stake. Before you become a NED consider the risks as they are unique to your position as a NED.

Companies Act implications for non-executive directors

As a NED you have to supervise and monitor that executive directors do a good job in running the company. That includes financial oversight. A NED can be disqualified as a director for up to 15 years, fined or even imprisoned. Each year around 1,200 directors are disqualified, over a hundred criminally prosecuted. As a NED you have a right to see the company’s accounts, use that right to check the finances on regular basis. You can also speak to the accountants if you need to.

Staying independent

The role of a NED is to bring strategic insight to the company and keep executives accountable. That includes questioning the decisions of the board to prevent bad business decisions or unsound investments. Failure to actively engage in strategic decision making can backfire when the company goes down. A paper trail is helpful.

Duty owed to the company

You have a duty to the company, not individual shareholders.  NEDs are often placed at companies by corporate shareholders. Corporate shareholders put pressure on the board to declare dividends or cut costs. Your loyalties are divided. There is a risk that you will be in breach of directors’ duties if you succumb to the pressure as you owe the duty to the company, not individual shareholders. You need to look long term. Voice your objections at board meetings and record them in the minutes.

UK Corporate Governance Guidelines suggest a maximum term of 6 years for a NED.  But many NEDs stay on the board for longer than that. If you remain as a NED for longer than 6 years your independence may come into question as your interests may be seen as aligned with the board.

Our track record in solving problems related to directors’ service  agreements

We work with companies to successfully help them avoid disputes with their directors.

Some of our recent instructions include:

  • Drafting a non-executive director letter for a company who was seeking investment from a foreign investor.
  • Drafting director’s service agreements for a high tech company who wanted to include specific bonus provisions.
  • Advising a recruitment business on various clauses to protect the business as well as the directors including directors’ and officer insurance, indemnities, restrictive covenants and confidential information.
  • Drafting specific intellectual property clauses within the directors’ service agreement to ensure that the intellectual property rights developed before the director joined the company were assigned and owned by the company.

We also work directly with directors addressing their concerns and providing guidance for them. Often we are working in the background on a discrete basis.