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How do you manage director disputes. The directors are also shareholders, but no longer agree how to run the business. When the company was set up, the directors were all mates together. So why bother with written agreements.  Now the relationship is broken.

So what can you, the other director, do?  You have many options, but each option has risks.  Here we outline your likely road map.

Questions to resolve director disputes

We usually start by asking these questions:

  1. What is the existing position in respect of the management of the company?
  2. Can the company remove an underperforming or dishonest director, and
    • What liabilities might the company incur?

Resolution depends on whether there is a director’s service agreement or a shareholders agreement signed by all the shareholders. Without a written agreement, resolution depends on the interaction between the:

  • Articles of association;
  • Employment protection rights under employment protection legislation;
  • Shareholder protection rights under company law.

If there is a written agreement, resolution is often much easier.

Director disputes: deadlock

Deadlock arises where the directors and shareholder’s vote are equally split.  For instance,  there are 100 shares and each shareholder controls 50%. The company is deadlocked. There is not a sufficient majority to pass a directors or shareholders resolution.

It is extremely tricky to resolve a directors dispute where there is deadlock. The most common remedy ordered by a court is to sell the company to the highest bidder.

Can the company dismiss a director?

If there is no written employment contract or director’s service agreement then statutory notice provisions apply. Statutory notice varies according to length of service. The longest notice period permitted under statute is three months.

The problem is that statutory notice only deals with termination of employment. It does not remove the director.  The person you wish to remove remains a director of your company.

For a director to dismiss another director without a board resolution they have to have authority to do so. A board resolution is usually required, as the decision falls outside normal day-to-day commercial decision-making. However, if the shareholders are in deadlock, you won’t obtain a majority vote required for the board resolution

Note, there is court of appeal authority: Smith v Butler 2012 – http://www.bailii.org/ew/cases/EWCA/Civ/2012/314.html. This indicates that the dismissal of a director and shareholder falls outside day-to-day commercial decision-making. You require a board resolution.

Risk for the company

You risk High Court proceedings, if the company steams ahead and dismisses the director without a board resolution.  High Court proceedings are expensive.

If matters go to a hearing, each party would incur costs in excess of £50,000. The losing side would bear the winner’s costs. Even worse, the company may face a security of costs demand from the defending director.  If the company doesn’t come up with the money, the case could fail fairly quickly.

Risk for the shareholders

High Court might decide the matter constitutes a shareholder rather than an employment dispute. Then other shareholders, not the company, could be personally liable for the cost of  the proceedings, or defending the action.

Director disputes: performance issues

The directors dispute might be about performance issues, e.g. absenteeism or dishonesty.  However, if there is no prior warning, or given instance of gross misconduct, then the company lacks sufficent grounds to dismiss the director. The company will incur liability for unfair dismissal.

The company must first take steps to manage performance.  This involves management time and usually stress. However, the problems explained above still remain. The person might be dismissed as an employee, but remains a director and possibly a shareholder, unless there is a board resolution.

Risk for the company

If a claim were brought in the Employment Tribunal and the director was successful, he would be awarded a sum equivalent to notice entitlement and compensation for loss of salary going forward. Loss of salary in practice varies from six months salary upwards. Legal fees would be in the region of £15,000+ if the matter proceeded to an employment tribunal. Note in an employment tribunal, costs are irrecoverable if you win or lose.  The director would be responsible for paying his own fees.

Companies with directors’ service contracts in place often do not face this problem as the contract usually provides that if you are dismissed as an employee you automatically resign as a director with a power of attorney to cover off the risk the director will not agree to resign.

The dishonest director

The position can be different is there is some element of fraud, e.g. embezzling company funds. The steps would be:

  1. Suspend the director from work;
  2. Carry out an investigation;  followed by a
  3. Disciplinary hearing;
  4. Decide whether on not to dismiss the director.

Unfortunately, the dishonest director may argue that suspension requires a board resolution. The justification is that he is a director, so the decision falls outside the honest director’s individual remit.

Note, if another director voted against the honest director, given strong prima facie evidence of serious misconduct, then this could constitute a breach of fiduciary obligations as a director. In practice, this might not get you very far.  The dishonest director can still commence  proceedings in the Employment Tribunal or the High Court if you try to dismiss him. The company will incur costs defending the claim, if the case against the company is weak.

What happens to the shares?

Note under the standard articles of association, you might dismiss and remove a director, but the directors share do not transfer to the remaining shareholders. This means the dismissed director retains his/her shares.

Companies with a shareholders agreement often avoid this problem,  if the shareholders agreement provides for automatic transfer on ceasing to be an employee or a director.

Shareholder steps

If no action is taken by the company, there may be redress from the shareholders and the company carries liability. The road map for shareholders throws up different issues