Director Service Agreements

Directors and NEDs possess power which needs regulating to channel the business in the way shareholders expect.  With the right agreement both shareholders and the director can benefit. We work with employers and investors to secure the position.  We also work with directors individually to confirm their position and provide guidance.

What the agreement should cover

The common law is deficient in the regulation of directors. A bespoke director service agreement plugs the gaps. If the relationship is not working out it makes resolution much easier.  In practice the director or NED agreement needs to be looked at in conjunction with the articles and shareholders’ agreement.

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 jeopardised 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.

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:

  • Design of the share award for a director;
  • Taxation of the shares awarded;
  • Implementation of either HMRC approved awards, unapproved options, share issues and LTIPs; and
  • Leaver provisions – a commonly over looked area, yet a common source of disputes and difficulties.  In some cases, if the structure is correct, the director will benefit from the 10% rate of capital gains tax under entrepreneurs’ relief.

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.

Non-executive directors

The duties owed by a director to the company are the same for all directors and the law does not distinguish between NEDs and other directors.

Letter of appointment for NEDs

There should be a letter of appointment covering:

  • The role and job description;
  • The statutory and other requirements on the NED and the obligation to comply with all laws, rules, the articles of the company etc.;
  • Fees; and
  • Protections relating to trade secrets.