7 key legal points for managing directors

There is no legal requirement to appoint a managing director. Therefore appointment is a matter of pure discretion and practicality. But, if the role is defined, then the company will have greater leverage to remove the managing director from his role if he or she fails to perform.

Managing director responsibilities range from a duty to avoid conflicts of interest, to disclosing self dealing, to promoting the company’s interests. The same responsibilities arise for any other director, not just managing directors. Complying with the rules is a mandatory exercise.

Here, we outline key legal points for managing directors and highlight some of the risks of non-compliance for managing directors and other directors.

Common misconceptions about Managing Directors

We find that many businesses mistakenly belive some or all of the following :-

• that the status of managing director imposes additional legal obligations and duties - under company law terms this is incorrect – director duties apply equally to all directors. All directors are subject to identical fiduciary and statutory duties set down by the Companies Act 2006. This includes non-executive directors.
• that it's legally more difficult to remove a Managing Director - as a starting point this is incorrect. Under the Companies Act, the majority of a company’s shareholders can remove a director from office. The procedure is lengthy. For that reason, it is common to find a short and simple method set out in the director's service agreement. Business disruptions can be avoided.

You don't have to have a director service agreement 

There is no legal requirement for a Managing Director to be signed up to a written service agreement. A director is usually also an employee. The roles are separate. If there is no written service agreement, then the company may run into problems trying to dismiss the managing director from either or both positions.

The powers of a managing director should be set out in the service agreement. However, the powers are subject to the provisions of the Companies Act.  The provisions exist to seek to protect minority shareholders.

Important issues for Board or shareholder approval

Whilst a Managaing Director may have more day to day input and control than other directors because all directors may not work in the business and it's impractical to seek Board approval for every decision, there are some issues where full Board approval and/or shareholder approval is common and reecommended. These include :.

The articles should set out a procedure as a safeguard measure. Under the Companies Act, the approval of the company’s shareholders will be required for:

• Long term service contracts with directors – guaranteed term of greater than two years.
• Substantial property transactions – entered into with a company “connected” with a director. Example being the managing director being a named director of Company A. Company A contracts to buy an asset from Company B. The managing director is a 40% shareholder of Company B. This is caught, as there is a connection.
• Loans, credit facilities, and quasi-loans with directors. There is a de minimis limit under the Companies Act.
• Payments for loss of office.

There are exceptions, so that approval from the shareholders will not be required. For example, there is a de minimis exception for substantial property transactions and loans with directors. The position needs checking before proceeding.

If shareholder approval is not sought, then the contract or transaction will be void. Result is that the contract or transaction can be undone.

Perception of Managing Director authority

There may be internal agreements on the scope or limitation of the managing director’s authority. However, in legal terms, third parties are generally entitled to assume the Managing Director has authority to bind the company.

Unless a third party is specifically made aware that a Managing Director lacks the actual authority to bind the company, the third party is entitled to assume that the Managing Director does indeed have the authority. Third parties can make this assumption regardless of the importance or value of the underlying matter or contract.

Interaction between directorship and shareholding is important

A shareholders’ agreement can hugely benefit a managing director who is also a shareholder. The shareholders’ agreement can:

• Protect equity – so that if the managing director leaves, he can retain all or a part of his shares;
• Prevent dilution of equity – so that the managing director is first offered any shares proposed to be issued to members of the public;
• Deal with leaver provisions in the event of resignation or dismissal – so that if the managing director voluntarily resigns, his shares are bought back at par;
• Impose 100% voting obligation for dismissal;
• Impose 100% shareholder approval to appoint new directors;
• Create powers of veto – this can give the managing director influence over the running of the business. A power of veto can override shareholder decisions.

A shareholders’ agreement can also give the managing director authority to enter into certain transactions, without first consulting the shareholders of the company. That right will be subject to the Companies Act, so care should be taken when drafting.

Liability of directors

A Managing Director has no greater legal duties than other directors. However, he or she is more likley to be a key decision maker which in reality means the risks of personal liability are higher. Areas of risk include :-

• Fraudulent and wrongful trading – if a company liquidator proves that the director in question ran the business during a period of no prospect of financial recovery, i.e. it was destined to fail.
• Guarantee – the directors may be eager to have the company sign up to a financing arrangement. A personal guarantee from the directors for the company’s repayment is not uncommon. If the company doesn’t pay, then the creditor will come after the directors. Personal assets are at risk.
• Claims from shareholders – minority shareholders have rights. One right is to bring a claim, on behalf of the company, against a director in default. The court can order a director to indemnify the company for its losses. The court may also make a costs award against the director in question.

Worst case is that directors can be made bankrupt, and disqualified from holding an officer’s position.