7 key legal points for managing directors
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 the 7 key legal points for managing directors and highlight some of the risks of non-compliance for managing directors and other directors.
Point 1 – Misconceptions surrounding managing directors
A common misconception is that the status of managing director imposes additional legal obligations and duties on a director. In strict company law terms this is incorrect – the 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.
Point 2 –No law requires a company to appoint a managing director
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 fails to perform.
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.
Point 3 – No law requires a written service agreement for any director
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.
Point 4 – A director can act in a conflict situation
Directors can find themselves in a position of conflict. But, that does not mean that the director cannot act. Conflicts can be authorised by the board. Alternatively, a company’s articles may authorise a director to act.
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.
Point 5 – Directors need to be aware that the public are entitled to make assumptions
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.
Shadow director problems
A shadow director can cause problems. A shadow director will be bound by the same duties and responsibilities as any other director. However, the public may not know that the shadow director is representing the company as a director. So, it is appropriate for the company to seek an indemnity from a shadow director for any engagement outside the scope of duties and or authority that causes the company to suffer loss.
Point 6 – Interaction between directorship and shareholding is not set down in law
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.
Point 7 – Liability of directors
A shareholder’s liability is limited to the amount, if any, unpaid on shares. The same does not apply to a director. A director can be personally liable for a company’s losses. Examples being:
- 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.