7 key legal points for managing directors

There is no legal requirement to appoint a managing director. Therefore, the appointment is a matter of discretion and practicality. However, if the role is clearly defined, the company may have greater leverage to remove the managing director from the 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 statutory and fiduciary duties apply to other directors, 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 believe some or all of the following :-

• that the status of managing director imposes additional legal obligations and duties - this is incorrect. Director duties apply equally to all directors, including non-executive directors, under the Companies Act 2006.
• that it's legally more difficult to remove a Managing Director - as a starting point this is incorrect. Under the Companies Act, shareholders can remove a director from office, although the procedure can be lengthy. A service agreement may provide a simpler contractual mechanism for dealing with the managing director's employment.

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, but the two roles are legally distinct If there is no written service agreement, 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 clearly, subject to the Companies Act and the company's articles.

Important issues for Board or shareholder approval

Whilst a Managing Director may have more day-to-day input and control than other directors, there are some issues where Board and/or shareholder approval may be required or advisable. These include :.

• Long term service contracts with directors –generally where the guaranteed term exceeds two years.
• Substantial property transactions – entered into with a company “connected” with a director.
• Loans, credit facilities, and quasi-loans with directors, subject to statutory exceptions.
• Payments for loss of office.

There are exceptions and de minimis provisions, so the position should be checked before proceedings. Failure to obtain required shareholder approval can have serious consequences, including the transaction or arrangement being void in certain circumstances.

Perception of Managing Director authority

There may be internal agreements on the scope or limitation of the managing director’s authority. However, third parties may generally assume that a managing director has authority to bind the company unless they know, or have reason to believe, that this is not the case.

This means that companies should ensure that any limitations on authority are properly documented and communicated where appropriate.

Interaction between directorship and shareholding is important

A shareholders’ agreement can be particularly valuable where a managing director is also a shareholder. A shareholders’ agreement can:

• Protect equity if the managing director leaves;
• Deal with dilution and pre-emption rights;
• Deal with leaver provisions in the event of resignation or dismissal;
• Set out voting arrangements for key decisions;
• Provide for the appointment and removal of directors; and
• Create powers of veto over specified decisions.

A shareholders’ agreement can also give the managing director authority to enter into certain transactions without first consulting shareholders. That right will be subject to the Companies Act, the articles and the terms of the agreement.

Liability of directors

A Managing Director has no greater legal duties than other directors. However, as a key decision maker, a managing director may face greater practical exposure to personal liability. Areas of risk include :-

• Fraudulent and wrongful trading – directors may face personal liability in certain circumstances where they continue trading when the company is insolvent or there is no reasonable prospect of avoiding insolvent liquidation.
• Guarantee – if a director gives a personal guarantee for company borrowing and the company fails to pay, the creditor may seek repayment from the director personally.
• Claims from shareholders – minority shareholders have various statutory rights and may bring claims relating to directors' conduct.. 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.

In serious cases, directors can face personal financial liability, bankruptcy or disqualification from acting as a director.