Excessive director remuneration

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Remuneration for directors in quoted companies is in the public domain and widely debated. However, a lesser known fact is that directors of private companies are not immune from challenge.  Private company directors can be ordered to repay to the company excessive director remuneration received.  As we enter what looks like more challenging trading conditions the topic of director remuneration is in the spotlight.  Private company shareholders are not the only ones with a keen interest – the Insolvency Service can investigate following a business failure and no doubt banks and lenders will take a close look.

We review a case which confirmed that excessive director remuneration can be successfully challenged by shareholders and the director forced to repay.

Breach of director duty in paying himself too much

In the case of Maidment v Attwood and Others the Court held that the company’s only director had breached his duties as a director by setting his salary in accordance with his own interests, in contrast to his duty as a director.  The court found that excessive remuneration amounted to unfair prejudicial treatment to minority shareholders.  There had been no regard to the ability of the company to pay the remuneration voted.  The director paid himself more than that paid to any other member of staff.  Unfair prejudice is a claim the minority shareholders can bring in court under s994 of the Companies Act 2006.  The director was ordered to pay remuneration back to the company.

Interestingly, the fact that the director’s salary was disclosed in the annual accounts and the shareholders could have spotted the payments earlier was found by the court not to be a barrier to unfair prejudice.

Apart from excessive remuneration paid to a director the court found there was a breach of duty when the director allowed the trading name to be used by another company with whom he was connected without payment. And, there was a further breach when the director sold the goodwill and trading name shortly before the liquidation of the company for minimal consideration.

Insolvency can complicate an unfair prejudice claim because shares in an insolvent company are valueless unless the value of any claims which the company has against the directors will eliminate the deficiency and produce a surplus for shareholders. In this case the shareholders were successful in establishing that the shares would have had value but for the wrong doing of the director.  The court will take a wide view of prejudice suffered by a shareholder.

For the full judgement please click here.

Employment law aspects

An employer cannot force a director to repay remuneration without the individual director’s consent. If the circumstances are right the employer could consider making the director redundant to stem the excessive pay.  If the employer is not prepared to take action – which can easily be the case where a decision is required by the director who is being overpaid – the alternative is for the shareholders to step in as they did in Maidment v Attwood and claim they have suffered.

What can be done?

Directors cannot prevent a shareholder claiming over payment the company and or other directors.  However, there are steps which can be taken which will make it harder for shareholders to successfully claim a director has been paid too much.  Ideas include:

  • A shareholders’ agreement can list director pay as a matter requiring all or a majority of shareholders to agree. A shareholders’ agreement is often the best and most practical step.
  • If the director holds shares the payment of dividends can also be regulated via the shareholders’ agreement. The director would have to hold a separate class of shares to the other shareholders for dividends to be regulated.
  • Where practical, we would recommend that private companies appoint a non-executive director to assess remuneration of directors and provide an impartial assessment of any proposed director remuneration.  There are guidelines for quoted companies to have remuneration committees for this function – there is no harm in larger private companies modifying the approach.  In small private companies assessment of pay could be seen as overkill.
  • If there isn’t a non-executive director in place, a private company with split shareholder base should maintain more than one director.  The directors can then approve each other’s remuneration which will provide a buffer.
  • All directors need to be prepared to justify pay.  Keeping track of pay in similar companies can be a good move.