Directors’ Service Contracts

Private companies are not answerable to institutional shareholders or analysts; nor are they subject to the same public scrutiny.  So they have far more freedom in how they construct the terms on which their directors are employed.

By contrast the terms on which directors are retained and remunerated in listed companies, and the packages they receive on leaving, regularly hit the headlines. Sometimes the cases become almost notorious: viz ex-Sir Fred Goodwin.
Yet it is remarkable how little attention is paid to these contracts, at least in the private sector. This freedom to agree broadly whatever is wanted often results in a laissez-faire attitude of agreeing very little or nothing.  Even in the case of owner-managed businesses, unless it is a one-man band, a slipshod attitude to the formal terms under which a director operates can lead to real difficulties if differences arise between the owner-managers.

As in the case of shareholders' agreements, the process of thinking through a contract for each director can save huge problems and expense later in the life of a business.

The law may imply certain basic terms; other terms may arise intentionally or unintentionally because of a course of conduct over time. But an out of date contract (or none at all) leaves a lot of gaps and potential room for argument over what specific duties are owed by a director. If no contractual duties are expressly agreed then the company is likely to be left with trying to enforce general fiduciary (trustee-like) duties, unless it can point to a specific breach of the Companies Act.

Of course, it is not always going to be the disaster scenario - a total falling out - but the problem is that without a specific, written agreement it is very difficult to monitor or enforce performance or to say that specific functions or standards have been not been met.

Over the long term, this can lead to resentment on the part of others having to carry someone else. For a director it can lead at best to a lack of focus, or at worst to a failure to perform to a reasonably competent standard.  If it becomes necessary to part company, it will be more difficult to prove breach of contract if there is nothing in writing. Alternatively, a director may be able to argue that the duties have altered over time and the original written contract is out of date and no longer relevant.

Such uncertainty is also an open invitation for a director when threatened with being forced out to bring a claim for compensation. If he is also a shareholder, that provides additional complications because the company will not be able to take advantage of any good leaver/bad leaver terms which may have been in a service agreement in order to take back the shares.

The flip side of the coin is that the absence of a service contract can be equally bad for the director, since he will not enjoy the protection it affords or, in the absence of a shareholders' agreement, the certainty that when he leaves he will get paid for his shares.

A blank sheet of paper may be a good place to start when looking at a director's rights and duties - but it is not a good place to end.