Companies and their Directors: Service Contracts and Legal Implications

Companies and their Directors

Service Contracts and Employment Agreements

1.1. Service contracts = employment agreement between a director and the company. . common for directors to be employees but not always the case. . generally, specifies: director's role, salary, and offers some protection against removal from office. . MA3 and MA19 - In most companies, directors are responsible for managing the company's business under MA3, including hiring employees = gives board of directors' power to enter into service contracts with individual directors. - MA19 = allows board of directors to decide what services directors carry out for the company and decide their remuneration. - Powers granted by MA3 and MA19 must be exercised by board of directors acting together, unless delegated authority to particular individual.

Approval Requirements and Procedure for Service Contracts

. Approval requirements and procedure Contracts awarded by the board - simple cases can be approved by board in a board meeting. Procedure: - Draft contract is presented, reviewed, and approved by a majority vote. o Good practice board minutes to record that directors considered entering into contract will promote the success of the company, as may help rebut any allegation it breaches s172 duty. - If approved, directors authorise one or two people to sign it on behalf of the company. o Does not need to be a deed (s43) - directors will resolve to place a copy of signed service contract for inspection at the registered office (s228) o if they have one, they will instruct the company secretary to do it = help demonstrate that they have discharged their duty under s228 by delegating it. - If contract for someone who is already a director, the rules on conflicts of interests must be observed. o unless there is a provision in the company's articles which requires a declaration, s177(6)(c) provides an exception to declaring interest for directors' service contracts MA14 must also be regarded = o conflicts of interests.

Shareholder Approval for Service Contracts

Shareholder approval - s188 = a guaranteed duration of longer than two years will be binding on the company only if approved by an OR of the shareholders. o Shareholders only required to approve guaranteed term in the contract, the whole of the service contract. . Once done, directors resolve to enter into the contract and appoint someone to sign it in the usual way, and to place a copy of the signed contract at the registered office for inspection. o If director entering into service contract with the company is also a shareholder, they can count in the quorum and vote on the ordinary resolution = conflict of interests does not normally prevent someone from counting in the quorum or voting as a shareholder.

Consequences of Not Obtaining Approval for Service Contracts

If approval not obtained - the contract will take effect without the guaranteed term and it will be terminable on reasonable notice s189(b).

Board Meeting Sandwich Procedure for Service Contracts

Procedure ("Board Meeting Sandwich" = Board Meeting -> GM/WR -> Board Meeting): Step 1 - First Board Meeting called by the Board of Directors to: - Approve the draft service contract. - Table the memorandum (required under s188(5) CA 2006) setting out the terms of the contract. - Resolve to seek shareholder approval via GM or WR. - CONFLICT RULE o If contract is with existing director, assume Model Article 14 applies - they cannot vote or count in quorum. o No need for the director to declare an interest in their own service contract under s177, because s177(6)(c) provides an exception when the matter is being considered under s188.

General Meeting for Shareholder Approval

Step 2A(if chosen): The Board, based on the Step 1 resolution, calls a General Meeting for shareholders to: - pass an ordinary resolution to approve the contract. - Important procedural requirements: O s188(5) - memorandum must be: . Available at the registered office for 15 days before GM. . Available at the GM. o s307(4) - short notice not allowed, so the GM must have 14 clear days' notice.

Written Resolution for Shareholder Approval

OR Step 2B (if chosen): The Board, based on the Step 1 decision, circulates a WR for shareholders to: - approve the contract by returning the WR (ordinary resolution). - Important to note that: s288 - allows written resolutions instead of GM. o 1. MA14 = a director with interest in a transaction on which the directors are voting cannot count in the quorum for the purposes of that vote and cannot vote on that transaction. o s188(5) - memorandum must be circulated with the WR. o This is usually a faster route than calling a GM

Second Board Meeting for Service Contracts

Step 3: Second Board Meeting called by the board to: - Formally resolve to enter into the contract (now approved by shareholders). - Sign the contract on behalf of the company.

Shareholder Right of Inspection for Service Contracts

. Shareholder right of inspection - s228 = companies must keep a copy of all directors' service contracts (or summary of terms, if contract not in writing) available at their registered office for inspection by the shareholders until one year after the contract expires. - s229 = any shareholder can inspect directors' service contracts without charge, and are entitled to be provided with copies on payment of fee

Substantial Property Transactions

1.2. Substantial property transactions · s190 CA 2006 - Decisions to buy or sell assets are taken by the board of directors under their power of management in MA3. o This power is open to abuse by unscrupulous directors. - s190 CA 2006 o protects a company and its shareholders where: . the company is acquiring · a substantial non-cash asset non-cash asset = any property or interest in property other than cash (s1163) . from a director or any person connected with a director . or a director or connected person is acquiring a substantial non-cash asset from the company. o Provides that the transaction must first be approved by an OR of the shareholders. o applies when the asset is "acquired" by or from the company. . Money does not need to change hands, so OR also required where asset is acquired for free.

Meaning of "Substantial" Non-Cash Asset

. Meaning of "substantial" non-cash asset - Under s191, a non-cash asset is considered substantial based on its value relative to certain thresholds: o Assets worth £5,000 or less are not substantial. o Assets worth more than £100,000 are automatically substantial, regardless of the company's net assets. o Assets valued between £5,000 and £100,000: . Whether the asset is substantial depends on the value of the company's net assets (i.e., the total assets minus the total liabilities). . The asset will be substantial if its value is greater than 10% of the company's net assets. - Example: o If a machine is valued at £70k and the company's net assets are f500k, the machine is substantial because £70k is greater than 10% of £500,000. o If the machine were worth £4,000, it would not be substantial, even though it falls between £5,000 and £100,000, because it's below the 10% threshold. o If the machine were worth £150,000, it would be substantial regardless of the company's net assets, as it exceeds £100,000.

Consequences of Not Obtaining Shareholder Approval for SPTs

. s195 - consequences of not obtaining shareholder approval - Company can set the transaction aside. However, there are exceptions. For example, the company cannot set the transaction aside if it is no longer possible to return parties to position they were in before it. - Liabilities are imposed on: o The other party to the transaction with the company. o If that other party is a connected person, the director who was connected to that person. o Any other director of the company who authorized the transaction. - These individuals will be liable to indemnify the company for any losses caused by the transaction and must account for any profits made from it.

Shareholder Approval Procedure Under s190

. Shareholder approval procedure under s190 2- Step 1: Initial Board Meeting called by the board to: o Resolve to seek shareholder approval o At the meeting . the draft contract for the proposed transaction may be presented. . Directors must declare any interest in the transaction under s177. Direct interest: where a director is a party to the transaction. " Indirect interest: where a connected person (e.g., spouse, child, or company the director controls) is involved in the transaction Directors may rely on the s177(6)(b) exception (i.e., if the other directors already knew about the interest), but it is best practice to make an express declaration). . Board Meeting Quorum & Voting: Under MA 14 (or similar provisions), an interested director: - Cannot vote on the resolution. - Cannot count toward the quorum for that agenda item. Board meeting minutes should record that the directors considered whether entering into the transaction would promote the success of the company (per their duty under s172 CA 2006). . s190 does allow the directors to conditionally enter into the transaction before shareholder approval.

Shareholder Approval for Substantial Property Transactions

- Step 2: Shareholder Approval: Shareholder approval is obtained via an OR passed at: · A GM, or · By WR. o There is no statutory requirement under s190 to circulate a memorandum or draft contract in advance - unlike the requirement in s188 for director's service contracts. o Therefore, a GM can be held on short notice if the requisite percentage of shareholders agree.

Final Board Decision for Substantial Property Transactions

- Step 3: Final Board Decision (Second Board Meeting) o Once shareholder approval is granted, the directors must: . Meet again to formally resolve to enter into the transaction. . Authorise one or more persons (e.g., a director or officer) to sign and execute the transaction documents. o This step is required because shareholder approval does not in itself authorise the company to act - directors retain the power to manage the company under Model Article 3.

Comparison of Shareholder Approval Requirements

Comparison where shareholder approval is needed Aspect Substantial Property Transaction (s190) Director's Service Contract (s188) Initial Board Meeting Directors resolve to seek shareholder approval for the transaction. Directors resolve to seek shareholder approval for the service contract. Declaration of Interest Directors must declare any direct or indirect interest under s177 (unless they want to rely on s177(6)(b) exception (i.e., if the other directors already knew about the interest), but it is best practice to make an express declaration.). Director does not need to declare an interest under s177, due to the s177(6)(c) exception (if the matter is being considered under s188). Shareholder Approval Required by ordinary resolution at a GM or by WR if the transaction is substantial. Required by ordinary resolution at a GM or by WR, only if the contract is longer than 2 years or includes guaranteed benefits beyond 2 years. Memorandum Requirement No requirement to circulate or make available a memorandum of the transaction. Memorandum of the service contract must be made available to shareholders before the GM or sent with the WR (s188(5)). Final Decision Directors retain authority to execute the transaction after shareholder approval (under MA3). Directors retain authority to enter into the service contract after shareholder approval (under MA3).

Exceptions from Shareholder Approval

. Exceptions from shareholder approval - The exception under s190(4)(a) as follows: 3