When Directors Fall Out: The Importance of Director Service Agreements
Company directors keep the heart of an SME beating. Working tirelessly to serve the needs of a business, they invest time, energy – and lots of blood, sweat and tears!
Usually, director relationships are very strong and underpinned by a sense of trust and confidence, and often feel like they will last a lifetime. While many board relationships can and do stand the test of time, it is true that nothing lasts forever, and it’s a universal truth that when director relationships turn sour, they often turn very sour indeed.
Entrusted to run a business, directors have access to a company’s most valuable and confidential information. This means that when a director relationship turns sour, all this information and ultimately, the business, is at risk. A rogue director can turn the tables in the event of a dispute, and seek to use information they hold about the company to their own personal advantage or to ends which are not in the best interests of the company or its co-directors.
When director relationships turn sour
Largely because of the genuine sense of trust that exists between directors, many businesses do not put in place the appropriate contractual documentation to protect them against director relationships turning sour and to set a precedent for how director change – good or bad – is managed. while a relationship of trust is fine, having the basic principles of the director’s duties, obligations and rights set out in a Directors’ Service Agreement brings a wealth of benefits, security and surety to a business.
A Director’s Service Agreement (DSA) is not a basic contract of employment- it is much more than this. While a DSA will include familiar contractual terms including pay, holiday, and benefits, it will also include much more robust and complex provisions on termination of employment.
This would include the length of notice required (having an MD on a one week notice period should they wish to resign probably wouldn’t be ideal), the cross-over with any shareholding, a right for the company to remove the director from employment if they are removed from the board, and delegation of certain powers to managing directors. The DSA will further include handover provisions and strict post-termination restrictive covenants that prevent competitive behaviour and the poaching of staff and/or customers, as is the interplay with fiduciary duties.
The importance of a Director Service Agreement
Not having the appropriate documentation that sets out how these types of situations are dealt with can make it very difficult to facilitate a smooth outcome to any potential dispute. What’s more, when directors come to blows in the Employment Tribunal, sparks will fly- and there will usually be a need for incredibly deep pockets.
Two common and tricky scenarios which can occuer when DSA is not in place include:
- Where a director’s employment terminates, in the absence of any agreement to the contrary, any shareholding will continue. Their office of director might also continue. Both of these instances can cause untold disruption to a business if the disgruntled director decides to veto shareholder resolutions or fails to fulfil director duties.
- Where a director is removed from their officeholding as such, their employment might continue. The individual concerned remains part of the business and an employer would have to identify a potentially fair reason under the Employment Rights Act 1996 to facilitate termination in the absence of a DSA provision, setting out what will happen in this situation.
Author: Charlotte Geesin, Legal Director at Howarths