Director Employment: Service Agreements and Dual Status

Directors have a complex legal status. Understanding the interplay between company law and employment law is essential.

Director Status

Types of Director

Executive directors:

• Full-time management role
• Usually employees
• Service agreement in place
• Involved in day-to-day operations

Non-executive directors (NEDs):

• Part-time oversight role
• Usually not employees
• Letter of appointment
• Independent advice and governance

Shadow directors:

• Not formally appointed
• Company accustomed to act on their directions
• Same duties as formal directors

Office Holder vs Employee

Being a director makes you an office holder under company law.

Being an employee requires:

• Contract of employment
• Control by employer
• Personal service
• Mutuality of obligation
• Integration into business

Many directors are both - office holder AND employee.

Service Agreements

What Is a Service Agreement?

Employment contract for a director, typically including:

• Standard employment terms
• Additional director-specific provisions
• Often more detailed than standard contracts

Key Contents

Standard terms:

• Job title and duties
• Reporting structure
• Place of work
• Hours and availability
• Salary and benefits
• Holiday entitlement

Director-specific terms:

• Duties as director
• Board meeting attendance
• Fiduciary duties acknowledgment
• Longer notice periods
• Comprehensive restrictive covenants
• Garden leave provisions
• Termination linked to directorship

Notice Periods

Directors often have longer notice:

• 6-12 months common for senior roles
• Linked to garden leave provisions
• Consider shareholder approval requirements

Companies Act Requirements

If director's service agreement exceeds 2 years guaranteed term:

• Must have shareholder approval
• Without approval, terminable on reasonable notice

Dual Capacity

Two Separate Relationships

Director may be:

1. Director (office holder under Companies Act)
2. Employee (under contract of employment)

These are separate. Can be:

• Director only (office holder)
• Director and employee (both)

Why It Matters

Action	As Director	As Employee
Removal	Shareholder resolution	Dismissal/termination
Rights	Companies Act	Employment law
Compensation	Possible contractual	Notice, unfair dismissal, etc.
Process	s.168 procedure	Fair dismissal procedure

Interaction

Removing someone as director doesn't automatically end employment (and vice versa).

Common approach:

• Remove as director (s.168)
• Terminate employment (giving notice or PILON)
• May happen simultaneously

Removing a Director

Under Companies Act

Section 168: Shareholders can remove any director by ordinary resolution (>50%), regardless of contract terms.

Process:

1. Special notice (28 days) to company
2. Company gives notice to director
3. Director can make written representations
4. Director can speak at meeting
5. Resolution passed at general meeting

Doesn't End Employment

Section 168 removal doesn't terminate employment contract.

If director is also employee:

• Employment may continue (awkward)
• Must separately terminate employment
• May trigger compensation

Compensation for Loss of Office

Payments to directors for loss of office:

• Must have shareholder approval (s.217)
• Unless small (less than £200)
• Or pursuant to legal obligation

Risk: Unapproved payments can be void and recoverable.

Terminating Director Employment

If Employee Status Exists

Standard employment law applies:

• Unfair dismissal (if 2 years' service)
• Notice or PILON required
• Restrictive covenants may apply
• May be wrongful dismissal if breached

Fair Reasons

Same as any employee:

• Capability
• Conduct
• Redundancy
• Statutory restriction
• Some other substantial reason

Director-specific "SOSR":

• Loss of confidence by board/shareholders
• Breakdown in working relationships
• Strategic disagreement

Process

Even for directors, need fair process:

• Investigation (if conduct/capability)
• Opportunity to respond
• Consider alternatives
• Right to appeal

Tribunal will scrutinise - directors get same protection.

Common Approach

For executive director departure:

1. Board decision to remove
2. Negotiate exit terms
3. Settlement agreement
4. Resignation as director
5. Announcement management

Restrictive Covenants

Why Stronger for Directors

Directors typically:

• Have greater access to confidential information
• Have closer client relationships
• Can cause more competitive damage

Courts more likely to enforce reasonable restrictions.

Typical Provisions

Restriction	Typical Duration
Non-compete	6-12 months
Non-solicitation (clients)	12 months
Non-solicitation (employees)	12 months
Non-dealing	6-12 months
Confidentiality	Indefinite

Enforceability

Still must be reasonable:

• Legitimate business interest
• No wider than necessary
• Reasonable in duration and scope

Garden leave helps - active employment during restriction.

Garden Leave

Purpose

• Keep director away from competitors during notice
• Protect confidential information
• Reduce competitive harm
• Restrictive covenants start from end of garden leave

Contractual Right

Need express clause to:

• Require director to stay away
• Require director to remain available
• Restrict activities during notice

Without Clause

Without contractual right:

• Director may be entitled to work
• "Garden leave" may be breach of contract
• Could undermine restrictive covenants

Fiduciary Duties

Duties During Employment

Directors owe duties under s.171-177 Companies Act:

• Act within powers
• Promote success of company
• Exercise independent judgment
• Exercise reasonable care, skill, diligence
• Avoid conflicts of interest
• Not accept benefits from third parties
• Declare interest in transactions

After Termination

Some duties continue:

• Confidentiality
• Not to misuse company property
• Not to exploit opportunities learned during service

Restrictive covenants add contractual protection.

Non-Executive Directors

Typically Not Employees

NEDs usually:

• Office holders only
• No service agreement
• Letter of appointment instead
• Paid fees, not salary

Appointment Letter

Should cover:

• Time commitment expected
• Term of appointment
• Fee level
• Expenses
• Conflicts policy
• Termination provisions
• Insurance coverage

Termination

Usually simpler:

• No employment law protection
• Remove under s.168 if needed
• Or per appointment letter terms

Shareholder Directors

Owner-Managers

In SMEs, directors often own shares:

• May have shareholders' agreement
• May have service agreement
• Dual protection

Shareholders' Agreement Provisions

May include:

• Board composition rights
• Removal triggers
• Good/bad leaver provisions
• Compulsory transfer of shares

Interaction

Dismissal may trigger:

• Loss of employment
• "Bad leaver" share provisions
• Loss of voting control

Negotiate carefully - significant financial impact.

Tax Considerations

Termination Payments

• First £30,000 tax-free (genuine compensation)
• Notice pay taxable
• PENP rules apply
• Share-related payments complex

Share Options

On termination:

• "Good leaver" may retain/accelerate options
• "Bad leaver" may lose unvested options
• Tax treatment varies by scheme type

Get Advice

Director terminations often involve:

• Complex share arrangements
• Significant sums
• Tax planning opportunities

Checklist

Service Agreement

• Clear duties and powers
• Appropriate notice period
• Garden leave clause
• Comprehensive restrictive covenants
• IP and confidentiality provisions
• Termination provisions clear
• Linked to director status
• Shareholder approval if over 2 years

Termination Process

• Board decision documented
• Employment termination separate from directorship
• Fair process followed
• Settlement agreement considered
• Shareholder approval for payments over £200
• Director resignation obtained
• Companies House filing
• Announcement managed