Directors’ service contracts have an important function for companies. Not only are they are used to define the role, responsibilities and remuneration of the company’s directors, they also provide key legal protections to safeguard the interests of the business.
Since directors are the most senior employees in the company, the directors’ service agreement is used to take account of their more complex position in relation to their responsibilities, rights and remuneration, both as an employee and in many cases, as a shareholder.
What is a directors’ service contract?
A Directors’ Service Contract or ‘DSC’ is fundamentally an employment contract which covers standard clauses related to such employee rights and entitlements, but also includes further provisions covering matters specific to the role of the director. This would usually include terms relating to the legal obligations placed on the director and details of the remuneration package.
An executive director will almost always be an employee of the company. Whilst it is more likely that a non-executive director will be self-employed, in both cases the arrangement needs to be covered by a contract stating the director’s role, duties and responsibilities.
Why do you need a directors’ service contract?
DSCs are needed because directors are the highest-paid employees in the company and have more responsibility than any other employees in the company. They are liable for the overall running of the company, including finances, strategy and day-to-day management.
In addition, directors are under express statutory responsibilities by virtue of the Companies Act 2006, which differentiates the role from senior employees who are not directors.
As a matter of good corporate governance, shareholders and other stakeholders expect to see that a company’s contractual arrangements with its most senior employees are on a sound, professional footing.
Finally, as directors are privy to the most detailed workings of the company, including confidential technical and brand knowledge, it is essential that they are bound to protect this information while they are in its employment. In order to protect the company’s interests after they have left office, directors should also be placed under an obligation not to share such confidential information with competitors once they leave the firm.
Directors service contract terms
A DSC should include the following provisions:
- pay and benefits – this can include bonuses, pension contributions, share options, dividends, a company car and life insurance;
- length of the contract – DSCs are often short, fixed-term contracts. In addition, the Companies Act 2006 states that a DSC of longer than two years has to be approved by shareholders;
- holiday arrangements, plus any travel the director will be expected to undertake and how their expenses will be covered;
- ill-health – as the director is so pivotal to the business, it may not be appropriate for them to be entitled to a lengthy period of sickness absence with pay as there will be no-one to lead the business. It is advisable to include a provision whereby you can ask the director to undergo a medical examination, the results of which have to be shared with the company;
- fiduciary duties of directors – it is a good idea to include these in the contract of employment so that breach of a fiduciary duty can be used as a ground to terminate the employment contract;
- voting rights in board meetings – usually each director has one vote. If you would like to prevent deadlock, you could choose to give one director the casting vote. This should be stated in the DSC;
- confidentiality – obligation not to disclose confidential information, during the contract or afterwards. The director must be under an obligation to maintain privacy while travelling and in public places. This provision should also state that the director will have to hand over all company property on termination and allow their home and personal devices to be cleansed of sensitive company information;
- policies – understand and adhere to the company’s policies on the prevention of corruption and bribery and not to allow discrimination or discriminatory practices in the workplace;
- intellectual property – the director must be placed under a duty to protect the company’s IP; and
Power of Attorney – under this clause the company would reserve a power to sign on behalf of the director. This is particularly useful where an unco-operative or embittered director is leaving the company.
- statutory obligations under the Companies Act 2006:
(i) the overriding duty to act “ in good faith” in the way which “would be most likely to promote the success of the company for the benefit of its members as a whole”;
(ii) to act with due care, skill and diligence;
(iii) to avoid conflicts of interest;
(iv) to declare any interests the director might have in an arrangement of the company or as soon as possible after they become aware of their interest;
(v) not to accept inducements;
(vi) to act within their powers; and
(vii) to exercise independent judgment.
If the company is also listed then there will be additional obligations under the Listing Rules and other codes of practice
Severing a directors service contract
A well-drafted DSC is invaluable when the director has to leave the company, for whatever reason. If the director is employed under an employment contract that is not fit for purpose, the company may find that the director remains a director of the company even after the employment contract has been terminated. Moreover, if the director is also a shareholder of the company, they may still be able to attend shareholder meetings in spite of the fact that their employment relationship has been terminated.
For this reason, it is vital that the DSC is drafted in such a way as to completely sever all ties between the director and the company, if that is what the parties intend.
First, the director should be required to give a longer period of notice than the statutory minimum, which is one week for each completed year of employment. Usually a notice period of between six and twelve months is considered appropriate. If it is more, and the company is listed, then this must be reported to shareholders.
Second, it is highly advisable to include garden leave provisions, both where the director is given notice by the company and the director gives notice to the company. The reason for this is that if the director is required to come into work for the duration of their notice period, it is likely that they will have lost motivation in their role. In addition, the company will want an outgoing director to be out of the way in order that that director is not privy to strategic decisions and other confidential information.
An alternative to garden leave is to include a PILON clause in the DSC. PILON stands for Pay In Lieu of Notice and allows the director’s contract to be terminated immediately in return for a one-off payment covering the director’s notice period and benefits they would have received during that period.
It is of course possible to dismiss summarily (i.e. immediately, without notice) a director who has committed gross misconduct, fraud or gross negligence. However, the company must have clear, irrefutable evidence of the wrongdoing before taking such a step. If the company is found to have acted unfairly and dismissed the director too hastily, the director could be due significant sums in compensation and there would the possibility of significant reputational damage to the company.
The notice period will also be the time to put in place arrangements regarding the possible selling of the director’s shares in the company, if relevant, and other ‘handover’ paperwork. As stated above, if the director is unco-operative then a power of attorney is essential to ensure the smooth running of the business.
As long as a provision is expressly included in the DSC, the director can also receive a payment for loss of office, or a so-called ‘golden parachute’. If there is no such provision, then any such compensatory payment could be subject to shareholder approval under sections 215 to 22 of the Companies Act 2006. In addition, where the payment to a director seems ‘excessive’ when compare to their entitlements under the DSC, shareholders may also invoke the Companies Act.
The board of directors is under an obligation to make full disclosure of a director’s remuneration in the directors’ remuneration report to shareholders. Those shareholders will then have an advisory vote on the report. In addition, the directors have obligations under both the Code of Directors’ Duties and UK corporate governance codes to act in the best interest of the company, and to avoid rewarding poor performance.
In addition to the use of garden leave, as described above, most DSCs will also contain post-termination restrictions on the director, also known as restrictive covenants. The UK courts will generally only consider these to be enforceable if they are in place to protect a legitimate business interest and constitute the minimum necessary protection of those interests. The courts will also take a dim view of a restrictive covenant of over twelve months’ duration.
Therefore, you should draft restrictive covenants with the particular director in mind. For example, if the director has a great amount of technical knowledge, a tightly drawn confidentiality clause plus a non-compete clause of twelve months may be necessary. By contrast, where a director has been in a more client-facing role, both a non-solicitation and a non-dealing clause may be appropriate. It is usually advisable to take specific legal advice on the drafting of restritive covenants to ensure that they are enforceable and will protect the company’s interests.
Directors service contract FAQs
What is a contract service agreement?
A contract service agreement is a contract of employment. It should contain the standard provisions of an employment contract such as pay, holidays, hours and place of work and notice period. However, in the case of a contract of employment for a director of a company, known as a ‘Directors Service Contract’ or DSC, there will be additional provisions to reflect the complexity of the director’s role. For example, a director is under additional statutory obligations to the company, and they are responsible for the day to day running of the company, as well as long-term strategic planning.
What is the difference between a service agreement and a contract?
There is no difference between a contract of employment and a service agreement – they are both contracts of employment. However, directors of a company are often appointed under a service agreement known as a ‘Directors Service Contract’ or DSC. The reason for this is that the DSC must include more provisions than a standard employment contract because of the complexity of the directors’ role and the additional responsibilities they have, to the company, but also under the Companies Act 2006.
What is a service agreement between employer and employee?
A service agreement between an employer and employee is an employment contract, such as that between a company and each of its directors, that sets out the duties and responsibilities of the employee. The contract of employment between a director and the company is often known as a directors Service Contract (DSC) to distinguish it in importance from a standard employment contract. The DSC must take into account the statutory obligations on a director, the expertise and care expected of the director, what happens when the director leaves the company and how the director’s role interacts with any shareholdings they have in the company.
Is a director an employee UK?
Most executive directors are employees of their companies. They work under an employment contract called a ‘Directors Service Contract’ that is like a standard contract of employment, but tends to be longer and more detailed to take into account the extra statutory duties placed on directors and the extra responsibilities placed on them in terms of finance, strategy and risk. By contrast, many non-executive directors are self-employed and will have to account for their own tax. There should still be a contract in place with a non-executive director to cover their duties and responsibilities towards the company.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.
This article first appeared on our sister publication www.lawble.co.uk