Terminating a director's employment
This guide is based on UK law.
The options
Dismiss summarily for gross misconduct
Where there is clear evidence of dishonesty or other serious
misconduct amounting to a repudiatory breach, the company is
legally entitled to dismiss the culprit with immediate effect,
without any requirement to serve notice or pay in lieu of notice.
The need for clear evidence, however, cannot be over-emphasised: in
all but the most clear cut of cases, instant dismissal carries a
significant risk of litigation; there may be a High Court claim for
wrongful dismissal and, possibly, a statutory claim for unfair
dismissal (see our OUT-LAW guide to Wrongful
or unfair dismissal of a director).
Serve notice and require director to work notice period
This option may not be in the best interests of the company.
Directors who are asked to serve their full notice can be
demotivated and even hostile towards the company and the remaining
directors. Their main focus will, understandably, be on finding
another job rather than ensuring the long-term success of the
business. The company will usually prefer to cut ties – and bring
in someone else – as soon as possible. Serve notice and put on
garden leave Garden leave provisions are becoming increasingly
common. In summary: garden leave helps limit the threats to a
business posed by a director’s departure to a rival and can provide
more security than covenants. It also gives the company time and
space to negotiate a severance package.
The director on garden leave will often approach the company to
agree an earlier termination date so that they can take up their
new position. Their entitlement to further payment will then
cease.
Garden leave is also useful where cashflow makes a lump sum
payment in lieu undesirable.
Steps should be taken to ensure the terms of the garden leave
are consistent with the director’s contractual rights. The director
should continue to receive all salary and benefits and should not
be financially disadvantaged. An employing company should also
ensure that there are very clear instructions about what a director
can and cannot do while on garden leave. These should cover:
contact with clients, employees or other business contacts; the
steps the director is to take if contacted; the extent to which the
director can be called upon to carry out particular tasks and
provide assistance.
Terminate instantly under express payment in lieu
provision
It is also increasingly common for service agreements to allow
the company to terminate a director’s employment on making a
payment in lieu of notice. This provides a mechanism to bring the
director’s employment to an end instantly without being in breach
of contract. Any restrictive covenants will continue to have effect
insofar as they are enforceable.
Initiate a dialogue and negotiate a package
Frequently, the first instinct of the other
directors/non-executive directors is to initiate a “cards on the
table” chat with a view to negotiating an appropriate package. This
can work well, particularly if there is a good relationship between
those who will have the discussion, the reasons for the departure
are understood and the circumstances are not acrimonious – in other
words, if the negotiations are likely to succeed.
Generally, however, there are risks attached. Employment cases
make clear that even where there is an agreement to talk off the
record “without prejudice”, a party may still be able to rely on
these discussions to support a legal claim. The risk is
particularly acute where there has been no formal prior procedure.
In these circumstances, the discussions and the absence of any
formalities could be used in an unfair dismissal claim and/or
negotiations for a significant sum in addition to contractual
severance entitlements.
Legal/regulatory constraints
Sections 215 to 222 of the Companies Act 2006
The above sections (which replace sections 312 to 316 of the
Companies Act 1985) preclude payments “of compensation for loss of
office” where particulars of the payment have not been approved by
a company’s shareholders. Generally, though, this will not apply.
Section 220(1) of the Act provides for express exclusions in
relation to a payment made:
- in good faith;
- in discharge of an existing legal obligation (effectively
defined as an obligation that was not entered into in connection
with or in consequence of the event giving rise to the
payment);
- by way of damages for breach of such an obligation;
- by way of settlement or compromise of any claim arising in
connection with the termination of the person’s office or
employment; or
- by way of pension in respect of past services.
In addition, case law authority says that payments made to a
departing director under express contractual provisions – for
example, an express payment in lieu or golden parachute clause –
are not covered by what was section 312 of the Companies Act 1985.
This would certainly still seem to be the case as a result of the
express drafting of the new provisions. These sections could be an
issue, however, where a proposed payment to a director seems
excessive in relation to their legal entitlements.
Code of directors’ duties
If there is evidence to suggest that proposed payments are
excessive when set against an individual director’s legal
entitlements, it is possible that the code of directors’ duties has
been breached and that a challenge from shareholders will follow.
Shareholders could argue that directors, in agreeing particular
payments for a departing executive, were acting other than in the
best interests of the company. If a payment is proposed that seems
out of line with an individual director’s contractual entitlement
and unfair dismissal rights, the company’s remuneration committee
or full board ought to minute the reasons why. Such payments will
need to be justified.
The Combined Code
The Combined Code says that:
“The remuneration committee should carefully
consider what compensation commitments (including pension
contributions and all other elements) their directors’ terms of
appointment would entail in the event of early termination. The aim
should be to avoid rewarding poor performance. They should take a
robust line on reducing compensation to reflect departing
directors’ obligations to mitigate loss.”
This provision can be useful when negotiating a package on
behalf of a listed company. In particular, it can help endorse the
point that payments must be closely linked to financial loss. If
there is every reason to believe that a director with a 12 months’
notice period would find a position within six months following
termination, the remuneration committee would probably find a
package of more than six months hard to justify to
shareholders.
But “avoiding rewarding poor performance” and “taking a proper
line to reflect mitigation” are often difficult to reconcile. A
director employed under a contract with a 12 months’ notice period
is, in the absence of gross misconduct, entitled to 12 months’
notice irrespective of performance. If they have performed poorly,
it may be more difficult for them to find another job and thereby
mitigate their loss. In other words, it can be more difficult to
negotiate a discount when a director hasn’t delivered.
Disclosure requirements
Full disclosure of amounts paid to departing directors is
required in the directors’ remuneration report, which will then be
put to an advisory vote by shareholders. So a board needs to bear
in mind the likely reaction of investors before any deal is
agreed.
