Month: December 2020

It is very important to determine whether someone is an employee, an independent contractor or a worker for employment law purposes. The answer will essentially determine who qualifies for certain employment rights and who does not.

On a very simple level, independent contractors are individuals who set up business on their own account and provide services to others under a contract for services. This could be, for example, an individual who has set up his own contract cleaning business. He will normally provide cleaning services to a number of different customers when needed and invoice the customer on a weekly or monthly basis. He will incur his own expenses in running the business and sort out his own tax affairs with HMRC directly. Independent contractors are therefore regarded as self-employed and have no employment relationship with those for whom they perform services.

Employees on the other hand are usually required to work regular hours, on tasks set by the employer, at a set location and for a fixed salary. They will generally receive the usual employee benefits including a fixed salary and paid holiday leave.

Who is an employee?

The definition of an employee

Section 230(1) ERA 1996 provides that an employee is an individual who has entered into, or works under (or where the employment has ceased, worked under) a contract of employment.

This definition is fairly unhelpful because (as with most contracts) the courts will look at the substance and not the form of the contract. The label the parties choose to put on a contract in terms of whether they call it a contract of employment (sometimes also called a contract of service) or label it a contract for services is of very little significance. This label will only be one of the many factors which the courts will look at before deciding whether an individual is an employee or falls into some other category.

The answer to the question of whether an individual is an employee rests instead on a number of common law tests. These are:

1. the personal service test;
2. the control test;
3. mutuality of obligation test; and
4. other factors – economic reality and integration tests.

The personal service test

This test considers whether the individual must perform work personally. If the
individual has a right to send a substitute to perform the work in his/her place
this may negate employment status. However the Tribunal will consider if the
right to substitute is fettered in any way (e.g. does the substitute have to be
selected from a list that the employer has pre-approved?). The Tribunal will
also look at whether the right to send a substitute has actually been exercised
in practice.

The control test

The control test explores the level of control an employer has over the individual’s work pattern. The control test involves applying a number of questions to the circumstances of the case to determine what level of control the employer has. For example:

• To what extent does the employer control who does the work?
• Does the employer control what work is done e.g. does he control the order in which jobs or tasks are undertaken?
• What control does the employer have over where the work is done?
• Does the employer have control over when the work is done and the number of hours worked?
• Can the employer control how the work is to be performed?

If, after asking these questions, you arrive at the conclusion that the employer has very little control, this will tend to point away from an employment relationship existing.

The mutuality of obligation test

Under this test the employer should be under a duty to provide work and the individual under a duty to accept and then perform the work when given it. The expression ‘employer’ is used in this context as meaning the person to whom the services are being provided and not the ‘employer’ in the legal sense of an employer/employee relationship.

Other factors – economic reality and integration tests

The courts recognise that the question of whether an individual is an employee comes down to a combination of features taking into account all aspects of a person’s work activities.

The tests mentioned above are relevant and examples of additional factors taken into account under this test include:

• whether the individual is integrated into the workforce;
• whether the individual bears a degree of financial risk;
• how the individual is paid (is it via a regular wage slip or does he/she submit an invoice for work done?);
• whether the individual is able to work for others;
• how have the parties described their relationship?
• is the individual subject to the company’s disciplinary or grievance procedure?
• is the individual paid holiday or sick pay?
• does the individual wear the uniform of the company and/or appear to the outside world to be an employee of the company? and
• how his/her earnings are taxed (is tax deducted at source via PAYE or does he/she account to HMRC for his/her own taxes?).

Once you have applied these tests, you should be able to paint an overall picture from which to decipher who is likely to be considered an employee and who is not. If the individual is not an employee then he will not be able to benefit from some of the very important and more traditional employment rights, including the right not to be unfairly dismissed and the right to receive a redundancy payment in the event of a redundancy situation arising.

Who is a worker?

Why do we need to know?

As the scope of employment protection broadens, workers have acquired new rights in the workplace. The following are some of the legislative measures that contain provisions covering workers and not just employees:

• Public Interest Disclosure Act 1998
• Working Time Regulations 1998
• National Minimum Wage Act 1998
• Equality Act 2010

The definition of a worker

All employees are also workers, but not all workers are employees. Therefore, the category of ‘worker’ is wider and extends certain employment law protection to others who are not employees.

Section 230(3) ERA 1996 defines a worker as an individual who has entered into or works under (or where the employment has ceased, worked under):

1. a contract of employment; or
2. any other contract, whether express or implied, and (if it is express) whether oral or in writing, whereby the individual undertakes to do or perform personally any work or services for another party to the contract whose status is not by virtue of the contract that of a client or customer of any profession or business undertaking carried on by the individual.

The requirement to perform the services personally and not to be doing so as part of a business venture or profession where there is a client/customer relationship is the key to whether or not the person will be regarded as a worker. Workers may fall into any of the following categories: temporary workers; casual workers; locums; sub-contractors; and consultants.

Who is an independent contractor?

An independent contractor is someone who works under a contract for services rather than a contract of service. They are sometimes referred to as freelance workers or self employed.

Independent contractors are commonly found in certain industries such as construction, catering, shipping and the IT industry. Very often the individual concerned will enter into a contract through which his services will be provided to the relevant business.

The contract between the individual and the business will be drafted to provide for maximum flexibility, to ensure that the individual is not required to perform the services personally, is not subject to overt control and can be seen to bear a degree of financial risk. Again the courts will look at the substance and not just the form of the contract. Provided the arrangement is genuine, the independent contractor should not be an employee or a worker.

Introduction to Employment Law

As a corporate lawyer you will not be expected to be an expert in employment law. However, you will need to be able to identify potential employment law issues, know when to consult an appropriate colleague and understand the solution being suggested to your client and how this will impact on the work that you are doing.

A good example of this is the impact of TUPE on corporate transactions. As a corporate lawyer you will need to be able to identify a potential TUPE transfer. You will also be expected to understand at a basic level what obligations arise for your client as a result of the deal constituting a TUPE transfer.

By illustration, the potential impact of TUPE was highlighted in a case in June 2005 when The Transport & General Workers Union alleged that William Hill had failed to consult with employees prior to its acquisition of Stanley Racing and brought a claim for compensation of up to £4,000,000. Thankfully for William Hill the claim was subsequently thrown out by the Employment Tribunal on the basis that there had only been a share sale and not a business sale, so TUPE did not apply. However, this demonstrates the potential costs of not complying with these regulations and the importance of being able to identify such employment issues in the context of a corporate deal.

The impact of European Law

EC legislation and case law has had a major influence on UK employment law. You may already be familiar with the Equal Treatment Directive, the Equal Pay Directive and the Acquired Rights Directive which gave rise respectively to the Sex Discrimination Act, the Equal Pay Act (both of which have now been replaced by the Equality Act 2010) and TUPE.

The role of EU law in domestic legislation is something that could undergo significant change following the UK’s decision to leave the EU as a result of the Brexit referendum in June 2016.

The law is moving towards the protection of workers generally, and not just employees.

General nature of Employment Law

Employment law is best described as a mixture of contractual and statutory rights.

In essence, the employment relationship is largely governed by the employment contract between the employer and the employee (whether it is an oral agreement or an agreement in writing). The employment contract will always be the starting point when advising an employer or employee of their respective rights and duties. Many issues relating to employment law therefore involve the application of the common law principles of contract law.

However, the reality of the employment relationship is such that the employer is typically in a much stronger negotiating position than the employee. To address this inequality and protect employees, a raft of statutory provisions has been introduced. The employment contract and the entire employment relationship is now very strictly controlled by statutes (many of which have derived from EC law). For example, we have statutory control over the two most basic elements of the contract of employment, namely the minimum amount which employees must be paid (this is controlled by the National Minimum Wage Act 1998) and how long they can be required to work (controlled by the Working Time Regulations 1998).

Employment law is driven by the economic and political climate making it an extremely fast-changing area. The economic downturn of 2007-09 led to a government drive to try and promote business recovery and remove excessive restrictions and regulations upon businesses. Much of the consequent employment law legislation was designed with this aim in mind and it produced a real reduction in employment rights. For example, an increase in the qualifying period needed to claim unfair dismissal has meant that fewer employees are eligible to bring claims for unfair dismissal and the introduction of fees for Employment Tribunal claims, designed to discourage unmeritorious claims, has resulted in a huge drop in proceedings being issued against employers.

Whether the Government will take this deregulation agenda further following the UK’s decision to leave the EU as a result of the Brexit referendum is something that remains to be seen.

Requirement for shareholder approval

In the situation where a director leaves or loses his position, the company may wish/agree to pay him compensation for loss of office due to the specific circumstances involved. As a check against less scrupulous directors awarding each other gratuitous payouts, s.217 CA 2006 requires that any such payments must be approved by the company’s shareholders by way of ordinary resolution unless:

1. the payment, together with any other relevant payments, does not exceed £200 (s.221 CA 2006) (a definition of “other relevant payments” is given in s.221 CA 2006); or
2. the payment is made in good faith: (i) in discharge of an existing legal obligation; (ii) by way of damages in respect of such an obligation (for example, damages for breach of contract as discussed at paragraph 2.4 above); (iii) in settlement or compromise of a claim in connection with termination of a person’s office or employment; or (iv) by way of pension in respect of past services (s.220 CA 2006).

Any such payment by a company to a director of its holding company must also be approved by that company – in this case, approval must be obtained from the shareholders of both companies. However, no approval is required under s.217 CA 2006 from the shareholders of a wholly-owned subsidiary (s.217(4) CA 2006).

Directors cannot avoid these provisions by the payment being made to a third party rather than directly to the director himself – under s.215(3) CA 2006 payments made to a person connected to a director, or made to any person at his direction, or for the benefit of, a director or a connected person, will be treated as a payment to the director and will also require shareholder approval.

A memorandum setting out particulars of the payment must be made available to shareholders for 15 days before the ordinary resolution is passed, ending with the date of the general meeting (s.217(3) CA 2006). The legislation also includes provisions requiring shareholder approval for:

• any payment for loss of office made by any person to a director in connection with the transfer of the whole or part of the undertaking or property of a company (for example, on a share or business sale of the company) (s.218 CA 2006); and
• any payment for loss of office made by any person to a director in connection with a transfer of shares in the company, or one of its subsidiaries, resulting from a takeover bid (s.219 CA 2006). Note that in such a vote neither the offeror nor their associates (defined in s.988 CA 2006) will be allowed to vote on the resolution (s.219(4) CA 2006).

As specific shareholder approval is required under the above sections (ss.217, 218 and 219 CA 2006) for such compensation payments, it is not also necessary to comply with the authorisation requirements set out in s.175 CA 2006 regarding the directors’ duties to avoid conflicts of interest (s.180(2) CA 2006).

Meaning of “payment for loss of office”

What exactly is a “payment for loss of office”? This is defined under s.215(1) CA 2006 as a payment made to a director or past director by way of:

1. compensation for loss of office as director of the company;
2. compensation for loss of any other office or employment in connection with the management of the affairs of the company or its subsidiary undertakings while director of the company or in connection with ceasing to become a director of the company; or
3. consideration for, or in connection with, retirement from the office of director, or from any other office or employment in connection with the management of the affairs of the company or its subsidiary undertakings while director of the company or in connection with ceasing to become a director of the company.

Section 215(2) CA 2006 makes it clear that “compensation” includes both cash and non-cash benefits.

Consequences of breach

These are found in s.222 CA 2006. Where a payment is made in contravention of s.217 the recipient will hold the payment on trust for the company (s.222(1)(a) CA 2006). In addition, any directors who authorise the payment are jointly and severally liable to indemnify the company that made the payment from any resulting loss (s.222(1)(b) CA 2006).

A payment in contravention of s.218 (payment in connection with transfer of undertaking or property) will result in the recipient holding the payment on trust for the company whose undertaking or property is or is proposed to be transferred (s.222(2) CA 2006).

Where s.219 CA 2006 (payment in connection with share sale) is contravened the recipient will hold the payment on trust for those who have sold their shares as result of the offer. Moreover, any expenses in distributing the sum to those persons will be borne by the recipient and cannot be deducted from the sum received (s.222(3) CA 2006).

Corporate Governance Code requirements (listed companies only)

Corporate Governance Code (‘CGC’)

For listed companies whose shares are listed on the Main Market on the London Stock Exchange only, the CGC sets out requirements in respect of service contracts and compensation. You will study the CGC in further detail if you take the Equity Finance or Corporate Finance elective modules. Companies should carefully consider what compensation commitments the director’s terms of appointment would entail in the event of early termination. Unless certain limited exemptions apply (in relation to the recruitment of new directors) notice or contract periods should be for a period of one year or less.

In addition, the CGC contains specific provisions relating to directors’ remuneration. In particular:

• The remuneration should be designed to support strategy and promote the long-term sustainable success of the company.
• Remuneration arrangements should ensure reputational and other risks from excessive rewards, and behavioural risks that can arise from target based incentive plans are identified and mitigated.
• The link between individual awards, the delivery or strategy and the long-term performance of the company should be clear. Outcomes should not reward poor performance.

As compensation for loss of office is likely to be linked to remuneration, the above provisions should also serve to reduce the scope of any compensation payable to a director.

Directors’ Remuneration Report

The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 as amended by The Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019 set out the requirements for preparation of the directors’ remuneration report (which forms part of the company’s Annual Report and Accounts) by UK incorporated quoted companies and, as from 10 June 2019, unquoted trading companies (of which there are only a very small number in the UK) . The directors’ remuneration report must include:

1. an annual statement by the chair of the remuneration committee which summarises the major decisions the committee has made on directors’ remuneration that year and any exercise of discretion in the award of directors’ remuneration;
2. an annual report on remuneration disclosing how the existing remuneration policy is intended to be implemented in the current financial year; and
3. the directors’ remuneration policy.

Shareholders of UK incorporated quoted companies and unquoted trading companies will need to approve the director’s remuneration policy at least once every three years by way of ordinary resolution (s.439A(1) CA 2006). This resolution will be binding so that once the remuneration policy has been approved, the company must only make payments in accordance with the policy or else seek shareholder approval to amend the policy to authoirse the Company to make the payment (s.226B(1) and s.226C(1) CA 2006). Any obligation, however arising, to make a payment of remuneration or loss-ofoffice payment which would be in contravention of the policy will have no effect (s.226E(1) CA 2006).

From 10 June 2019 references to “directors” in s226A – 226F CA 2006 dealing with remuneration payments and loss of office payments include somone who isn’t a director but is a company’s chief executive office or deputy chief executive officer. Although it would be unusual for someone with this job title not to be a director.

Waiver of directors’ personal liability

It may be that, even though a director has not acted in compliance with his duties to the company, the shareholders are willing to forgive him for the breach. This often occurs when the breach was inadvertent or minor. As you are aware already, if a director acts negligently or in breach of duty or trust in relation to the company he will incur personal liability. However, the shareholders of a company have the option to forgive conduct by a director amounting to negligence, default, or breach of duty or trust with the
consequence that the director’s personal liability in respect of that conduct will be waived.

This ratification of a director’s conduct was dealt with under the common law, until the introduction of s.239 CA 2006 which put ratification on a statutory footing. Section 239 CA 2006 sets out the minimum requirements which must be met for a ratification to be effective. It applies to former directors and shadow directors, as well as to current directors. Although s.239 CA 2006 is very much based on the common law requirements, it also introduces more restrictive elements.

Shareholder approval required

Unless the company’s articles require a higher majority (or unanimity), an ordinary resolution must be passed in order to ratify conduct by a director amounting to negligence, default, or breach of duty or trust (s.239(2) CA 2006). However, it is important to note that in obtaining the required level of approval, any votes which the director and any person connected to him may have as shareholders of the company cannot be taken into consideration. This introduces a significant restriction on ratification which did not exist under common law. The intention behind it is to prevent those who may gain a personal advantage from the ratification from voting – it is not appropriate for those that have done wrong, or those connected to them, to be able to vote to waive their own liability.

“Connected persons” is defined in s.252 CA 2006 and includes, amongst others, the spouse, children and parents of a director (s.253 CA 2006) as well as companies with which the director is connected. Notably “connected persons” for these purposes may also include a director’s fellow directors if they satisfy one of the other requirements in the connected person definition (s.239(5)(d) CA 2006).

As a result of this new restriction:

1. if the ratification is proposed as a written resolution, as the director and any shareholders connected to him are not eligible to take part (s.239(3) CA 2006), the resolution need not be sent to them and they are not taken into account in determining whether the requisite majority has been achieved to pass the resolution; and
2. if the resolution to ratify is proposed at a meeting, the necessary majority must be achieved disregarding any votes in favour made by the director and any members connected to him (s.239(4) CA 2006). The director and connected member can, however, still attend, count in the quorum and take part in the proceedings at a meeting where such a resolution is proposed.

Section 239(6) CA 2006, however, does clarify that nothing in s.239 CA 2006 affects the validity of a decision taken by unanimous consent of the shareholders. Therefore, when such consent has been obtained, the restrictions on who can vote will not apply.

Overall, these statutory provisions will make it harder for companies to ratify a director’s conduct, particularly in small family companies where the directors often hold the majority of the shares and are related.

Other requirements for valid ratification

Section 239(7) CA 2006 makes it clear that the requirements set out in s.239 CA 2006 are in addition to, rather than an alternative to, any other requirements that statute or common law may impose for ratification to be valid. It states that s.239 CA 2006 does not affect:

1. any statute or rule of law imposing additional requirements to those set out in s.239 CA 2006; and
2. any rule of law as to acts that are incapable of being ratified by the company.

So, for example, it is still not possible for illegal acts or acts which defraud creditors to be ratified.

Removal by shareholders is obviously not the only way in which a director may leave his position. The other ways in which he may cease to be a director are set out below.

Resignation by notice

A director could be put under pressure to resign either by the shareholders or by fellow board members and may simply take the decision to resign from the board by tendering a letter of resignation. This procedure is provided for in MA 18(f). A director may also decide to resign for personal reasons. It is usual, although not obligatory, in these circumstances for the board to pass a board resolution accepting the letter of resignation. If the resigning director is also a shareholder, consideration must be given as to what will happen to his shares i.e. will the other shareholders be able/willing to buy them?

Automatic termination

Under MA 18 a person ceases to be a director as soon as:

1. the director becomes disqualified from being a director;
2. the director becomes bankrupt;
3. the director becomes the subject of an individual voluntary arrangement or enters into some other similar arrangement with his creditors; or
4. a registered medical practitioner who is treating the director states in writing to the company that the director has become physically or mentally incapable of acting as a director and will remain so for more than three months.

Retirement by rotation

Public companies

The model articles for public companies require retirement and reappointment of directors by the members every three years.

Listed companies

In addition, listed companies are required under the Listing Rules to comply with the UK Corporate Governance Code (‘CGC’), or at least to explain in their annual accounts where and why they have not done so. One of the requirements of the CGC is that all directors should be subject to annual re-election.

Disqualification – Company Directors Disqualification Act 1986 (‘CDDA’)

The CDDA is the key piece of legislation regarding disqualification of directors. Under this Act, the court may make a disqualification order against a person preventing them, unless they obtain leave of the court, to be a director, liquidator, receiver or in any other way directly or indirectly involved in the promotion, formation or management of a company. The purpose of such an order is to protect the public against the activities of such a director. The period of disqualification is for a maximum of 15 years.

Grounds for disqualification

These include:

• conviction for indictable offences connected with the company’s promotion, formation, management, liquidation or striking off (s.2 CDDA);
• persistent breaches of company legislation (s.3 CDDA);
• fraud in a winding up (s.4 CDDA);
• unfit conduct of directors of insolvent companies (s.6 CDDA);
• fraudulent and wrongful trading;
• breach of competition law (s.9A CDDA); and
• conviction of certain offences overseas (s.5A CDDA – introduced by SBEEA 2015).

The most common reason for disqualification is the conduct of directors of insolvent companies which makes them unfit to be concerned in the management of a company (s.6 CDDA).

Unfit conduct of directors of insolvent companies

When a company goes into insolvency, the appointed insolvency practitioner (i.e. liquidator, administrator or administrative receiver) is required to submit a confidential report to the relevant Government department, dealing with the conduct of directors (and shadow directors) holding positions in the three years prior to the insolvency practitioner’s appointment. Save for competition infringements, only the Secretary of State or, in certain cases if the Secretary of State so directs, the Official Receiver, can make an application to court where the report indicates that a disqualification order should be sought. The application must be made within three years of the company becoming insolvent (this period was increased from two to three years by SBEEA 2015). The relevant Government department is currently the Department for Business, Energy and Industrial Strategy.

Where an application satisfies the court under s.6 CDDA that the conduct of a director of an insolvent company (which has gone into liquidation, administration or administrative receivership) makes him unfit to be concerned in the management of a company, the court is required to make a disqualification order against him. Matters to be considered by the court when determining the question of unfitness to be concerned in the management of a company are referred to in s.12C CDDA and Schedule 1 (they are nonexhaustive and are intended to be guidelines only).

Relevant matters include:

• misfeasance or breach of any fiduciary or other duty to the company;
• responsibility for the causes of the company becoming insolvent; and
• responsibility for any material breaches of legislation or other obligations by the company.

Undischarged bankrupts

It is a criminal offence for an undischarged bankrupt to take part directly or indirectly in the management of a company without leave of the court (ss.11 and 13 CDDA).

Consequences of failing to comply with a disqualification order

It is a criminal offence to act as a director or to participate directly or indirectly in corporate management without leave of the court (s.13 CDDA). The director is also personally liable for the company’s debts incurred while involved in the management of a company, in breach of a disqualification order (s.15 CDDA).

Disqualification undertakings

The Insolvency Act 2000 (‘IA 2000’) introduced s.1A to the CDDA with a view to improving the speed and efficiency of the disqualification process. Directors who are considered to be ‘unfit’ may consent to an appropriate period of disqualification from being a director or involved in the management of a company or acting as an insolvency practitioner, without the need for court proceedings. Disqualification can therefore occur administratively, where agreed, by such a director giving a ‘disqualification undertaking’ to the Secretary of State. The maximum and minimum periods are the same as under a disqualification order.

Human rights

The IA 2000 s.11 also amended s.219 of the IA 1986, whereby answers obtained from an individual under powers of compulsion in a company investigation (given in s.218(5) IA 1986) cannot generally be used against that person in subsequent criminal proceedings. This amendment resulted from the ECHR decision in the case of Saunders v UK 1996 23 EHRR 313, that such use of those answers infringed Article 6 of the First Protocol to the European Convention on Human Rights.

Disqualification for competition infringements – CDDA ss.9A-9E

The Enterprise Act 2002 amended the CDDA by allowing the Competition and Markets Authority (‘CMA) (which took over the functions of the Office of Fair Trading under this provision from 1 April 2014) to apply to the court for a competition disqualification order against any director of a company which has infringed either UK or EC competition law. The court will need to be satisfied that the director’s conduct in relation to that infringement, makes the director unfit to be concerned in the management of a company (s.9A CDDA). A maximum of fifteen years’ disqualification as well as possible disqualification undertakings apply.

Foreign disqualification

Under CA 2006 the Secretary of State is given power to make regulations to disqualify a director who has been disqualified under foreign laws. This power is intended to close a gap in the current law through which people who had been disqualified in other countries could still set up, and be directors of, UK companies.

The CDDA has also been amended by SBEEA 2015 to provide that in considering an application for disqualification of a director of an insolvent company, the court must have regard to conduct of that director in relation to overseas companies.

Whether or not unhappy shareholders choose to remove a director, there are two key actions which shareholders may be able to bring in respect of a director’s misconduct.

Section 260 CA 2006 has introduced a new statutory derivative claim which allows a shareholder to bring a claim on behalf of the company (i.e. where the cause of action vests in the company) arising from an actual or proposed act or omission involving the negligence, default, breach of duty or breach of trust by a director of the company. This includes a breach of the director’s general duties set out in ss.170-177 CA 2006. Section 260 CA 2006 applies to current, former and shadow directors.

The second action is for protection of shareholders against unfair prejudice. Under s.994 CA 2006, a shareholder can apply to the court for an order that the company’s affairs are being, have been, or are proposed to be conducted in a manner that is unfairly prejudicial to that shareholder’s interests or to the interests of shareholders generally.

Case law (in respect of the equivalent provision in CA 1985) has tested the meaning of unfair prejudice. The courts have been specific and restrictive in their interpretation of what amounts to unfair prejudice. Examples can include excessive remuneration of directors or a failure to pay a dividend. The courts are, however, unwilling to intervene in internal affairs or management decisions of companies. Therefore petitions based on disagreements in company policy (e.g. as to whether to pursue a sale of the business or some
other exit strategy) will be more difficult to bring.

Such an action is often brought at the same time as an action under s.122(1)(g) IA 1986 which gives a shareholder the right to apply for the company to be wound up on the grounds that it is just and equitable to do so.

The ability to remove a director from his office is the ultimate sanction shareholders have against a director. Under s.168(1) CA 2006, a company (i.e. the shareholders) may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in any agreement between the company and that director.

Under s.168(2) CA 2006 special notice is required of a resolution to remove a director.

What is special notice?

For simplicity, I will refer to a resolution to remove a director under s.168(1) CA 2006 as a “removal resolution”.

Shareholders proposing a removal resolution must give notice of that proposed removal resolution to the company (i.e. to the board of directors) at least 28 clear days before the general meeting at which the removal resolution will be voted on by shareholders (ss.312(1) and 360(1) and (2) CA 2006).

The board usually decides what matters will be considered at a general meeting. Therefore, when the board receives notice of the proposed removal resolution, two courses of action are open to it:

Place the removal resolution on the agenda

The board may decide to place the removal resolution on the agenda of a general meeting, in which case, when the general meeting is held, shareholders will vote on that removal resolution.

If the board does decide to place the removal resolution on the agenda of a general meeting, it should give the shareholders notice of that removal resolution at the same time and in the same manner as it gives notice of the general meeting (s.312(2) CA 2006). This means that the board will need to give shareholders at least 14 clear days’ notice of the removal resolution under ss.307(1) and 360(1) and (2) CA 2006 (see Fenning v Fenning Environmental Products Ltd (1981), which was an authority for the equivalent rule under CA 1985).

If that is not practical (e.g. because notice of the general meeting has already been sent out), notice of the removal resolution may be given either by advertisement in a newspaper or any other mode allowed by the company’s articles of association at least 14 clear days before the general meeting (ss.312(3) and 360(1) and (2) CA 2006).

It might seem strange that the board needs to give shareholders notice of the removal resolution when it was the shareholders who sent the removal resolution to the board in the first place.

The reason for this lies in understanding that only some of the shareholders will have sent the proposed removal resolution to the board. We shall call these shareholders the “unhappy shareholders”. The company’s other shareholders may have no knowledge of the fact that the unhappy shareholders have proposed a removal resolution.
Therefore, if the board decides to put the removal resolution on the agenda of a general meeting, it needs to give notice to all shareholders (including the unhappy shareholders) of the fact that a general meeting will be held and that, at that general meeting, all shareholders will have the opportunity to vote on a removal resolution.

Decide not to place the removal resolution on the agenda

Alternatively, the board may decide not to place the removal resolution on the agenda of a general meeting. Directors are not bound to place the removal resolution on the agenda for consideration at a forthcoming general meeting (Pedley v Inland Waterways Association Ltd (1977), a CA 1985 authority). In practice, this creates a problem for shareholders as directors may choose simply to ignore the proposed removal resolution.

If the removal resolution is not placed on the agenda, it will not be considered at the general meeting. In this case, the shareholders may need to force the directors to call a general meeting in accordance with s.303 CA 2006.

Shareholders’ power to require calling of general meeting

As we have seen above, it is sometimes the case that the board of directors will try to frustrate an attempt to remove a director by refusing to call a general meeting. In this situation, the unhappy shareholders may have the ability to require the directors to call a general meeting and, if the directors refuse to do this, the unhappy shareholders may be able to call the general meeting themselves.

How do shareholders require the directors to call a general meeting?

Under s.303(1) CA 2006, shareholders together holding not less than 5% of the paid up voting share capital of the company can serve a request on the company i.e. the board. The request will require the board to call a general meeting (a “s.303 request”). The threshold of 5% is found in s.303(2) CA
2006.

A s.303 request must state the general nature of the business which the shareholders wish to be dealt with at the general meeting, and may include the text of the resolution they want proposed at the meeting (here, to consider a removal resolution pursuant to s.168 CA 2006).

What are directors’ obligations on receipt of a s.303 request?

Under s.304(1) CA 2006, when the directors receive a s.303 request, they must call the general meeting:

1. within 21 days from the date on which they become subject to the s.303 request to call the general meeting; and
2. to be held on a date not more than 28 days after the date of the notice convening the general meeting.

What happens if the directors fail to call the general meeting?

If the directors fail to call a general meeting under s.304(1) CA 2006, all of the shareholders who submitted the s.303 request or any of them representing more than one half of the voting rights of those who submitted that s.303 request, can call a general meeting themselves pursuant to s.305 CA 2006.

If the shareholders call the general meeting themselves then that general meeting must be called on no fewer than 14 clear days notice (s.305(4) CA 2006) and held within 3 months of the date that the directors received the s.303 request (s.305(3)).

Under s.305(6) CA 2006, if the shareholders are forced to call the general meeting themselves, they can recover their reasonable expenses for doing so from the company.

Conclusion

In order for the unhappy shareholders to ensure the resolution to remove a director is heard as soon as possible, they will submit a s.303 request requiring the directors to call a general meeting at the same time as sending their s.312 CA 2006 special notice to the board.

By sending these two notices to the board at the same time, shareholders will comply with s.312 CA 2006 (which is a stand alone requirement that needs to be satisfied) and also ensure that:

1. the directors either call a general meeting with an agenda which includes the resolution to remove the director under s.303 CA 2006; or
2. the shareholders can step in and call the general meeting under s.305 CA 2006 themselves.

Director’s rights to protest removal

If a company receives notice that one or more members intends to propose a removal resolution, the company must immediately send a copy of the notice to the director concerned (s.169(1) CA 2006).

The director then has the right to make representations in writing provided those representations are of a reasonable length (s.169(3) CA 2006). These representations will, for example, set out the reasons why the director feels he should not be removed. These representations should, unless they are received too late for the company to do so, be circulated to the members of the company. If the representations are not circulated, they should be read out at the general meeting (s.169(4) CA 2006).

In any event, the director concerned has a right to be heard i.e. to speak in his defence at the general meeting, whether or not he is a shareholder (s.169(2) CA 2006).

Will the director be entitled to any compensation?

Section 168(5) CA 2006 provides that removal under s.168 CA 2006 does not deprive a person of any right they may have to compensation or damages payable by reason of the termination of any appointment. This means that if the director’s service contract (i.e. his employment contract) is breached by reason of his removal from the office of director under s.168 CA 2006, then he may be entitled to damages or compensation for breach of that service contract.

Payments under the terms of a director’s service contract need to be distinguished from any additional payment for loss of office which will require shareholder approval.

What if the director is also a shareholder?

Always check the articles to see if there is a Bushell v Faith clause.

A Bushell v Faith clause in the articles of association may give a director, who is also a shareholder, weighted voting rights at a general meeting at which a s.168 CA 2006 resolution is proposed. This is likely to mean that shareholders are unable to pass an ordinary resolution to remove the director concerned.

This type of clause is often found in the articles of association of smaller companies where the directors have played a key role in setting up the company and have an expectation that they will be able to continue to be involved in the running of the business. Any shareholders’ agreement should also be checked for similar provisions.

The articles should also be checked in order to determine whether there are any transfer provisions which may govern the transfer of the outgoing director’s shareholding in the company. From a practical point of view, if a director is to be removed, the company and the shareholders are unlikely to want him to retain his shareholding, so transfer provisions are usually found in a company’s articles of association and/or in any shareholders’ agreement. These transfer provisions would, for example, require the director to transfer his shares to the other shareholders if he is removed as a director.

Can you use a shareholders’ written resolution to remove a director?

No, the procedure cannot be used – see s.288(2)(a) CA 2006.

Can a director be removed from office by fellow directors?

The answer to this is not unless the articles specifically provide for this. Where the articles expressly provide that a director can be removed by the other directors, this power has been upheld by the courts (see Bersel Manufacturing Co Ltd v Berry [1968] 2 All ER 552). The Model Articles do not provide for this. If the directors were able to remove their fellow directors, this could lead to difficulties in decision making.

Introduction

• the directors have control of the company’s day to day management;
• directors necessarily have broad powers to carry out such management;

but

• statute places certain controls on directors which act as a check against abuse of their powers;
• directors must disclose certain information about themselves and their dealings with the company;
• shareholder approval must be obtained for certain transactions; and
• shareholders have certain important decisions reserved to them (such as amending the company’s articles of association).

Over the next few posts, I will provide an overview of the statutory provisions governing a shareholder’s power to remove a director from office and related issues. Also covered will be other ways that a director’s office may be terminated and a shareholder’s power to “forgive” (i.e. ratify) a director’s breach in certain circumstances.

General prohibition

A director acts as an agent for the company but from time to time may incur personal liability to the shareholders or to a third party. Under the general prohibition, a company cannot indemnify a director of the company or an associated company for any liability he may have incurred as a result of his negligence, default, breach of duty or trust in relation to the company of which he is a director. Any provision purporting to do so is void (s.232 CA 2006).

Companies are associated if one is a subsidiary of the other or both are subsidiaries of the same body corporate (s.256 CA 2006).

The aim of s.232 CA 2006 is to protect companies from loss caused by their directors. However, this protection must be balanced with the practical need to encourage people to become directors. The legislation attempts to achieve this balance by:

1. not preventing companies from purchasing and maintaining insurance for a director against such liability (ss.232(2)(a) and 233 CA 2006) (usually referred to as ‘Directors’ and Officers’ Liability Insurance’ or abbreviated to ‘D & O insurance’); and
2. not preventing companies from providing ‘qualifying third party indemnity provisions’ (‘QTPIP’) (ss.232(2)(b) and 234 CA 2006) and, in respect of companies which act as trustees of an occupational pension scheme, ‘qualifying pension scheme indemnity provisions’ (‘QPSIP’) (ss. 232(2)(c) and 235 CA 2006), to their directors.

QTPIP

QTPIP is defined in s.234 CA 2006. Under this definition, a company is permitted to indemnify its directors against liability incurred by the director to a person other than the company or an associated company provided that the indemnity does not include:

1. an indemnity for a director in relation to a fine he has to pay as a result of criminal proceedings or a sum payable as a penalty imposed by a regulatory authority for non-compliance with “any requirement of a regulatory nature”;
2. an indemnity for a liability a director incurs in defending criminal proceedings if he is convicted;
3. an indemnity for a liability a director incurs in defending any civil proceedings brought by the company or an associated company where the judgment is given against the director; or
4. an indemnity in relation to a director’s unsuccessful application to court for relief in connection with s.661(3) or (4) CA 2006 (acquisition of shares by innocent nominee) or s.1157 (general power to grant relief in case of honest and reasonable conduct).

The practical effect of this is that a company can indemnify a director against liabilities incurred by the director to anyone other than the company or an associated company. This may include the costs of defending those proceedings and the financial costs of an adverse judgment. However, a director can still be liable to the company itself and cannot be indemnified against this.

QPSIP

Section 235 sets out the meaning of qualifying pension scheme indemnity provision. A ‘pension scheme indemnity provision’ is a provision which indemnifies a director of a company that is a trustee of an occupational pension scheme against liability incurred in connection with the company’s activities as a trustee of the scheme. Again, it will only be ‘qualifying’ if certain conditions set out in s.235 CA 2006 are met.

QPSIPs were introduced by the CA 2006 in recognition of the fact that companies which act as occupational pension scheme trustees can find it hard to attract high calibre individuals as directors without such protection in respect of the personal liabilities they may incur in the position.

Expenditure on defence proceedings and in connection with regulatory actions or investigations

Section 205 permits a company to provide a director with funds to pay for his expenses in defending any criminal or civil proceedings in connection with any alleged negligence, default, breach of duty and breach of trust in relation to the company or an associated company or in making any relief applications in connection with s.661(3), s.661(4) and s.1157 CA 2006. These funds will need to be repaid if the director is convicted in the criminal proceedings or receives an adverse judgment in the civil proceedings or his relief application is unsuccessful.

There is a similar provision at s.206 CA 2006 in relation to a director’s costs in defending himself in investigations or actions by regulatory authorities. Note that shareholder approval is not required under the CA 2006 provisions requiring member approval for loans etc. for a company to provide a director with funds for defence proceedings or regulatory actions and investigations. Sections 205 and 206 CA 2006 expressly state this.

Indemnity provisions in the articles of association

The sections of the act discussed above set out the fullest extent to which a company may lawfully indemnify its directors in respect of negligence, default, breach of duty and breach of trust in relation to the company.

MA 52 provides companies with the authority but not the obligation to indemnify their directors, former directors (and those of their associate companies) to the fullest extent permitted by the CA 2006. However, they cannot indemnify beyond the scope of the CA 2006 provisions. Consequently under MA 52(2) no provision can indemnify a director against liability incurred to the company of which he is director or to an associated company.

A company is under no obligation to provide an indemnity to the fullest extent permitted by law and should consider the extent of the indemnity it is willing to provide. The Department for Business, Energy and Industrial Strategy’s guidance also suggests that the company needs to consider whether it is in the company’s best interests to agree to pay a director’s defence costs.

Disclosure

QTPIPs and QPSIPs need to be disclosed in the directors’ report (s.236 CA 2006). Copies of the indemnities must be kept by the company at its registered office (or a place specified in regulations under s.1136 CA 2006) during their term and also for one year after they have expired or terminated (s.237 CA 2006). Non-compliance with s.237 CA 2006 is a criminal offence. Shareholders have the right to inspect copies of the QTPIPs and QPSIPs and, on payment of a fee, to be provided with a copy (s.238 CA 2006).

A number of duties and obligations are imposed on directors in relation to conflicts of interest by CA 2006. Importantly, the duty of directors to avoid conflicts of interest (s.175) does not arise where the conflict arises in relation to a transaction or arrangement with the company (s.175(3)). Therefore the s.175 duty will not be relevant to the transactions involving a company and its directors, which you will consider during the LPC course.

Other directors’ duties, including, in particular, the duty under s.177 to declare an interest in proposed transactions or arrangements (or, in respect of existing transactions or arrangements, the requirements under s.182) will still apply in such cases.

There are also two exceptions to the conflict duties under ss.175 and 176 (duty not to accept benefits from third parties), namely:

• if the situation or benefit cannot reasonably be regarded as likely to give rise to a conflict; or
• for s.175 only, if the potential conflict is authorised by the directors (excluding the potentially conflicted director).

In addition to these, there is a further exception in s.180(2). If a transaction needs shareholder approval under CA 2006, and shareholder approval is properly obtained, it is not necessary to comply with the ss.175 and 176 duties.