Compensation payments for loss of office

TheLawStudent

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.