Disagreeable directors

Fallouts among directors can be messy for a business.

Adam Bernstein

Writer/researcher for independent businesses.

No matter how well a fi rm is set up, as the saying goes: ‘stuff happens’ and when it does, the fi nger pointing starts and heads begin to roll. Parting company with an employee is one thing, but what happens when it’s a director? Maybe one who is also an employee and a shareholder? It’s a problem for all fi rms regardless of size.

It’s a problem that Paul Taylor, a partner in the corporate department of Fox Williams, has seen. The issue can appear worse because an individual can wear three totally separate hats — director, employee, and shareholder — each of which comes with a different matrix of rights and obligations. From experience, Taylor knows that “nine times out of ten it will be necessary to come to an arrangement which results in the individual ceasing to act, at a minimum, as both a director and an employee and, ideally, also as a shareholder.” But that’s not always possible.

Removing a director

According to Vickie Williams, a director at Freeths, the starting point for resolving any dispute is the company’s constitutional documents. As she points out: “In most companies, the power to remove a director is granted to the board of directors or to a majority of the shareholders under the company’s articles of association or in a shareholder agreement.”

“Most articles,” says Taylor, “contain a list of circumstances when a director will be deemed to have resigned.” He says that they usually include statutory disqualifi cation; bankruptcy; mental disorder; or prolonged absence.

But there are more: Williams cites resignation; under the company’s articles which may provide that the offi ce of director is automatically vacated on the occurrence of certain events; under the law, where for example, no one can be under 16 when appointed; under contract where a provision in a service agreement requires the director to resign; by court order; and, logically, on the death of a director.

George Marques, a senior associate in the company commercial department of Bishop & Sewell LLP, considers articles or shareholder agreements as essential since they can offer easier routes to remove a director. Further, he notes that company form — private or public — “does not in and of itself alter the options available for removal.”

Employee directors

Starting with the removal of employee directors, companies should fi rst examine any service agreement that may be in place. Here Taylor advises looking for any resignation of directorship clause as “this may include useful provisions, such as an obligation to resign as a director upon any termination of employment. It may also include a power of attorney, allowing a resignation letter and other relevant documents to be signed by the company if the outgoing director refuses to do so.”

If properly drafted, Williams says documents should make the process relatively straightforward, but adds that “if they are not available, the Companies Act 2006 will step in with a mechanism for shareholders to remove a director by passing an ordinary resolution.”

Removal by shareholders

But what if the director’s removal is sought by fellow directors or if it’s the shareholders who are seeking a removal? Does the process differ?

Williams says that it can, adding that if the removal is sought by shareholders “the Act requires that an ordinary resolution is needed, subject, of course, to any agreement between the director and the company as well as a special notice of the resolution.” She makes the point that the law “also demands that upon receipt of notice of intended resolution to remove a director the company must send a notice to the director concerned.”

But while the procedure is set down in law, Taylor explains “that this method of removing a director is not always going to be practical, especially where the rapid exit of a director is desired.”

And Marques agrees. He says that the statutory procedure can be a drawnout process and can cause delays to any removal. It’s for this reason, he believes that “it is preferable to have an alternate procedure in the articles of association which simplifi es and shortens the timescales for a removal.”

Lastly, those seeking a removal should take a tip from Taylor — that they should check the articles of association to confi rm whether any shares exist that give holders enhanced voting rights, for instance, which might permit the director in question, if they hold shares, to weighted voting on any resolution to dismiss them.

Removal by directors

But where the removal is sought by directors, Williams says that “they need to have been given the power in the company’s articles which should also set out the procedure.” If they are not given this power, then the matter must be passed back to the shareholders for a simple majority view.

It’s also possible, as Taylor and Williams noted earlier, that a director’s appointment can be terminated ‘automatically’. But to their lists Marques adds another circumstance that “a director is appointed to the role under the proviso of a fi xed-term tenure and once that term expires, they will relinquish their position.” But if they fail to leave at the appropriate time, he says that litigation or a s.168 Companies Act removal may be required to enforce the point.

Marques adds that in the event of a confl ict between the articles and a shareholder’s agreement, the articles take precedence. That aside, he says that there are ways to override the removal provisions in the articles that confl ict with those in a shareholder’s agreement.

Size can mean everything

A natural question to ask, is whether a director’s shareholding bears any relevance to their position and rights? In other words, can a majority shareholder director be removed as easily as a director who is in a minority?

On this, Marques says that a director who leaves their role is not obliged to sell their shares in the company as “the two roles are entirely separate unless linked under the company’s articles of association or a shareholders’ agreement.” However, he sees a chance of confl ict rising when a director shareholder is removed from the management of the company unless there is an agreed or stipulated mechanism in place for dealing with the shareholding of a terminated director.

Williams advocates the soft approach through negotiating their position or exit. In contrast, a hard approach would involve a petition to wind up the company. But again, she says that “the starting point should be the company’s articles or shareholder agreement to see if they contain any provisions requiring director shareholders to sell their shares if they are removed as director.”

She cautions, however, that the company should be aware of the risk of an unfair prejudice application by removing a director if the shareholders are in a quasipartnership.

For the record, in terms of an unfair prejudice petition, the Act, s994 specifi cally, helps those in a minority where a director is removed from the management of the business, or a shareholding is deliberately devalued. Regarding this, Williams says that “courts have very broad discretion in these types of claims and can make orders that the prejudiced shareholder be bought out or buy the other shareholders out requiring independent valuations to be undertaken to determine share price.”

Marques expands the point and comments that “it is worth noting that S.994 claims usually result in one party or another selling shares, not the re-instatement of directors.”

Something else he draws attention to is the size of shareholding, and he says that “all other things being equal, a majority shareholder director will usually have an easier time of defending themselves in a campaign to remove them as a director and, if they own over 75% of the share capital they cannot be removed.”

However, in some cases minority shareholders can fare almost as well due to provisions in the articles or shareholders’ agreements that give a shareholder the right to appoint a director and have super-voting rights with respect to their removal.

A refusal to go quietly

While some directors will walk when they see the writing on the wall, not all will. So, should they be ‘bought off’ to get their compliance to keep the peace and keep the matter private? Or should the company and remaining directors stand their ground?

The answer, reckons Williams, is that “usually, the remaining directors will not want the expense of going through the courts; they just want to get on with running the business.” In her view, the best route is to try to negotiate with the exiting director and reach some sort of agreement.

And Marques believes the same and thinks that potential issues are better thought through at company formation stage rather than when they appear: “One often used approach is for the articles to provide that the removal of a director automatically triggers a transfer of their shares to the other shareholders.”

As to buying off the director concerned, Marques says that “it is unlawful for a company to make ‘a payment for loss of offi ce to a director of the company unless the payment has been approved by a resolution of the members of the company.’”

But if there is serious confl ict with minimal likelihood of amicable resolution, Williams does offer one more and very fi nal solution: “If negotiation is not an option, there is always the threat of winding up the business as a nuclear option.” Assuming the business is solvent, a members voluntary winding up allows the directors and shareholders to extract the value of the business in a cost effective and tax effective way.

Seek good advice

It’s easy to act in haste only to repent at leisure. Removing a director is not a simple process as procedures are, if not documented elsewhere, set down in law. In any situation requiring action, talking and negotiation are the best options to fi nding a resolution and staying out of the courts.