What Restrictions Are There on Directors Who Enter Into Long-Term Service Contracts?

While directors have day-to-day management responsibilities over a company, the law reserves some powers for shareholders. One area where shareholders can check directors’ powers relates to directors’ long-term service contracts. This article will explain the law restricting directors’ power to enter service contracts. 

What is a Service Contract?

A service contract is a director’s employment contract with the company. In some cases, a director may not qualify as an employee of the company. Nonetheless, they may have a contract with the company that sets out the terms of their engagement with it. Any such arrangement constitutes a service contract. It does not matter if the long-term service contract is written or not. 

Who Determines the Terms of Service Contracts? 

The default position is that directors have broad powers to negotiate the terms of their own service contracts with the company. This is consistent with the general principle that directors manage the company’s day-to-day affairs.

Of course, a director’s power to set the terms of their contract creates a conflict of interest. For instance, directors may seek to maximise their salary or stock options. To check this power, the law grants shareholders the absolute right to approve all service contracts with a term guaranteeing the director’s engagement for more than two years.

What is a Service Contract With a Term Greater Than Two Years? 

This would include any contract with an express term that guarantees the director a contract of more than two years. 

However, the definition of two years is actually broader. For instance, the contract may state that the director’s contract lasts only 18 months. However, another provision may give the director the power to extend the contract for another 12 months. This would effectively be a term greater than two years. Accordingly, you would need to obtain shareholder approval.

That said, shareholder approval is unnecessary if the company has the general power to dismiss the director for any reason, regardless of the service term. Importantly, this cannot be a restricted power. For instance, a term that only entitles the company to dismiss the director for gross misconduct. 

Examples of Long-Term Service Contracts

Below are some examples of terms greater than two years and therefore require shareholder approval, as well as some that are not.

What Happens If Directors Are Non-Compliant?

If shareholders do not approve the service contract with a term exceeding two years, the law essentially strikes out the term governing the length of the agreement. Likewise, the law implies a term in the agreement that the company can terminate the agreement at any time, provided it gives reasonable notice. Importantly, all other terms stay the same. 

What Are the Procedural Requirements For Long-Term Service Contracts? 

If you are a director and wish to seek shareholder approval for a long-term service contract with a term longer than two years, you must put the matter to shareholders in the usual way. 

This includes:

• convening a board meeting to agree to the wording of the resolution and ensure the terms of the service contract are recorded in a memo (or reproduced if in a contract);
• giving enough notice to the shareholders for the meeting and ensuring they have a copy of the service contract’s terms;
• holding the meeting (if not using the written resolution procedure); and 
• allowing the shareholders to vote on the resolution. 

The resolution must pass by an ordinary resolution, which means that more than 50% of the shareholders must approve the resolution. That said, you should always refer to your company’s constitution because a term may require a higher threshold. Likewise, you should check any shareholders’ agreement in effect. A corporate solicitor can advise you if there are any conflicting provisions. 

Other Considerations For Long-Term Service Contracts

There are two other laws related to service contracts. Hence, you might want to consider that your company must:

• keep copies of all directors’ service contracts at its office for at least a year following their termination; and 
• permit its shareholders to inspect the contracts at any time and without charge. 

Key Takeaways 

The law gives shareholders the absolute right to approve any long-term service contract of a company director with a term greater than two years. The two-year period effectively includes any term and notice periods exceeding two years. If you do not seek shareholder approval, the law:

• automatically voids the term of your contract; and
• substitutes a new term that allows the company to terminate the contract at any time with reasonable notice. 

If you need help with regulatory advice as to your duties as a company director, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.

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