Restrictions on Directors’ Long-Term Service Contracts

Summary

• Shareholders have the absolute right to approve any director’s service contract with a guaranteed term exceeding two years, and the two-year threshold is interpreted broadly to include notice periods and director-held extension rights that together push the effective term beyond two years.
• If shareholder approval is not obtained, the law automatically voids the length of service term and implies a right for the company to terminate the contract at any time on reasonable notice, while all other contractual terms remain in force.
• Shareholder approval requires an ordinary resolution passed by more than 50% of shareholders, though the company’s articles of association or any shareholders’ agreement may impose a higher threshold.
• This article is a plain-English guide to shareholder approval requirements for directors’ long-term service contracts in England and Wales, written by LegalVision’s business lawyers.
• LegalVision specialises in advising clients on directors’ duties, corporate governance and company law in the UK.

Tips for Businesses

When structuring a director’s service contract, map out the full effective term including notice periods and any extension rights before assuming shareholder approval is unnecessary. Check your articles of association and any shareholders’ agreement for approval thresholds before convening the meeting. Keep copies of all directors’ service contracts at the company’s registered office and make them available for shareholder inspection without charge.

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On this page

• What is a Service Contract?
• Who Determines the Terms of Service Contracts? 
• What is a Service Contract With a Term Greater Than Two Years? 
• What Happens If Directors Are Non-Compliant?
• What Are the Procedural Requirements For Long-Term Service Contracts? 
• Using a Written Resolution Instead of a Meeting
• Can a Director Vote on Their Own Service Contract?
• Other Considerations For Long-Term Service Contracts
• Key Takeaways 
• Frequently Asked Questions

A director’s service contract is a formal engagement agreement that governs the terms on which a director serves a company under the Companies Act 2006. The Act grants shareholders an absolute statutory right to approve any service contract guaranteeing a director’s engagement for more than two years, reflecting Parliament’s recognition that directors negotiating their own long-term contracts face an inherent conflict of interest. The Companies Act 2006 also imposes broader duties on directors, including the duty to avoid conflicts of interest and the duty to declare interests in transactions, both enforced by Companies House and overseen within the framework of UK company law. 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. 

Using a Written Resolution Instead of a Meeting

Private companies can use a written resolution instead of holding a general meeting. This is often simpler and faster, particularly where the company has a small number of shareholders.

To use this process, you circulate the resolution and a copy of the proposed service contract terms to all eligible shareholders. Each shareholder then signs to indicate their agreement. You do not need a meeting.

The resolution passes once shareholders holding more than 50% of the eligible voting shares have signed. Shareholders who have a personal interest in the resolution, including the director whose contract is being approved, are not eligible to sign.

You must keep a record of the signed written resolution. This forms part of the company’s statutory records and should be stored alongside the service contract itself.

Written resolutions cannot be used by public companies. If your company is public, you must hold a general meeting.

Can a Director Vote on Their Own Service Contract?

This is a common question and the answer depends on your company’s articles of association.

Under the Model Articles, a director cannot vote on a resolution where they have a personal interest in the outcome. A director approving their own service contract clearly has a personal interest. This means the director should not vote on the resolution and should not be counted in the quorum for that part of the meeting.

However, your articles may modify this rule. Some companies adopt bespoke articles that allow interested directors to vote in certain circumstances. Check your articles before the meeting.

The director must also formally declare their interest in the contract to the board under the Companies Act 2006 before the resolution is put to shareholders. Failing to do so is a breach of duty, even if the shareholders ultimately approve the contract.

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, LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced corporate lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.

Frequently Asked Questions