Top tips for dismissing directors – the company law issues

UPDATED May 2021 – Please click here to read the latest version of this article.

One of the most difficult areas to deal with in commercial life is dismissing an employee. This can be an emotionally and legally difficult process to undertake both for the employer and naturally, the employee. The legal minefield we are familiar with when considering dismissing employees becomes that more treacherous when the employee in question is also a director or office holder under the Companies Act 1985.

Ideally, when dismissing an employee who is also a director, obtaining their agreement to resign as a director is the simplest way of achieving your aim. However, when agreement cannot be reached, you will have to look at more formal ways of dealing with the removal of a director. We list below some corporate issues that employers ought to bear in mind when considering the departure of a director whether by agreement or dismissal.

Service agreement

• Look for a resignation of directorship clause – this should include an obligation to resign as a director upon any termination of employment.
• There is often also a power of attorney drafted into the resignation clause allowing another person nominated by the board of directors to sign a resignation letter and other relevant documents if the outgoing director refuses to do so.
• If there is a power of attorney, the service agreement must have been executed as a deed for the power of attorney to be valid.
• An alternative route could be for the company to go to court to order the director to resign. There should be easier routes than this to achieve the director’s removal.

Articles of association

• Most articles of association will contain a list of circumstances when a director will be deemed to have resigned.
• Standard provisions include deemed resignation in the case of disqualification as a director; bankruptcy; mental disorder; prolonged absence or resignation.
• Many articles of association will also contain a provision allowing the Board to unilaterally remove a director upon agreement by the majority of the board, failing which, if the director does not voluntarily resign, the company will have no choice but to follow the cumbersome section 303 procedure described further below.

Shareholders agreement

• The shareholders agreement will be relevant where the director who is leaving is a party to that agreement. A shareholders agreement may contain provisions which could have gone in the articles of association of the company but which the shareholders want to remain private. For example, the director concerned may have been appointed by a certain shareholder. It is quite common for shares to be divided into different classes, for example A, B and C and each class of share has the right to appoint or remove a director.
• If the director is not a party then the shareholders agreement should be treated with a little more caution. The articles of association of a company are deemed to be incorporated into the service contract of a director. This may not be the case with a shareholders agreement.
• If, having reviewed the service agreement, the articles of association and any shareholders agreement there does not seem to be an efficient mechanism to remove a director who is refusing to resign, the next place to go is the Companies Act.

Section 303 Companies Act 1985

• There may be a number of mechanisms in the service agreement, articles or shareholders agreement for removing a director, for example, the articles may say that a director may only be removed with a 95% vote of shareholders. No matter what other mechanisms there are in these agreements, section 303 of the Companies Act 1985 always allows a director to be removed by an ordinary resolution of the shareholders. An ordinary resolution is a simple majority of the votes cast.
• Section 303 contains a special procedure. A shareholder who wants to propose the ordinary resolution to remove the director must give the company 28 clear days notice of the proposal. The 28 day rule means that if a meeting of shareholders has been convened and is less than 28 days away, the removal resolution cannot be tabled at that meeting and a separate shareholders meeting will be necessary at a later date.
• If there is no shareholders meeting currently convened, on receiving the shareholders notice, the directors are obliged to call a shareholders meeting in the usual manner. A copy of the notice of the shareholders meeting must be sent to the director in question. The director has the right to attend the shareholders meeting and he can make representations at the meeting if he chooses. The director can also make written representations to the company before the meeting and ask the company to send out those representations to each shareholder.
• The Section 303 removal procedure, although time consuming, is the ultimate way in which shareholders can control their company. This is why the procedure applies no matter what other agreement has been made. There is one variation to this right. This comes in the form of weighted voting rights.

Weighted voting rights

• You will need to check the articles and any shareholders agreement for weighted voting rights on a removal resolution.
• The weighted voting rights are given to the director in his capacity as a shareholder or to another shareholder so that on any resolution to remove a director or any particular director the shares of that shareholder have increased voting rights, for example, ten votes per share rather than the normal one vote.

Quorum and number of directors

• Along with weighted voting rights, you should also consider the quorum for the directors and shareholders meetings. The quorum is the number of people who must be present for the meeting to be validly held. It will be no surprise to you that the minimum number for a meeting is two.
• A board meeting will be needed to call a shareholders meeting to pass the removal resolution. Accordingly, if there are only two directors or other directors are on holiday, the director being removed may be able to prevent a board meeting being validly held if he does not attend.
• If the director is also a shareholder you will also need to check the quorum provisions for a shareholders meeting. The director may again be able to prevent a valid meeting being held by his non-attendance.
• There may be technical issues like this which appear to cause a problem. However, if the company has shareholders who control 75% or more of the votes then that will be sufficient to change the articles. So, for example, if there will be a difficulty with quorum, you might consider changing the articles to say that a director may be removed by a written notice signed by shareholders holding 50% or 75% or more of the votes.

Unfair prejudice and Section 459 Companies Act 1985

• At this point in the process you might find that having looked through the service contract, the articles and if there is one, the shareholders agreement, everything is in order to have the director removed. The director has a small shareholding but not enough to block an ordinary resolution.
• If the director is a shareholder you will need to consider whether he might claim that Section 459 of the Companies Act applies. Section 459 gives protection to a shareholder who can show that the affairs of the company are being conducted in a manner which is unfairly prejudicial to his interests as a shareholder. Just because a director is also a shareholder does not mean that this section will apply.
• A common ground for an unfair prejudice action is where the shareholder claims he has a legitimate expectation of playing a management role in the company. A typical example would be where the company has been started by ,say, four shareholders who each own 25% of the shares and are each directors of the company. The legitimate expectation of involvement in management will be denied if the shareholder is removed as a director. A detailed analysis of when Section 459 might apply and the consequences of it applying are outside the scope of this article but it is an area which needs to be considered particularly where there will be a negotiation with the director over compensation.

Directors’ remedy

• The right of removal under Section 303 is clearly stated as “not to be taken as depriving a person removed…of compensation or damages in respect of the termination of his appointment as a director”. This takes us back to the service agreement.
• It is unlikely that the service agreement contemplates the directors’ employment being continued after the director has ceased to be a director. Even if the service agreement does contain a provision allowing for continued employment after ceasing to be a director, the removal from office under the terms of the articles could lead to a claim for constructive dismissal by the director.
• When considering negotiating a payoff to a director there is a statutory control, of sorts, on the payment of compensation.

Compensation for loss of office – Section 312 Companies Act 1985

• This section provides that payment to a director of compensation for loss of office must be approved by the shareholders. However, it is clear from a later provision in Section 316 that compensation “is not to include a “bona fide” payment by way of damages for breach or contract or by way of pension for past services”. This can be a difficult area. Often compensation is agreed as compensation for loss of employment and not for loss of the office of director. There is some authority to say that Section 312 does not apply if compensation is for loss of employment.
• Where compensation has been agreed in advance in the service contract, for example a golden parachute, that compensation can be paid without the need for shareholder approval under Section 312. Any payments made in full and final settlement of a directors’ claim for breach of contract which can be justified as a reasonable compromise should fall within the Section 316 exception so that shareholder approval should not be necessary.