Disagreeable directors

Adam Bernstein
Monday, August 23, 2021

If a company falls out with one of its directors, what can it do? It’s likely to depend on the specific circumstances but there are a number of ways to resolve the situation.

Competent leadership with a strong sense of the positive is essential for any organisation to thrive. Similarly, the team must get on well and share a vision along with common cause. In contrast, an executive team comprising individuals hell-bent on asserting their rights will likely only ever succeed in achieving one thing: abject failure.

But no matter how well an organisation is set up, as the saying goes, ‘shit happens’ and when it does the finger-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?

The process can appear as clear as mud and it’s a problem that Paul Taylor, a partner in the corporate department of Fox Williams, often sees. The issue can appear worse because, oftentimes, he says that 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 10 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 should begin with 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,” adds Taylor, “contain a list of circumstances under which a director will be deemed to have resigned.” He says that they usually include statutory disqualification, bankruptcy, mental disorder or prolonged absence.

To this list Williams adds situations such as resignation, at any time (subject to anything to the contrary in the articles). There is also potential for removal under the company’s articles, which will usually provide that the office of director is automatically vacated on the occurrence of certain events; or under the law, where for example, no one can be under 16 when appointed; or under contract where a provision in a service agreement requires the director to resign; or by court order – courts have a wide discretion to remedy unfair prejudice; and, logically, on the death of a director.

George Marques, a senior associate in the commercial department of law firm Bishop & Sewell, 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.”

Nevertheless, Taylor warns, regarding shareholders’ agreements, “if the director in question is party to an agreement, it is important to check if any relevant provisions apply, for instance identifying if there anything which entrenches a right of appointment as a director”.

Employee directors
So, starting with the removal of employee directors, companies should first examine any service agreement that may be in place. Here Taylor advises looking for any resignation of directorship clause. He says: “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.

In particular, she says 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 drawn-out 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 simplifies and shortens the timescales for a removal”.

He explains that “removal procedures in articles are subject to shareholder scrutiny since shareholders can by special resolution restrict the powers of the directors through their reserve power and/or amend the articles of association”. The reality is, he says, that any non-statutory procedure to remove directors must be seen in this light.

Lastly here, those seeking a removal should take a tip from Taylor – that they should check the articles of association to confirm 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 to remove a fellow director 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 fixed-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 Companies Act removal may be required to enforce the point.

So, while shareholders should agree the terms of articles at the outset, Marques says that they also offer comfort in that they can “provide an additional removal process under which it is easier to remove a director, such as not requiring special notice”. He adds that in the event of a conflict between the articles and a shareholders’ agreement, the articles take precedence. That aside, he says that there are ways to override the removal provisions in the articles that conflict with those in a shareholders’ agreement.

Fallout case study

“I have a case where the only two shareholder directors have fallen out; the other director is seeking to remove our director and he has a majority shareholding so there is little our client can do to prevent being removed. The other director also just appointed a third director without consulting our client.

“But in order to obtain some leverage our client has called in an overdue loan to the company and threatened winding-up proceedings. He is also looking to sell his shares to a third party under the provisions of the shareholders’ agreement to apply pressure utilising pre-emption rights under the shareholders agreement.

“Strangely, this shareholders’ agreement contains a provision that if our client wishes to sell his shares, he can issue a seller’s notice to the other shareholder specifying the price per share; the other shareholder can then offer up his own shares at the same price and if he does so, our client is contractually bound to purchase them. It’s a very strange provision and position for our client to be in when ultimately, he wants to be out of the business. The point is that the parties can agree any terms they like in a shareholders’ agreement, and they remain bound by them.”

Vickie Williams, Freeths


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 conflict 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 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 quasi-partnership (defined as a relationship between the shareholders formed or continued based on mutual trust and confidence; an understanding that they will all participate in the management of the business; and restrictions on the transfer of shares.)

For the record, in terms of an unfair prejudice petition, the Act, Section 994 specifically, helps those in a minority where a director is removed from the management of the business, or a shareholding is deliberately devalued. On 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 Section 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, really depends on several factors: the nature of the business, what plans the remaining directors have for the business going forward, what the business may lose by falling out with the exiting director, whether they are likely to bring an unfair prejudice claim, and whether they might bring an unfair dismissal claim.

“Usually,” she says, “the remaining directors will not want the expense of going through the courts; they just want to get on with running the business so will want the situation to be resolved quickly and with the least disruption to the business.” In her view, the best route is to try and negotiate with the exiting director and reach some sort of agreement. Ultimately, a director cannot prevent their removal if the person does not have a majority vote of shareholders. But in tense situations, negotiation can be the best way to calm the situation down.

And Marques believes the same. It’s for this reason that he thinks that potential issues are better thought through at company formation stage rather than when they appear. As he says, “the cost of good legal advice at the outset will pale in comparison to the costs of negotiating or litigating a resolution down the road”. He adds that “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”. For the director shareholder, a good strategy will include protecting his position with super-voting rights on removal resolutions.

As to buying off the director concerned, Marques says that “it is unlawful for a company to make ‘a payment for loss of office 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 conflict with minimal likelihood of amicable resolution, Williams does offer one more and very final 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
You don’t want to act in haste only to repent at leisure. So as soon as trouble rears up, firms should seek legal advice and ensure the processes set out in the articles of association, shareholder agreements and Companies Act are followed.

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 finding a resolution and staying out of the courts.



How to remove a Shareholder

By far the most difficult issue when removing a director is achieving the successful exit of a shareholder director. A common misunderstanding is that there is always a contractual or statutory right for the company to buy back a shareholder’s shares. In the absence of a leaver clause in the shareholders’ agreement or articles, there isn’t.

But there are options and among the principal methods of removing a shareholder are:

  • Good/bad leaver provisions – such provisions allow companies to claw back shares from members, subject to certain conditions. In particular, the company will need to consider and apply the evaluation criteria of ‘good’ and ‘bad’ leavers to determine the value attributed to their shares
  • Sale of assets – the directors could consider selling the company’s assets to a third-party or newly incorporated company. Once the assets have been transferred, the remaining shareholder director would own shares in an empty shell company
  • Compulsory winding up – the directors and shareholders could decide that the only option is to discontinue the business and wind up the company. A petition to a court would be required, but if successful the relevant director shareholder may be left with very little after the distribution of the company’s assets

The company may also consider offering inducements to encourage a director shareholder to agree a settlement. The benefits of a settlement include a favourable tax rate if relief applies; a possible tax-free payment of £30,000 in compensation for loss of office; a relaxation of restrictive covenants/non-compete obligations; and an agreed reference and press release.

But if non-compliance remains, there are several ‘stick’ options such as the threat of removal as a director/employee that may put at risk the leaver’s relief; bringing in an administrator and looking to action a pre-pack sale which can have a galvanising impact; and reducing the price offered by the other shareholders for the shares if the leaver holds out.

If it is not possible to achieve the successful exit of a shareholder, the company should consider whether the relevant individual is the beneficiary of any enhanced rights under the company’s articles or any shareholders’ agreement, for instance being a member of a group of shareholders from which the company must obtain consent for the approval of certain business decisions. If so, the company should consider whether amendments to the articles or shareholders’ agreement are needed to remove that individual from the consent group.

At this point in the process, everything may be in order to have the shareholder director removed. However, before any decisive action is taken, thought should be given to whether Section 995 of the Companies Act applies. This section 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 their interests as a shareholder.

Paul Taylor, Fox Williams


 

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