Posted: Wednesday, 30 November 2011 @ 12:22
Whilst pretty rare up till now, there has been a recent increase in the number of SMEs who are making directors redundant, and we expect this to continue. It can often make sense: if a company’s activities have shrunk, with fewer sales and a reduced workforce, it can now appear too top heavy and underperforming directors might be at risk.
Managing a director redundancy is complicated by the fact that a director usually has several legal roles: he or she is usually an employee, an office holder, a creditor and a shareholder. Each needs to be looked at in turn.
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Director as Employee
Most directors of SMEs are employees, but this is not always the case. A director-employee will usually have a service agreement, be paid a regular salary and pay tax by way of PAYE. However, directors could be receiving remuneration simply as a director and not count as an employee. It is advisable to take legal advice if there is any doubt.
A director can be made redundant as an employee in the same way as any other employee. The selection procedure must be fair as must be the dismissal procedure. The director would be entitled to redundancy pay and might make a claim to an Employment Tribunal if payments are not made or unfair procedures used.
Director as Office Holder
A director is an important company official who is legally responsible for running the company. The procedures to remove a director will be set out in the company’s Articles of Association. Usually, it involves the shareholders convening a meeting where they can vote to remove a director. The Articles will set out how much notice should be given for the the meeting and how it should be run. These procedures must be followed correctly. After a director has been removed in this way, notice should be given to Companies House.
A common complication is that a director will usually have given personal guarantees to the bank, other lenders, factoring companies and sometimes trade suppliers. A director cannot be released from these by an agreement between the directors or as part of a redundancy negotiation. The most that the remaining directors can agree is to indemnify the leaving director (i.e. agree to repay him anything that he has to pay under called-in guarantees) but that indemnity is useless unless that remaining directors can honour it, both now and in the future.
A director can only be released from a personal guarantee by the organisation it was given to, i.e. usually the bank or other lender. In these troubled times, many financial organisations will refuse to release a director from a guarantee unless they are satisfied that the remaining directors have sufficient means to protect them.
Guarantees should be examined closely. Often they will relate to different forms of lending given by the same organisation. For example, the bank might have let the company open a bank account without a guarantee in place but later insisted on one when the company took out a loan. Repaying the loan in full might not however now release you from the guarantee, as it might be worded to attach to all lending from the bank, including any overdraft. In addition, the departing director needs to be aware that he might also be liable for future borrowing incurred after he has left.
Director as Creditor
A director will often have a loan account with the company whereby he or she is entitled to repayment of money previously lent to the company. There might be a loan agreement saying when and how the money is to be repaid; however, often there is not. If there is no loan agreement, then the loan may be repayable on demand.
However, issues can arise if the company is insolvent or repaying the loan would make it insolvent. In these cases, the departing director might later have to repay the loan to the company if it goes into liquidation. More details about Directors’ Responsibilities in Times of Financial Trouble.
Director as Shareholder
A director cannot usually be forced to sell his shares if he is made redundant, but you will need to check any shareholders’ agreement. A shareholding can often be used as an important bargaining tool. Although the shares might not be worth much now, what are they likely to be worth once the recession is over and the company grows again? Remember, a shareholder also usually has a right to attend and vote at shareholders’ meetings and to be paid a dividend along with other shareholders.
Extreme care must be taken when a company is thinking of making a director redundant, both from the company’s point of view and the director’s point of view. Both should obtain legal advice from a solicitor specialising in Directors’ Duties. The company should take advice before the director is given notice and the director should seek advice before he agrees to anything.
Call Gary Cousins on 0845 003 5639 for advice or book an appointment here.
Blog by Gary Cousins
Gary has been providing legal advice to shareholders, directors and business owners for over 25 years. Specialising in dispute resolution Gary is based in Birmingham with clients throughout the UK and overseas. View profile
This blog is not intended to constitute legal advice, nor is it intended to be a complete and authoritative statement of the law, and what we say might be out of date by the time you read it. You should always seek legal advice to confirm whether or how any information in this article applies to your particular situation. We offer a free telephone consultation
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