Removing directors – how to do it and potential consequences
The principal role of a company director is, in conjunction with the other directors, to run the company on a day to day basis in accordance with legal requirements set out within the Companies Act 2006 (the “Act”) and the company’s articles of association.
The above sounds reassuring to shareholders but the reality is that there are many situations where, without additional clarification or restriction of powers in the company’s articles, a shareholder agreement or director service contract, shareholders and especially minority shareholders can be at risk and may need to look to remove a director.
With private limited companies, especially where some of the shareholders are also directors, disagreements and disputes can arise and it can be particularly difficult to try and remove a director.
Reasons to remove a director
There may be a number of reasons why a company wants to remove one of the directors.
A director may be under performing, acting outside of his or her duties, bringing the company into disrepute, medically unfit or simply struggling to see eye to eye with fellow directors on strategy or management styles. Where a resolution of issues cannot be found, the company may seek to remove the director.
How to remove a director – the statutory procedure
Under section 168(1) of the Act, shareholders can remove a director by passing an ordinary resolution (meaning over 50% of shareholders votes) at a meeting of the company.
Special notice is required, which means shareholders must serve formal notice on the company, at its registered office, of any resolution to remove a director by at least 28 clear days before a general meeting. On receipt of such special notice, the board must convene a meeting and send a copy of the notice to the director concerned.
Procedural requirements to call a general board meeting must also be followed (14 clear days’ notice) and the director will then be able to make representations in writing to the company with respect to the proposed resolution. The decision will then be put to vote.
Companies should be cautious when following the procedural requirements, as failure to comply may mean the process is void.
Companies should also be cautious when attempting to call a general meeting to remove a director on short notice. Statute is somewhat ambiguous on this point, therefore it should be avoided.
Removing a director using amended articles or shareholder agreement
Provisions in articles of association that seek to exclude the operation of section 168 of the Act are an unlawful fetter on the company’s statutory powers and consequently, unenforceable against the company.
However:
· The company’s articles could include an additional removal process, for example, one not requiring special notice, under which it is easier to remove the director.
· Shareholders may unanimously agree to fetter their discretion by contract (such as a shareholders’ agreement to which neither the company nor the director are party) and agree not to use the section 168 power.
· The company could include weighted voting right provisions in its articles providing that in the event of a resolution being proposed at any general meeting for the removal of a director from office, any shares held by that director will, on a poll on that resolution, carry the right to a higher multiple of votes per share.
Legal risks of removing a director
Aside from getting the process right, there are some situations where there are inherent complications and risks. In addition, with the vast majority of small to medium companies, if there is a perceived need to change directors, there is often an underlying problem or wider dispute.
Simply removing the director may be a necessity but often needs to be looked at as part of an overall shareholder dispute.
Common problem areas include :
· where directors are employees.
· where the director is also a shareholder
· whether there are good leaver/bad leaver provisions in place.
· valuing shares associated with a director leaving
· protecting the company in terms if it’s IP, confidential information and data and potentially enforcing non-competition against a departing director.
Do the Articles of Association deal with removing a director?
As a first port of call, the company’s articles of association and constitutional documents should be reviewed to identify provisions in relation to removing a director.
What those provisions state will depend on the type of articles adopted by the company. Where the company has adopted ‘model articles for private companies limited by shares’, article 18 provides that a director may be removed ‘by an ordinary resolution of the company’s members’ when more than 50% of all votes are cast in favour of the matter put to vote.*
Where the articles do not provide for removal of a director, members (i.e. shareholders) can turn to the Act.
Director removals can create employment law risks
Extra care should be taken when removing a director from office who is also an employee. If the director is an employee, always check the employment contract or director service agreement. You are likely to be on stronger ground if the director is clearly in breach of his or her agreement and/or it allows removal of the director for example, for bankruptcy or criminal charges or fraud.
The company will also be on stringer grounds legally if the director is likely to be in breach of duties under the Companies Act, such as where there is a conflict of interest or he or she has acted outside of powers.
Whilst employee status does not prevent the shareholders from removing a director, the removal may, in some circumstances, amount to constructive dismissal and the director may be entitled to make a claim against the company for unfair or wrongful dismissal.
It is crucial that a company seeks employment law advice when it is considering removing a director from office, whom is also an employee of the company.
What happens if the director is also a shareholder?
Whilst the removed director’s position as a shareholder of the company may not always be affected, if a director has been removed, there is usually an underlying conflict or mistrust. This, in turn, means that the company usually wants a clean break with the director being compelled to sell or transfer his or her shares.
it is possible that such removal may amount to unfairly prejudicial conduct (the removed director can claim that the affairs of the company are being, or have been, conducted in a manner that is unfairly prejudicial to the individual’s interests as a shareholder).
How we can help
Our specialist lawyers advise companies on the proper procedure that should be followed when removing a director, discuss the associated risks, offer pragmatic solutions, and assist with the preparation of corporate authorisations and preparation of settlement agreements.
In many cases, a negotiated departure from the company, with a director resigning, transferring any shares and resolving any employment law issues, is a better outcome for all parties. We are experienced in negotiating departures, whether on behalf of the company or director.
For further information on the issues raised, please contact Harender Branch at: hkb@branchaustinmccormick.com
Branch Austin McCormick LLP
32 St James’s Street
London
SW1A 1HD
