Dismissing an employee can be an emotionally and legally difficult process to undertake both for the employer and naturally, the employee. The legal minefield often associated with dismissing employees is further complicated when the employee in question is also a director of the employing company and/or other companies in the group.
In an ideal world, the dismissed employee would agree to resign their office as a statutory director at the time of their termination. However, when agreement cannot be reached, more formal ways of dealing with the removal from office need to be undertaken so that the unsatisfactory situation of the relevant individual continuing to have the rights and authority of a director despite being dismissed can be avoided.
Companies Act 2006 (the “Act”)
Section 168(1) of the Act provides that a director may be removed by ordinary resolution “before the expiration of his period of office, notwithstanding anything in any agreement”. Whilst an ordinary resolution only requires a simple majority of shareholder votes, the Act imposes a number of additional procedural requirements on director removal resolutions, including:
- special notice of 28 clear days is required before a director removal resolution can be passed;
- the resolution must be passed at a duly convened meeting (and therefore cannot be passed via the more streamlined written resolution process); and
- the affected director has a right to receive a copy of the notice, make written representations which the Company must circulate to shareholders and have the right to be heard at the meeting at which removal is discussed (even where they do not have a shareholding themselves).
This time-consuming and very public procedure can potentially be costly and disruptive to a Company’s business. Fortunately, the Act acknowledges that the section 168 procedure is not ideal for most directorship terminations by also permitting “any power” to remove a director apart from this provision. In order to avoid this cumbersome section 168 procedure, it is important to ensure that more straightforward director removal rights are contained in one or more of the employee’s service agreement, the Company’s articles of association (the “Articles”) or any shareholders’ agreement, as further discussed below.
Where employees are directors it is vital that the service agreement contain a clause requiring the employee to resign as a director of the Company (and any other directorships held in the group) following the termination of employment. This can be backed up with a power of attorney contained in the service agreement executable by the Company on the employee’s behalf if the employee refuses to resign their directorships in such circumstances, provided the service agreement is executed as a deed. One of the many advantages of this is that both the employment and directorship termination can be dealt with simultaneously and swiftly. It is advisable to use such a clause even where a senior level employee is not then a director as there is always the possibility that they may be appointed as a director in future.
Most Articles will contain a list of circumstances when a director will be deemed to have resigned / be automatically removed. Standard provisions in Articles include deemed resignation / automatic removal in the case of disqualification as a director; bankruptcy; mental incapacity; or prolonged absence due to illness or otherwise. These provisions can be amended or added to by a special resolution (i.e. 75% majority of voting shareholders) and should always be checked, particularly if the service agreement does not address the termination of a directorship.
It is possible for example to amend the Articles to dispense with the need to provide the 28 day special notice period contemplated by section 168 of the Act and allow the removal of a director by written ordinary resolution rather than having to hold a meeting. This type of provision is particularly common in the Articles of subsidiary companies in a group to allow the ultimate parent to act decisively in removing directors quickly and without undue administration.
The Company may also have a shareholders’ agreement in place which contains rights and obligations around the appointment and removal of directors that may not necessarily be reflected in the Articles. It may be that the termination of the employment of a senior employee may give rise to a contractual obligation of a shareholder (or specified majority of shareholders) to notify the Company that the relevant director be removed.
Minority shareholders and unfair prejudice
One note of caution arises where the director being removed is also a significant minority shareholder as they may argue that their removal as director, notwithstanding no longer being an employee, amounts to unfair prejudice under section 994 of the Act. This provision entitles the shareholder to apply to the Court where the affairs of the Company are being conducted in a manner that is unfairly prejudicial to the shareholder’s interests, or if a proposed act or omission of the Company would be so prejudicial. If the Court finds that the minority shareholder is prejudiced then the most common order made is for the shares of the petitioning shareholder to be bought by the other shareholders or the Company itself. There is precedent for such orders to be made where the removal of the director is seen as prejudicial to their shareholding.
In summary, the process of removing a director upon their termination as an employee can be quickly and seamlessly actioned provided care is taken in advance in the drafting of the employee’s service agreement and the Company’s Articles. Absent this foresight, there is the potential for a protracted statutory process to be gone through to achieve the desired outcome.