When a small business makes the decision to part company with a director, it’s not as simple as following the normal rules of employment.
A director usually has several legal roles; he/she is usually an employee, an office holder, a creditor and a shareholder. Each needs to be looked at in turn before any steps are taken.
Director as employee
Most directors of SMEs are employees. A director-employee will usually have a service agreement or contract, be paid a regular salary and pay tax by way of Pay as you earn (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 who is an employee can be made redundant in the same way as any other employee. The proper procedures must be followed and the whole process, including the dismissal procedure must be fair.
The director would be entitled to redundancy pay in the same way as any other member of staff and could make a claim to an Employment Tribunal if they felt payments or procedures were unfair.
A common complication is that a director will usually have given personal guarantees to the bank, other lenders, factoring companies and sometimes trade suppliers
Director as office holder
The procedures to remove a director will be set out in the company’s articles of association. Usually, it involves the shareholders calling a meeting where they can vote to remove a director.
The articles will set out how much notice should be given for 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 the 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. It’s not uncommon for financial organisations to 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 release you from the guarantee, as it might be worded to attach to all lending from the bank. 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/she is entitled to repayment of money previously lent to the company. If there is no loan agreement in place, which is often the case, the loan may be repayable on demand.
If the company is insolvent or repaying the loan would make it insolvent, significant issues arise. In these cases, the departing director might later have to repay the loan to the company if it goes into liquidation.
Director as shareholder
Check your shareholders agreement to establish whether the departing director can be forced to sell his shares if he is made redundant. A shareholding can often be used as an important bargaining tool.
The shares might not be worth a great deal at this moment but things could change over time. 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.
Advice on director redundancies
Much 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.
