A service contract covers an individual’s rights and responsibilities as a director as well as an employee of the company. As a minimum, properly drafted contract should cover hours and place of work, the duties to be undertaken and the director’s remuneration.
Share scheme and bonuses
A director will frequently be offered a long-term success based incentive such as a share scheme. Such schemes are typically discretionary and the service contract should only refer to the director having the right to be considered under a scheme, which is to be administered separately.
Similar principles apply to the right to receive a bonus. A company must consider whether a bonus is payable according to a set formula (eg the company attains pre-agreed financial performance) or is in the discretion of the company’s board.
For both share schemes and bonuses careful consideration should be given to the director’s rights upon leaving the company.
Good and bad leavers
A service contract might provide that a director forfeits all rights to a bonus and under a share scheme upon leaving the company. That has the advantage of transparency and certainty but might be thought unfair, particularly where the director is not leaving voluntarily.
An alternative is to provide for good and bad leavers. Good leavers retain their rights under bonus and share schemes whereas bad leavers do not. A good leaver is typically defined as a director who dies, retires or is made redundant. A bad leaver is typically defined as a director resigning other than by way of retirement (eg going to a competitor) or someone who is dismissed for gross misconduct.
Notice periods and PILONs
Directors’ service contracts often have much longer notice periods than are found in other employment contracts – of 12 months or more. If the director’s employment is terminated (other than for gross misconduct) the director can claim for pay outstanding over the notice period. This is subject to a general duty to mitigate (find another job) but the service contract can provide for a fixed sum to be payable on termination. A company can have the right to pay off the director by inserting a payment in lieu of notice (PILON) clause.
Post-termination restrictions and garden leave
Directors will have access to the company’s secrets, such as price lists, customer details and intellectual property. A service contract will often contain post-termination restrictions (PTR) to give a reasonable level of protection should a director leave to join a competitor. Such restrictive covenants are only enforceable to the extent they are reasonably necessary to protect a business interest.
An alternative to enforcing a PTR is to require a director to work out his or her notice period. Particularly if the director is leaving on acrimonious terms the company is unlikely to want the director to continue to work during the notice period because this will give the director access to further confidential information and may be a disruptive influence to the company’s business. In such circumstances the director can be put on “garden leave” during which they continue to be paid and owe duties to the company so are prevented from joining a competitor but are not required to carry out any work.
This note considers the factors that apply to all directors.
Directors of listed companies are subject to various other regulatory provisions, which need to be considered separately.