The Companies Act 2006 is to change the way in which directors' compensation for loss of office is regulated. The provisions of section 312 of the Companies Act 1985 are to be replaced with the provisions of section 215 of the Companies Act 2006 with effect from October 2007. The new provisions may result in changes in the way in which service agreements with executive directors are drafted, as well as changes in the way in which payments made by a company to a retiring director are considered and quantified.
The current section 312 of the Companies Act 1985 is relatively short in comparison with the rather more detailed new provisions in the 2006 Act that will replace it. Section 312 provides that it is not lawful for a company to make to a director of the company any payment by way of compensation for loss of office, or as consideration for or in connection with his retirement from office, without particulars of the proposed payment (including its amount) being disclosed to, and approved by, shareholders of the company. This fairly general statement is then qualified in a later section of the 1985 Act which provides that the payments which are generally within the ambit of section 312 do not include bona fide payment by way of damages for breach of contract or by way of pension in respect of past services. Accordingly, section 312 is concerned with regulating (amongst other things) so-called ex gratia payments to directors.
Certain companies have sought to avoid the application of the regime under the 1985 Act by making payments to directors in connection with the loss or termination of that director's executive (or employment) relationship with the company. The argument employed here was essentially that because such payments were being made on termination of the person's employment relationship they were not payments made "to a director … by way of compensation for loss of office". The potential for a company to avoid the provisions of section 312 in this way was one of the matters that the joint Law Commissions considered in their consultation, and subsequent report, on company directors in 1998 and 1999. One recommendation of the Law Commissions was that where a director receives a payment for the loss of some employment position with the company in the context of the loss of office as a director, section 312 should apply to that payment (that is to say, details of such payment should be disclosed to shareholders and subject to their approval).
As a result of the recommendations of the Law Commissions, the provisions of the Companies Act 2006 will create a new regime for dealing with the issue of payments to directors for loss of office. Of note is the fact that the new provisions of the Companies Act 2006 are intended to capture payments made to a director in connection with the loss of certain other positions held by that director. Section 215 provides that a payment for loss of office includes a payment made to a director "by way of compensation for loss, while a director of the company or in connection with his ceasing to be a director of it, of any other office or employment in connection with the management of the affairs of the company". One result of the new provisions is that there will be limited ability for a company to make ex gratia payments to retiring executive directors without shareholder approval, even if such payments are being classified as payments made in connection with the termination of an employment relationship. The general requirement to seek shareholder approval in wider circumstances than was previously the case is subject to certain specific exceptions. These include payments made in good faith in discharge of existing legal obligations and by way of settlement or compromise of any claim arising in connection with the termination of a person's office or employment.
The new regime for dealing with payments to directors in connection with loss of office under the 2006 Act will, amongst other things, close off one potential route by which persons may seek to avoid the requirements of obtaining shareholder approval of ex gratia payments made to retiring executive directors. It will be important for both companies and individual directors to be clear on the terms of service contracts put in place when a new director joins the board. In addition, it will be equally important that, should a director be leaving office, advice is taken to ensure that any proposed payments being made to the director concerned do not require shareholder approval.
It will continue to be important to obtain specialist advice on the issues arising from the termination of directors' employment, ensuring that these are approached with precise planning and awareness of the range of employment and corporate issues which can arise.