Directors Service Agreements & Non-Compete Covenants
Service Agreements
Directors are not necessarily employees of the Company. (They may have non-executive roles and just participate in board meetings). Full-time executive directors with monthly drawings may, as a matter of law be employees, even if not engaged under a formal contract of service. It is also quite common for full-time directors to draw down such director’s fees as may be voted from time to time at board meetings. Any well-regulated Company will require its executive or full-time directors to have a formal written service agreement with the Company, setting out in detail the relationship between the director and the Company. Such agreements will also invariably include confidentiality and non-compete covenants.
Notice Clauses
An important term of such agreement is how much notice should be required for the termination of the service contract. The notice period works both ways. The longer the period, the more protection the director may have, and also the greater protection on the part of the Company. A longer notice period will give comfort and security to the Company in that the director will not leave on short notice and this will provide a reasonable timeframe to the Company for a replacement director to be found and to be engaged. (Note- the replacement director/manager may himself have to give long notice of termination of his current post).
However, a longer period of notice will make it more expensive for the Company to remove the Director if there are any issues with the Director. This is the trade-off.
However, a Director if unlawfully removed has a duty to take reasonable steps to mitigate his loss. In other words, if the Director is able to and/or does secure new equivalent employment within a short time frame, then this time frame will represent the “damages period” in respect of any claim for compensation. Therefore, a potential claim for 6 months’ loss of earnings may result in a much shorter damages period.
There are nuances if the new employment is for a lower remuneration package (including fringe benefits), where there will be a continuing loss claim.
Pilon (Pay in lieu of Notice) Clauses
These clauses are a tax disaster but are useful if the Company wishes to terminate a director’s contract on short notice and to preserve any non-compete covenants to which a director may be subject. (There is legal authority that termination of the employment contract by the Company in breach of contract or following a resignation by a director resulting from a fundamental breach of contract by the Company, will release the restrictive covenants/non-compete contained in the contract.) Accordingly, there is legal authority that if a director’s contract is terminated without proper notice, then any restrictive covenants will fall away and be legally unenforceable. A PILON clause permits a company to terminate the employment contract immediately and to instead pay money in lieu of notice. A service agreement should contain relevant provisions for the protection of the Company and is generally drafted in an onerous manner as against a director.
A director should receive independent advice as to the terms and conditions of any draft service agreement presented to him for signature, and if necessary the director should negotiate the terms of such agreement.
Non-Compete Covenants
Directors in their service agreements and in shareholder agreements may be subject to onerous noncompete covenants. Such covenants endeavour to prevent the director from joining a competing business after the termination of his/her engagement. Such covenants additionally prevent the director from soliciting and/or dealing with clients/customers/staff of the Company for a defined period after the termination of his engagement. These covenants are presumed in law to be unenforceable, but they may be enforced by the court if:
a) They are not against the public interest, and
b) they are no wider than reasonably necessary to protect the legitimate interests of the Company. This will be considered in terms of scope, duration, and geographical area.
The normal remedy to a breach of a covenant is an emergency pre-trial injunction which will require the Company to provide a cross-undertaking in damages on the part of the Company. The unsuccessful party in such cases is at risk of significant legal costs. Such costs will be claimed as against the director or former director if the application should transpire to be successful and held at trial to be justified.
The employer may also seek to exert pressure upon a director by referring the existence of the covenants to a new or prospective new employer who may withdraw a job offer to avoid threatened litigation by engaging the former director in a new role with them. A director may endeavour to counter this by applying to the Court for a declaration that particular non-compete covenants are legally unenforceable and asking the Court to fix a swift hearing.
If threatened with an injunction in relation to a non-compete covenants and/or confidentiality or both, a director or former director should take urgent legal advice.
A threat of an injunction application may be diffused by the director/former director offering undertakings to his former Company- without prejudice to the legal issues in the case- to hold the position pending trial of the matter.
Customer Information
This is a danger for directors if they take with them a client/customer list in anticipation of and/or following the termination of their engagement. This may give rise to a separate claim by the Company against the Director for an injunction to protect the Company’s confidential information rights. It is always best for Directors when leaving the Company to remove any client/customer contact details from their personal computer(s) and from their personal mobile telephone(s). The taking of client lists is a danger to directors who are not subject to any non-compete covenants, but who nonetheless will find themselves injuncted from competing as against the Company by what is known as a springboard injunction.
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