Firms must know the rules concerning directors’ pay

With recent high-profile scandals putting the focus on ‘fat cat’ pay, it is
important for organisations and HR to get their directors service agreements
right from the outset

Corporate scandals have pushed directors’ pay into the

Their contractual remuneration and termination entitlements have taken
centre stage following various high-profile payouts to directors of poorly
performing companies.

Consequently, unlike other types of employment contracts, directors’ service
agreements (particularly in listed companies) have become the subject of a
degree of both ‘hard’ statutory and ‘softer’ policy regulation.

This has given rise to a maze of statutory and non-statutory considerations
that companies and HR must take into account if they are to avoid becoming
embroiled in potentially damaging shareholder and stakeholder revolts.

Companies must be aware of section 319 of the Companies Act 1985, which
makes it unlawful for a director’s service agreement to last more than five
years without notice (either as originally drafted or by extension), unless it
has received the backing of a resolution of the company passed at a general

Also important is section 312, which makes it unlawful to pay a director
compensation for matters including loss of office, unless the payment has been
disclosed to members of the company and approved by the company.

Perhaps the most difficult of statutory considerations – which have led to
the highest-profile shareholder revolts – are the Directors Remuneration Report
Regulations 2002.

These regulations apply to any UK company whose shares are listed on one or
more prescribed exchanges. They require the company to compile a remuneration
report that must be put to the vote of a non-binding resolution of the company.
Although the vote is non-binding, it has to receive strong support, or the
company may need to reconsider its remuneration policy.

Under the Listing Rules, shareholder votes are also required in connection
with new or substantially amended existing share option schemes and long-term
incentive schemes.

A wide range of opinion has been published by influential bodies and needs
to be taken into consideration:

– the DTI consultative document, Rewards for Failure

– the NAPF (National Association of Pension Funds) response to Rewards for

– the CBI response (and six-point best practice guidelines) to Rewards for

This documentation needs to be considered together with the July 2003
Combined Code on Corporate Governance that requires listed companies to: have
remuneration committees usually comprising three non-executive directors; and,
provide for one year or less notice periods for directors (with a maximum of
two years’ notice in certain cases).

Rewards for Failure adopts the argument that a one-year notice period is
adequate for most quoted company directors and this is endorsed in the NAPF and
the CBI responses.

Both organisations also accept that phased termination payments should be
made to reduce the cost of termination payments through director mitigation –
even though this could lead to the negotiation of ‘golden hellos’ to attract
the best talent.

Key points

– In listed companies, directors’ pay should be set by a
non-executive director committee

– Listed companies should reconsider their remuneration policy
if shareholders fail to support a resolution at a general meeting

– Justification is needed for a director’s notice period of
more than one year

– Severance entitlements should be restricted to salary

– Severance entitlements should be phased throughout the notice
period to take account of the duty to mitigate loss

By Nick Humphreys, Solicitor, people services, KLegal

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