Why it pays to control the powers of directors?
During the course of its life, every company is bound by any contract made by one of the directors. It doesn’t matter if the other directors didn’t agree to it. Nor does it matter if there is an agreement between the directors that no one of them has authority to sign on behalf of the company. The company is still committed.
The ability of a director to ‘go rogue’ means that the company could find itself the proud owner of such non-essential items as a pool table for the reception area, or hospitality tickets for a football match (that coincidentally involves the director’s favourite team), or even a sports car (euphemistically referred to in one company’s accounts as an “emergency response vehicle”). Alternatively, directors have not infrequently been known to employ their children or romantic partners on an inflated salary.
The way to counter the problem of rogue decisions by a single director is to make a list in the Shareholder Agreement of decisions where a single director must seek the permission of the shareholders first.
While no company could survive if a meeting of the shareholders was needed for every single decision, the Shareholder Agreement can clearly lay out decision making powers, as well as their limitations.
For example, the circumstances where wider shareholder permission is needed might include employing a family member, engaging any person on a salary greater than a specified amount or purchasing any item outside the normal course of business.
Remember that the company would likely still be committed in the event of an unauthorised purchase, as every company is bound by any contract made by one of the directors. However, if the offending director is also a shareholder then the Shareholder Agreement can include a sanction against him that would otherwise not be available. For example, shares could be removed or the director might be required to compensate the company personally. Or even that he must exit the company entirely and return his shares.
If the sanction is tough enough then it should act as a deterrent to pool tables, football tickets, luxury cars and highly paid mistresses becoming entangled in the affairs of your company.
What key decisions should rest with the shareholders?
The directors of a company are in control of the day to day decisions, for example hiring and firing and spending money, whereas big ‘life events’, such as selling the company or inviting a new shareholder into the company, are reserved for the shareholders. These decisions are generally internal ownership ones and, as such, the risk for the company being legally bound by them behind its back is different to the outward facing decisions of rogue directors described above.
A Shareholder Agreement can prevent these ‘big’ decisions being taken without the unanimous consent of all of the Shareholders. The Agreement can also set out the consequences for a shareholder, should they attempt to circumvent these rules.
Why it pays to protect the directors?
As well as providing the rules of the game, the Shareholder Agreement can also help to ensure that participants ‘play nicely’.
It takes anything greater than 50% of the voting power to remove a director from office, unless a Shareholder Agreement states otherwise. A Shareholder Agreement can therefore increase the voting percentage needed, or reduce it. Where there are three minority shareholders, such as Jocelyn, Daphne and Oscar in Multi Comms Ltd it creates the ability, in the event of a disagreement, for two shareholders to ‘gang up’ against one, removing her from the board.
A Shareholder Agreement can protect against this. Created in a time of unity, the Shareholder Agreement can state that that directors (who are also shareholders) cannot be removed without their consent.