How to get value out of a director's service agreement

28 September 2017

Your senior leaders are your most prized possession. Treat them well and they will serve you well. Getting your c-suite contractual arrangements right is a critical business task. If your agreements are not fit for purpose, your business objectives can become compromised. 

Over and above the standard inclusions in a director’s service agreement (DSA), such as making sure that the employing entity is correctly identified, and defining the length of the contract terms and notice periods, here are five additional strategies that will protect you and your business, and ensure you remain compliant with employment and company legislation . 

Five key areas to address

Define the status of the individual 

Will they be a formal Companies Act board director appointee or a senior executive afforded the status of director? You will also need to take into consideration the interrelationship of the DSA with other contractual documents supporting the executive’s role. These might include the shareholders’ agreement if the executive is a shareholder. This may contain complementary business protection provisions, or incentive plan provisions. It is important to identify in the preparation of the agreement the areas in which the director appointed under the Companies Act may have personal liability if there are breaches. 

How to deploy incentives and the impact of resignation

Many companies incentivise their senior personnel with executive share schemes, bonus or commission schemes. Consideration should be given in the DSA to some form of clawback or malus – holding back on payment of incentives due to breach or poor behaviours/performance. The loss of these incentive schemes when resignation occurs should also be a key feature. Sophisticated schemes such a LTIPs will likely have covenant terms which need to be dovetailed with the contractual business protection covenants in the Service Agreement.

Post termination restrictions, garden leave or PILON?

Is the key risk the loss of customers or is it risk to supply? Or is the real concern disrupting a cohesive team whose skillsets are critical to service delivery? Contract clauses can help you with these but if the risk posed includes intellectual property or company datasets then smart forensic IT policing will be a critical additional component. 

To properly protect the business, reasonable covenant promises should be secured but must allow for competition in business. Effective covenants should be no more than is reasonably necessary to protect your business interests, such as customer connections, truly confidential business information, your client base or a cohesive working unit. 

The most effective covenants are tailored to the role, tailored to the risk and tailored to the person. 

Consideration should be given to restrictions covering geographical territory and/or a complete competition ban for a short period. But this time period must be reasonable. Non-competition restrictions are hard to enforce unless there is pay during the restriction period. This is where garden leave can be used effectively, removing the need to rely on post-termination non-compete covenant restrictions.

Another useful technique can be a ‘pay in lieu of notice’ clause (PILON) which can be used not only as a full notice payment in advance but to continue to pay monthly and to keep the executive out of the market, at least for the notice period. 

Managing incapacity through ill health

Ill health in your most senior executives can be the most challenging of all to manage – as seen in the high-profile stress related sabbaticals for some senior banking executives in the aftermath of the global financial crisis. It is vital to ensure that senior executive contracts include an obligation to comply with the company ill health reporting policy and allow the employer to request medical advice on their employee’s illnesses. People often brush this aspect of working life aside, but we are all susceptible to ill health, whether physical or mental. Ensuring that the contracts allow for the management of medical conditions is as much to protect the employee as to enable the business to be managed effectively.

Facilitating suspension and automatic termination

Including the right to suspend can be critical. Should a business face an investigation, it may need to remove senior management from the premises. Businesses should also have clauses in director’s service agreements to facilitate automatic termination if there is certain misbehaviour such as criminal convictions or exceeding financial authority to protect them and allow decisive action to remediate when serious issues arise.