Corporate divorce need not be messy in times of crisis

Published on Sunday 21 June 2009 21:59

ONE of the commonly reported consequences of the recession has been the decline in divorces as a result of costs.

The same is not necessarily true in corporate relationships where, particularly in the SME sector, the drive for cost efficiencies and focus on areas of poor performance, have led to an increase in board-level fall-outs.

Often, issues between directors are long-standing and the relationship will erode until the tipping point, at which action by either side will result in "divorce" – ie, the exit of directors.

In these situations, there is a variety of factors that firms and directors would be well-advised to digest before a director's service agreement is terminated..

&#149 Post-termination restrictions: Usually, directors will have a contract that prevents them from working with competitors and existing customers, as well as from poaching staff and using confidential information.

Directors can find themselves unable to work in their specialisms for a period. If not, businesses must give consideration as to whether a director's exit presents a threat to their interests. In either case, severance agreements can be used to protect businesses or dilute restrictions for directors.

&#149 Intellectual property rights: Service agreements will usually have provisions on the ownership of intellectual property that have arisen during the director's time with the business. These normally ensure that such rights are owned by the company.

Such issues can have a catastrophic impact upon a business and may also restrict what a director might use in future. As such, the position should be checked carefully.

&#149 Shareholdings: Consideration of the shares held by a director is crucial. If the director has a substantial voting stake, it can lead to difficulties in the future conduct of the business.

A director's shareholding is distinct from his position as an employee, and he may remain entitled to participate in the running of the business. Likewise, directors planning to resign may have concerns as to the impact of this action on their shareholding, depending on what kind of leaver they are deemed to be.

&#149 Good leaver/bad leaver: SMEs will usually have provisions within their articles of association that deal with how to classify a director.

Good leavers are typically those who exit for some reason not attributable to them – for example, through ill-health, retirement or where a tribunal deems their dismissal "unfair".

Bad leavers are those in some way culpable for their exit, such as those dismissed for gross misconduct or, sometimes, those who resign.

Good leavers may be entitled to keep their shares or have them offered around the shareholders at fair value. By contrast, bad leavers may effectively be compelled to sell their shares to the business at nominal value. There can be a chasm of a difference

Where a business takes action without proper procedures, it could find itself facing difficulties, if a director retains their shareholding. In addition, purchasing this may be expensive and cumbersome.

Directors, on the other hand, would be well cautioned to have regard to the relevant provisions as, by resignation, they could effectively activate the bargain basement sale of their shares.

&#149 Personal guarantees and directors' loans: Frequently, directors will have offered personal guarantees for company loans. These will be unaffected by the termination of service agreements, and a director may wish to negotiate release from his obligations. Failure to take this into account can leave a director with an open-ended liability.

The corollary of this is directors may also have made personal loans to the business and the terms should be prudently analysed before termination.

&#149 Resignation of directorships: In many cases, an individual may have a number of directorships in associated companies, but there will usually be provisions governing the business's power to resign them on termination.

There are a number of other issues parties should address, such as whether any share options lapse on termination, the existence of any residual liabilities and any tax implications.

In any corporate divorce – as with matrimonial divorces – these issues can be addressed in an appropriate settlement agreement.

In cases where termination has not been thought through, these can become thorny points, making reaching agreement a far lengthier, more complex and more expensive process.

&#149 John Lee is head of employment at MBM Commercial.