At Francis Wilks & Jones we often see small to medium sized businesses where the shareholders are also registered directors. Directors, (whether they are shareholders or not), have a wide range of duties and responsibilities that they owe to the company. It is vital to understand them.
It is equally important to understand how director responsibilities change when a company enters the realm of insolvency, which is generally defined as being balance sheet insolvent or unable to pay its debts as and when they fall due. If this happens the responsibilities of a director move from that of being purely to the company, to being to the company’s creditors. These duties continue even when a company enters a formal insolvency situation.
Inequality of remuneration between shareholder directors
When a shareholder is also a director, there is a risk that they are not fairly remunerated. In a small company where the shareholders are often also the directors with different roles within the company, we frequently see problems where there is an imbalance within a company in terms of day to day involvement and the amount of time each director/shareholder spends dealing with the company.
- shareholders are only remunerated from dividends;
- directors may take a salary;
- a director/shareholder may take remuneration through a mix of either or both methods.
However, it is often the case in smaller businesses that shareholder & directors only take their remuneration by way of dividends, once there are sufficient profits to declare these. They may take monies out during the year in order to meet living expenses, which is then considered a directors’ loan, which is paid back when dividends are declared.
If all of the owner/shareholders have the same shareholding, then they will be entitled to the same dividend at the end of the year. Disputes can arise if all shareholder directors are remunerated via equal dividends, but some take a more active role in the company than others. We also see disputes where a majority shareholder might have little day to day involvement in the company but receives a larger return on their dividends than a shareholder that is an active director.
- technically shareholders are only paid on the basis of the value of their shareholding;
- therefore, if they are also acting as a director and involved in the day to day running of the company then they should ensure that they are also paid a salary for this service;
- directors can operate as employees of the company in the same way other employees do, and be paid as employees by the PAYE scheme.
A director might also want to consider a service level agreement between the company and the director which sets out the parameters of the director’s duties and responsibilities specific to that company. These can be extremely useful in preventing or settling disputes between directors and the company.
Another alternative for shareholder/directors who don’t want to take a salary though the PAYE scheme but want to even out the playing field, is to use a shareholders agreement. A shareholders agreement can set out the shareholder’s rights and obligations and expectations and should be able to head off disputes on remuneration, or at least settle them easily if they arise between shareholders who also act as directors. For more information on shareholders agreements see: [Link to 2].
At Francis Wilks & Jones we can assist in advising on and dealing with shareholders agreements no matter how small the company, to help to avoid disputes and fall outs between shareholder directors.
Shadow or de facto directorships
There is a significant risk to shareholders who may act as a director but are not registered as such. This can sometimes arise in a situation where a shareholder is particularly close to the company and is involved in influencing and decision making.
A person can be considered a director in two ways:
- a de facto director – a person who on the face of it acts as a director and appears to third parties as if they are a director of a company. They will undertake general company director functions including decision making even though they are not registered at Companies House.
- a shadow director – this is frequently more common with shareholders and is something that they must be conscious to avoid, because it may not be immediately obvious to them that they have crossed the line into shadow directorship and all that this entails. A shadow directors is ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act’. A shadow director has a strong influential control over the management of the company. They are frequently referred to as the ‘puppet master’ because they are pulling the strings of the directors. Read more about shadow directors and their duties.
This scenario is very common in family run businesses, particularly where a shareholder may not be running the company on a day to day basis but exerts significant control over the company’s decision making and the direction of the company.
Both shadow directors and de facto directors have the same responsibilities as registered directors. The danger is that they may not recognise themselves as such, and therefore find themselves in breach of these duties. The remedies against them are identical to those of registered directors.
- the company can bring a claim against the directors for breach of duties;
- the director may be found to be personally liable for recompense;
- they are also equally liable to be disqualified as company directors under the directors disqualification procedure. This may lead to a disqualification of between 2 and 15 years depending on the misconduct.
Our expert team at Francis Wilks & Jones have many years and much experience between them of assisting directors in all types of claims. If you are involved in a claims – then contact us to talk through the issues. We are here to help.