Employment contracts and director service agreements: differences

In this article, we will highlight the difference between an employment contract and a director service agreement.

In the intricate landscape of employment relationships within the UK, two fundamental legal instruments govern the terms and conditions of work: the employment contract and the director service agreement.

While they establish the foundation for an individual’s engagement within a company, these documents serve distinct purposes and carry unique implications for employees and employers. Understanding the differences between an employment contract and a director’s service agreement is not only crucial for legal compliance but also for the clarity and transparency of the working relationship. This article aims to explain the key disparities that set these two agreements apart, shedding light on their respective legal frameworks, rights, and responsibilities.

What is a director’s service agreement and when is it necessary?

A director’s service agreement is a type of contract that applies to the appointment and engagement of directors. A director’s service agreement is necessary when a director is legally appointed, meaning that their details are validly registered with Companies House. You can be a director in name and still be “just” an employee. if you are a statutorily appointed director as well as an employee (known as an executive director), a company must provide them with a service contract that combines both statutory elements and a written statement of the basic terms of their employment such as salary, working hours and holiday entitlement by the start of their appointment.

What are the similarities and differences between an employment contract and a director service agreement?

Employment contracts and director’s service agreements are very similar, as certain provisions such as working hours, salary and annual leave are covered. However, it’s important to note that a basic employment contract used for a junior employee may not go into detail that covers a company director’s complex role and duties. There are a number of differences between employment contracts and director’s service agreements which include but are not limited to the following:

1. Nature of the Relationship:

Employment Contract: An employment contract is a legally binding agreement between an employer and an employee. It typically covers a wide range of roles and positions within a company, from entry-level employees to middle management.
Director’s Service Agreement: A director’s service agreement, on the other hand, is specifically designed for directors of a company. It outlines the terms of their appointment, responsibilities, and remuneration.

2. Statutory Rights:

Employment Contract: Employees enjoy various statutory rights, such as protection against unfair dismissal, redundancy pay, and maternity/paternity leave, which are automatically granted under employment law.
Director’s Service Agreement: Although considered employees, directors may have different statutory rights than regular employees. Some rights, like unfair dismissal protection, may be restricted or not applicable to directors.

3. Notice Period:

Employment Contract: Employment contracts typically include notice periods for both employers and employees, which vary depending on the length of service and the terms negotiated. These notice periods provide a timeframe for terminating the employment relationship.
Director’s Service Agreement: Director’s service agreements often contain longer notice periods than standard employment contracts due to the seniority and importance of their roles. These extended notice periods are designed to ensure continuity and stability within the company.

4. Restrictive Covenants:

Employment Contract: Employment contracts may contain restrictive covenants that limit an employee’s activities after leaving the company, such as working for a competitor or soliciting clients. These restrictions are typically more common in roles where confidential information or client relationships are significant.
Director’s Service Agreement: Director’s service agreements commonly include stringent restrictive covenants, given the seniority of the position. Directors are privy to sensitive corporate information, and these agreements aim to protect the company’s interests by preventing them from engaging in competitive activities after leaving. Although the English courts are reluctant to uphold restrictive covenants, the restrictions will usually apply to directors to help protect the company’s interests.

5. Termination and Severance:

Employment Contract: Terminating an employment contract may result in redundancy pay or other entitlements for employees, depending on the circumstances and length of service.
Director’s Service Agreement: Director’s service agreements often outline detailed provisions for termination, including severance pay, bonuses, and the treatment of share options. These agreements are more complex due to the high stakes involved in director-level appointments. Another important thing to note is that director’s service agreements may contain clauses that state that they may be personally liable for any losses sustained by the company, especially in serious cases. As such, it’s essential to include a clause in the agreement that the company shall be entitled to recover the lost sums.
Further, if a company decides to terminate a director’s employment, the agreement will usually state that they will have to resign from their position as a statutory director. This should be included in the agreement because, without this, you may have to force the director to resign from their position as a company director, which you should try to avoid.

6. Duties and Responsibilities:

Employment Contract: Employment contracts outline an employee’s general duties and responsibilities within the organization. They may specify job titles, roles, and reporting structures.
Director’s Service Agreement: Director’s service agreements are more comprehensive, detailing the director’s specific duties, authorities, and obligations, often in line with the company’s articles of association. These agreements address the director’s role in corporate governance and strategic decision-making. Regardless of their profession, a director will be subject to their statutory duties owed to the company under the Companies Act 2006. Under the Act, a director must:

Act within their powers
Promote the success of the company.
Exercise independent judgment
Exercise reasonable care, skill and diligence
Avoid conflicts of interest
Not accept benefits from third parties
Declare interest in proposed or existing transactions with the company

7. Remuneration:

Employment Contract: Employment contracts typically specify a regular salary, benefits, and perhaps performance-related bonuses.
Director’s Service Agreement: Director’s service agreements often include more complex remuneration structures, such as stock options, pensions, and additional bonuses tied to the company’s financial performance.

A note on insurance in directors’ service agreements

A further point to consider when appointing a statutory director is whether you have director’s liability insurance. A director’s service agreement may contain a provision requiring a director to have adequate liability insurance, which you’ll never see in standard employment contracts.

In case things go wrong, the insurance covers the cost of claims made against you for wrongful acts, such as breach of duty, negligence, misleading statements and wrongful trading.

If directors don’t have proper insurance in place, they’re at a greater risk of not being able to defend themselves against disqualification from their position as a director, civil proceedings leading to substantial legal costs and criminal prosecution leading to fines and possible imprisonment.

A final word – Directors’ service agreements

While both employment contracts and director’s service agreements establish legal relationships between individuals and their employers in the UK, they are tailored to the distinct needs and responsibilities of employees and directors.

As director’s service agreements cover the complex nature of a company director’s roles and duties, careful caution needs to be taken when drafting. Understanding the differences between the two is essential for both parties to ensure that their rights and obligations are clearly defined and legally enforceable and exercised before issuing the contract, especially if it hasn’t been updated or properly drafted. Should you have any queries, please contact Farringford Legal for more information.