Director's Service Contract - Including Bonus & Share Option Arrangements

Directors’ Service Agreements are referred to as “Directors’ Service Contracts” in the Companies Act 2006. The difference is in name only.

This Director’s Service Contract – Including Bonus & Share Option Arrangements sets out core terms a company may use when engaging a director who is entitled to a bonus and to participate in a share option scheme.

Although a director is an officer of the company (and not automatically an employee), a director may also be employed in another capacity (for example, as a finance director or managing director). Where the director is also an employee, they are typically an executive director and an employment contract will be required.

Written statement of main terms

This contract covers the requirements of a Standard Form Section One Statement. It complies with those requirements and must be provided to the employee or worker by day one of employment.

Bonus and share option terms

The contract includes an operative clause entitling the director to a bonus, with the detail set out in a schedule to the contract.

The bonus is drafted on the basis that there is a contractual entitlement, but payment is qualified by the director having to achieve certain personal performance targets each financial year.

The director also has a contractual entitlement to participate in the company’s share option scheme. This is drafted deliberately broadly, to avoid binding the company to provide a share benefits plan which it may not be able to deliver in future. Where employees have a contractual right to a particular share plan, their consent may be required for later changes to that plan.

PILON and treatment of bonus

This contract includes a payment in lieu of notice (PILON) provision. A previous version without a PILON clause has been removed, as with effect from 6 April 2018, all PILONs (regardless of their nature) are treated as earnings subject to income tax and Class 1 NICs. Click here for more information.

In this contract, bonus entitlement is carved out of the PILON clause. Both the main contract and the bonus schedule provide that the PILON clause covers basic salary only, and there is no liability for the employer to include any element of the director’s bonus within it.

Restrictive covenants

This contract contains three possible restrictive covenants:

• non-competition (to prevent the employee competing with the company’s business for a period after termination);
• non-solicitation of customers (to prevent the employee dealing with customers with whom they have had dealings, for a period after termination); and
• non-solicitation of employees (to prevent the employee poaching employees of the company for a period after termination).

It is important that any restrictive covenants are no wider than is necessary to protect your legitimate business interests, otherwise they may be unenforceable. Consider each covenant carefully and remove any that are not relevant to your business or to the individual in question. For those remaining, insert time limits and geographical limits that are appropriate and reasonable for the nature of your business.

If the schedule is tailored to match the particular individual, it is more likely to be deemed reasonable and therefore more likely to be enforceable. Using identically worded restrictive covenants for different employees without tailoring them to the individual may encourage a court to interpret the restrictive covenants as unreasonable.

Companies Act 2006 compliance requirements

A copy of every Director’s Service Contract must be open to inspection by the company under section 228 of the Companies Act 2006 either at the company’s registered office or at the single alternative inspection location permitted under the Act (and, in the latter case, the company must notify the Registrar of the location of the Service Contracts). Copies must be retained for inspection for at least one year following termination or expiry of the Service Contract.

Under section 188 of the Companies Act 2006, a Director’s Service Contract with a guaranteed term which is (or may be) longer than 2 years must be approved by an ordinary resolution of the company’s shareholders. Determining the length of the guaranteed period is subject to complex rules. The guaranteed term is either:

• the period (if any) during which the director’s employment continues (or may be continued) except at the option of the company (whether under the original agreement or under a new agreement entered into in pursuance of the original agreement), and it cannot be terminated by the company by notice, or it can be terminated only in specified circumstances; or
• where the employment can be terminated by the company by notice, the period of notice required to be given.

If there is both a period within the first category and a period within the second category, the aggregate of those periods is the guaranteed term. If the company enters into a further service contract more than six months before the end of the guaranteed term of a director’s employment (except where the original contract gives the other party that right), the unexpired period of the guaranteed term of the original contract will be added to the guaranteed term of the new contract.

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