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Service Agreements - 10 essential reasons to have one

29 Jun 2010

It’s surprising how many businesses still don’t have up-to-date service agreements in place for their key members of staff. Set out below are 10 reasons why service agreements are essential for all senior employees and directors.

1. Remuneration
A large number of disputes arise in respect of remuneration. This could be avoided if the executive’s service agreement clearly sets out remuneration terms. Benefits and bonuses, in particular, should be clearly defined. For example, are they discretionary or contractual, how are bonuses calculated and is the executive entitled to payment of a bonus when their employment ends?

If the employee is a director then the agreement should also state whether salary is inclusive of director’s fees.

2. Duties
A service agreement is essential for defining the executive’s duties. For example confirmation that they must:

  • comply with all reasonable instructions; and
  • devote all of their time (during business hours) to the employer’s affairs; and
  • act in a loyal and efficient manner.

Directors should be aware that any duties in service agreements are in addition to those set out in the Companies Act 2006. These include:

  • promoting the success of the company; and
  • exercising independent judgement; and
  • exercising reasonable care, skill and diligence.

Directors should also be aware that any provision preventing them from being held liable for breach of a duty to the company is unenforceable. Therefore if companies/directors wish to minimise the effect of personal liability then it is essential that directors are aware of their duties and that Directors and Officers Insurance policies and the company’s Articles are reviewed.

3. Conflicts of Interest
The service agreement should reflect the employer’s position on conflicts. For example it may specify that the executive will not:

  • hold any material interest in a competing business; or
  • receive any unauthorised inducement; or
  • remove or disclose any confidential information.

4. Copyright
Service agreements are also able to deal with the important issue of copyright to ensure employer’s interests are adequately protected.

5. Notice 
The length of notice, which both the employer and the executive must give, to end the employment should be clearly stated. 

Companies should be aware that directors’ service agreements, made on or after 1 October 2007, which have notice periods of 2 years or more now require shareholder approval. 

6. Payment in lieu of notice (“PILON”) and “Garden leave” 
Service agreements can give the employer the right during a notice period to end the employment immediately, by making a PILON, or to put the executive on garden leave. These are essential options when dealing with senior employees who could potentially damage the interests of the business if allowed to work their notice. 

If an employer makes a PILON without the contractual right to do so this would be in breach of contract and the employer could lose the benefit of any ‘restraints’ (see below).

7. Immediate Termination
Service agreements also set out the circumstances under which the employer may end the executive’s employment without giving notice. For example, if the executive:

  • becomes bankrupt; or
  • is convicted of a criminal offence; or
  • is guilty of any serious misconduct or neglect.

Employers should of course still take advice before making a decision to dismiss to ensure that a fair procedure is followed and that the executive would not have grounds for an unfair dismissal claim.

8. Directorships
If the employee is a director then the service agreement should include a provision that when employment ends the employee will also resign as a director. Furthermore it can confirm whether employment will continue if an employee resigns as a director (but not as an employee) and, if so, in what capacity.

Companies should also review their Articles to ensure there is provision for the removal of directors. Without this a director can only be removed from office by ordinary resolution following 28 days special notice to the Company. The director also has the right to have a statement in his defence circulated to all members. 

9. “Restraint” 
Service agreements can provide essential protection when an executive leaves. For example the employer may be able to prevent the executive, for a fixed period of time, from:

  • soliciting work from, and dealing with, a client/customer; and
  • being involved in a business which competes with the employer; and
  • poaching the employer’s staff.

The reasonableness of such restraints are rigorously tested by the courts. Therefore great care should be taken when preparing restraint clauses. As confirmed in a recent Court of Appeal case restraints can be enforceable if:

  • the employer has a legitimate business interest requiring protection; and
  • the clauses provide no wider protection than is reasonably necessary for the protection of those interests.

In that Court of Appeal case a 12-month ‘non-dealing clause’ was held to be enforceable.

10. Inspection
As a final point, companies must now keep all directors’ service agreements (or a memorandum of their terms) available for inspection by any shareholder. Any shareholder can request a copy of any director’s agreement (on payment of a fee).

It is important to take legal advice from employment law experts when drafting service agreements to make sure all angles are covered. Contact Neil Dwyer, Sarah Hall or Sarah Furness for further information.

Please note: 
This article is not legal advice; it is intended to provide information of general interest about current legal issues. Please contact us to discuss how the contents of the article may affect you.