Director’s service agreement: what is it and do I need one?

Posted on January 29, 2021
Posted by Helen Turnbull

Director's service agreementA Director’s service agreement is a contract that sets out the terms that a company director works under. Directors are key people within a company and it is essential to make sure their contracts are clear about their rights and responsibilities. Here you can find guidance on whether you actually need a director’s service agreement, and what you should include in it if you do use them, with links to handy templates to help you take matters forward.

Director’s service agreement

What is a director’s service agreement?

A service agreement is a contract of employment which typically contains terms suitable for the appointment of a senior employee who is also on the board (an executive director).

Service agreements are not legally required, but in practice it is always advisable to have one in place. As an employee, an executive director has the right to receive from your company a written statement of specified terms of their employment including their salary, hours of work, holidays and notice period and it is also advisable to spell out their broader rights and responsibilities; this is best done in a service agreement.

See below for guidance on the terms you might expect to see in a director’s service agreement, and a link to a template director’s service agreement that you can use.

Do I need a director’s service agreement?

If your director is also an employee of your company, you must provide them with a written statement of the basic terms of their employment (eg pay, hours, holidays) within two months of them starting work for you.

Aside from this, there is no legal requirement to enter into an agreement with your company’s directors, but it is good practice to do so in order to provide certainty about the respective rights and responsibilities of the company and the director, and to prevent disputes arising later.

The type of agreement a director signs with your company depends on whether they are:

  1. employed by the company (an executive director), in which case they should enter into a service agreement; or
  2. a non-employee (a non-executive director), in which case they should enter into a letter of appointment.

What should a director’s service agreement include?

You can use Service Agreement for a director as a template. Note that this template does not include a period of probation (commonly included in contracts of employment) as this is not typical for an executive director.

Note the following:

  1. This template includes all of the information that you are legally required to provide to new employees (including executive directors) in writing and various extra provisions to help the smooth running of your business. There are some terms that an executive director’s contract must include or which will automatically be included by law, even if you try to exclude them, eg terms relating to minimum notice periods for dismissal and your obligations to provide a safe place and system of work.
  2. This template is designed to work in harmony with our template Staff handbook and policies. Some matters are addressed in the handbook rather than the contract. These include your disciplinary and grievance procedures. This is because it is more difficult to change such procedures if they are included in your contracts and an employee could theoretically sue you if you do not follow exactly what the procedures say.
  3. You must ensure your contract does not discriminate against those with protected characteristics; see below for how.
  4. If your director will be part-time, bear in mind that part-time staff must be treated equally to full-time staff; see below for practical tips on how to do this.
  5. This template includes specific obligations for a director, including to:
    • comply with your company’s articles of association and the legal duties of a director;
    • resign as a director if the employment comes to an end;
    • agree that their employment automatically terminates if they are disqualified from acting as a director of any company;
    • spend all of their time on your company’s business, not have any involvement in any other business without the consent of your board, and act in your company’s best interests; and
    • disclose to your board any other business interests and any actual or potential conflict of interest.
  6. Given your director’s seniority, you should consider the following before completing the template contract (there is space within the template for the below information to be included):
    • You will typically want to have a longer notice period for a senior employee so that you will have time to prepare for a transition if they leave your business.
    • You will typically want to agree that any intellectual property which the director helps to develop in the course of their work belongs to your company.
    • If they leave your business you will want to do what you can to protect your business interests (such as your confidential information and business contacts).

You will need to ensure the agreement is properly approved by your company. For guidance on the process to follow, see Process and record keeping for directors’ agreements.

How do I decide what pay and benefits a director receives?

How much a director receives in pay and benefits is a commercial matter to be agreed between your company and the director.

Clearly the amount of pay and benefits any particular director receives will depend on their duties and responsibilities. Generally speaking, a director who is also an employee will receive considerably more than another director who is not an employee. When deciding on pay, you must always bear in mind your duties not to discriminate (see below) and to treat part-time and full-time staff equally (see below).

Your board must have the authority to negotiate and agree a director’s pay and benefits, which will be the case for most companies and will be the case for your company if you have adopted the model articles. In negotiating and agreeing the pay and benefits they must also comply with their general legal duties, in particular to act in good faith to promote the success of the company for the benefit of your shareholders as a whole.

How can I make sure that a director’s agreement does not discriminate?

You must make sure that you do not give a director less favourable terms because they have a protected characteristic. If you do, you are at best at a substantial risk of a dissatisfied and demotivated board and at worst you could face a claim for discrimination.

To avoid this, do the following:

  1. Treat all comparable employees equally, for example, you must not pay women less than men where they are in comparable positions (see Staff working hours and pay for the rules on this).
  2. Be careful not to discriminate indirectly by offering different terms to different groups that disadvantage one group more than another. For example, if you have working hours that are particularly difficult for single parents to comply with, these are likely to be discriminatory against women, who form the large majority of single parents.
  3. Note that there is a limited legal exception which permits you to discriminate indirectly if you can justify it as an appropriate and necessary way of achieving a genuine aim. For example, a requirement to work on a Saturday or Sunday has the potential to be discriminatory for religious reasons for those for whom that day is the sabbath; but it may be justified if it’s your main trading day.

Do I have to give part-time and full-time executive directors the same pay and benefits?

Yes. Except in very limited circumstances, the contract you offer a part-time executive director must be just as favourable as the contract that you offer full-time executive directors in a similar position, otherwise you could face a discrimination claim. For these purposes, comparable full-time directors are those doing the same or broadly similar work at the same place of work.

Simply put, your part-time executive director should get the same pay or benefits as an equivalent full-time director, just pro-rated to reflect the number of weekly hours they work. For example, if a full-time director is paid £50,000 and you have a part-time director in a comparable role who works 3 days per week, you must pay your part-time director a pro-rated equivalent of £30,000.

In limited circumstances, you can include a less favourable term in your part-time director’s contract. You can only do this if you need to do so for a real business reason and you have balanced this business need against the impact on the director before deciding to treat them differently. Any difference in treatment always risks dissatisfaction and discrimination claims, even if you are acting within your legal rights. If practicable, it is advisable to treat your directors and other employees equally or otherwise as fairly as possible. For example, if you are not able to pro-rate a benefit, you can of course provide the whole amount, or give a financial payment to represent the equivalent benefit. Alternatively, you could offer to fund the pro-rated proportion for the director with them funding the rest.

Example: Your full-time directors receive company cars but the cost of providing this to part-time directors is disproportionate. It is advisable to make a pro-rated payment to represent the benefit or, if practicable, two part-time staff could share a car.

What should a director’s service agreement say about intellectual property?

A service agreement should make it clear that all intellectual property rights which a director develops or helps to develop in the course of their duties or employment belong to your company.

Intellectual property that your director develops should, in most cases, belong to the company automatically if they are an employee. It’s still a good idea to include a provision that makes the position clear and requires the director to co-operate in transferring any rights to your company; this will help avoid difficulties if there is ever any dispute.

For guidance on your company’s rights regarding specific intellectual property which an employee has helped develop, see:

  1. Names and logos: Trade marks;
  2. Writing, music, pictures and code: Copyright;
  3. Designs: Design rights; and
  4. Inventions: Patents.

Can I protect my business from a director competing with me after they leave?

Yes. There are two main categories of clause to consider that you can use to protect your company:

Confidentiality clause

During the course of their employment, directors (as with all employees) are under an obligation of confidentiality to your business, whether their contract says so or not. This means that, whilst they are in your employ, they cannot disclose either confidential information or any trade secret to your competitors or misuse that information for their own purposes.

Once the employment comes to an end, they are only under a continuing confidentiality obligation to you in respect of your business’s trade secrets (eg secret manufacturing processes or designs), and not mere confidential information (eg knowledge of your supply chain or (in some circumstances) customer lists. To provide your business with additional (and more certain) protection, you can consider including a confidentiality clause restricting their use of your confidential information both during and following their employment by you.

Restrictive covenants

Restrictive covenants prevent your director from doing certain things for a period of time after leaving your business and usually take the form of:

  • a non-compete clause restricting the director from working with any competitor or setting up their own competing business for a specified period of time after leaving your employ;
  • an undertaking not to take, deal with or interfere with customers or suppliers; and
  • an undertaking not to hire staff or encourage them to leave.

Restrictive covenants must be drafted very carefully, be limited to a reasonable period after the director leaves and be reasonable in scope, otherwise they will not be enforceable against your director if they breach any of them.

See Confidentiality and restrictive covenants in employment contracts for full detail of how these work. There is an option to include a clause like this in our Director’s service agreement template.

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