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A decision to part ways is never easy, emotionally, financially, and very often legally.
Dismissing directors can be a particularly treacherous process to undertake, especially in start-up companies where the director may be a founder who has played a pivotal role in getting the business off the ground and is often also an employee and/or a shareholder.
To compound the issues further, the individual may be friends and long-time colleagues of the management team making the difficult decision that it is time for them to move on.
In this article, we consider the key corporate and employment law issues for start-ups to keep in mind when looking to achieve a smooth and effective director departure.
Often the individual will have three distinct relationships with the company:
Each relationship comes with a different matrix of rights and obligations and different legal hoops that will need to be navigated to bring it to an end.
It will be often necessary to come to an arrangement which results in the individual ceasing to act as both a director and an employee. However, in most cases and particularly in start-ups, the cleanest outcome will also be for the individual to cease to be a shareholder given they will have no ongoing role in managing the business.
To increase the chances of achieving a clean break, management need to consider and address the implications of ending each relationship from the outset.
When removing a director, a company should review the provisions in the company’s articles of association, any shareholders’ agreement and the director’s employment contract (commonly known as a service agreement) as well as being familiar with the relevant provisions of the Companies Act 2006.
Section 168 of the Companies Act
However, if neither the corporate documents nor the employee’s service agreement provide an efficient mechanism to remove a reluctant director, section 168 of the Companies Act 2006 (CA) becomes relevant.
Section 168 of the CA allows a director to be removed by an ordinary resolution of the shareholders. This provision applies regardless of anything contained in any other agreements. However, this method generally requires the convening of a shareholders’ meeting on 28 clear days’ notice and permits the director in question to make representations at the meeting. The practical barriers and timeframe mean that this is not a particularly attractive route for the business to take, but it does provide a useful legal fallback. It will still be necessary to check the articles of association to confirm whether any shareholders (including the director) may have enhanced voting rights, allowing for weighted voting on the resolution to remove the director.
A director is an officer of the company and in many cases will also be an employee, with the benefit of the usual contractual employment rights and statutory protection that applies to senior executives.
The director may have a long contractual notice period, potentially of up to (or exceeding) 12 months for example. Protection from unfair dismissal (which generally applies after two years’ service) may also apply, meaning that there would need to be both a fair reason for the dismissal (such as misconduct) and a fair process followed by the company. Where relationships have broken down and the facts leading to the director’s departure are in dispute, it is also common for senior individuals to raise additional high value employment claims such as whistleblowing and/or discrimination.
If the departing employee director signs a director’s resignation letter, this can be effective to waive common law claims (e.g. breach of contract or negligence) which they may have against the company. However, this will not be an effective waiver in respect of statutory employment claims, including unfair dismissal, discrimination or whistleblowing.
Consideration should therefore be given to whether the best outcome would be to negotiate a valid settlement agreement with the departing director to effectively waive their statutory employment claims (usually in exchange for a compensation payment), while maintaining any contractual protections for the business such as restrictive covenants.
A review of contractual rights under their service agreement and an assessment of relevant employment claims taking account of surrounding circumstances should therefore be the initial step for a start-up considering the dismissal of an employee director. There may be existing circumstances entitling the company to fairly dismiss the director for misconduct, such as a breach of the directors’ fiduciary duties, for example. Similarly, thought will need to be given to the message that will be communicated to investors, shareholders, and clients.
Specialist employment advice should always be sought to ensure any employment risks and commercial sensitivities are identified and mitigated where possible.
Section 217 of the Companies Act
A final note – when negotiating compensation to a director for loss of office, section 217 of the CA provides that payment to a director of compensation for loss of office must be approved by the shareholders. This does not, however, usually prevent payments made in good faith pursuant to an existing legal obligation or for damages for breach of contract. Where compensation has been contractually agreed at an earlier time, for example in a “golden parachute” clause, it may be possible to justify that compensation without the need for section 217 shareholder approval.
Where a shareholder director holds a large percentage of a company’s shares (particularly where they hold over 25% of the company’s share capital and can thereby prevent the passing of special resolutions, which typically require the support of those holding 75% or more of the shares in the company), it will often be desirable to negotiate the sale of that individual’s shares simultaneously with their removal as a director.
However, by far the most difficult challenge is achieving the successful exit of a shareholder director in the absence of a negotiated departure. A common misunderstanding is that there is always a contractual or statutory right for the company to buy back a shareholder’s shares against his or her wishes. In fact, unless (a) there is a clause in the shareholders’ agreement or the company’s articles, or (b) the shareholder has less than 10% and his shares are being bought as a result of a sale of all the rest of the shares in a company to a third-party purchaser, there is no such right.
An in-depth article discussing the ways a company can resolve shareholder disputes (which includes negotiating an exit) is available here. The principal methods of removing a shareholder include:
The company may also consider offering inducements to encourage a director shareholder to enter into a settlement agreement which takes account of their shareholding. The benefits of a settlement for the director will potentially include:
If such incentives are not possible, or are commercially unacceptable to the other directors, the shareholder may be more motivated by the threats associated with declining the offer:
If it is not possible to achieve a negotiated exit, the company should consider whether the impact of the shareholder’s continuing refusal to leave can be limited. For example, if he or she has enhanced rights under the shareholders’ agreement, such as membership of a group of shareholders whose consent must be obtained for certain business decisions, it may be worth exploring amendments to the shareholders’ agreement to remove that individual from the consent group.
Section 994 Companies Act 2006
At this point in the process, a company might find that everything is in order to facilitate the shareholder director’s departure. However, before any decisive step is taken it is important to consider whether section 994 of the Companies Act applies.
Section 994 gives protection to a shareholder who can show that the affairs of the company are being conducted in a manner which is “unfairly prejudicial” to their interests as a shareholder. If a court is satisfied that any proposal is unfairly prejudicial, the court has a broad power to prevent the proposed changes being made and to make orders for the future conduct of the company.
An example of an action that may be subject to challenge may be changing the company’s articles of association (if the proposed leaver has less than 25%) to introduce new good/bad leaver provisions before the exit process is commenced.
This is a key weapon in the arsenal of a shareholder and the risk of any such a petition will need to be taken into account by the other directors, particularly when it comes to considering negotiations over the settlement sum on offer to the departing director.
Dismissal of a director in a UK start-up business requires a meticulous approach, considering a myriad of legal aspects. Management should ensure they understand and address the key employment and corporate law issues before starting down that path. This will make the challenges of the process easier to navigate and the interests of both the business and its stakeholders can be safeguarded.
This short guide is for any HR professional or corporate leader who is asked to assume responsibility for the people side of a proposed merger or acquisition (“M&A”).
Our goal is to equip HR professionals with the essential information they need to know when they are involved in the sale or purchase of a business. This will enable them to quickly get up to speed and identify any potential employment or immigration law issues that may arise during the negotiations. M&A is not always familiar territory for HR professionals so we hope our short guide will be a useful starting point.
Whilst the UK’s M&A activity declined in 2023, various consulting firms have predicted there may be an increased appetite for deals in 2024 and beyond. The predicted uptick in M&A activity is largely due to stabilising economic conditions and other factors, such as businesses needing to acquire new technology capabilities given the rise of Generative AI. Against this backdrop, M&A deals are a means for businesses to acquire essential skills, capabilities and intellectual property at speed.
We discuss the particular issues facing HR in the context of M&A activity below.
In this article, we cover:
1. How might the sale of a business be structured and what impact does this have on the employees?
2. What are the consequences of choosing an asset sale instead of a share sale?
3. What protections does TUPE confer on the employees?
4. If TUPE applies, what liabilities transfer to the buyer?
5. If TUPE applies, to what extent might an employer still be able to change terms and conditions?
6. When assets are being bought from a company in administration, does TUPE still apply?
7. What paperwork is involved in the transaction?
8. Generally, what steps need to be taken by the HR team in relation to a corporate transaction?
9. What about where the buyer or the seller is a partnership and not a company?
The team at Fox Williams is happy to assist with any of these issues.
Broadly speaking, there are two ways of structuring the sale of a business: a share sale or an asset sale.
– In a share sale, the buyer purchases the shares of the target company from the seller. This means that the target company becomes a subsidiary of the buyer. However, for the employees of the target company, nothing changes. The target company will remain their employer and their contract terms and any liabilities will not be affected. Therefore, it will be business as usual for the employees. The only change that occurs on the date of the acquisition is the ownership of the company that employs them. However, the new owner may have plans for changes in the future.
– In an asset sale, the buyer only acquires certain assets which may be tangible (such as shops, factories, plant and machinery) or intangible (such as brand names and other intellectual property). The buyer can choose which assets of the business it wishes to acquire and acquires these from the seller instead of purchasing the shares in the company owning the assets. This allows the buyer to leave behind certain assets and liabilities of the seller.
Owing to the challenging economic conditions we are likely to see a rise in asset sales (as opposed to share sales) as investors pick out only those assets they wish to acquire leaving behind bad debts. Some assets will be bought from administrators appointed over an insolvent company.
Where a transaction is structured as an asset sale, the Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) may operate to transfer the employees from the seller to the buyer.
TUPE will apply where the assets sold to the buyer comprise the whole or part of an “undertaking” or business (essentially a grouping of economic resources such as a shop or factory) which retains its identity following the transfer. Continuing with the example of a shop, if a new company acquires the premises, stock, and the infrastructure, such as cash registers for the purpose of running the shop itself, then there will have been a transfer for the purposes of the TUPE Regulations.
The main effect of this is that the employees who were employed at the shop will automatically transfer to the new owner. This is the effect of the TUPE Regulations which ensure that employees who would otherwise be “left behind” while the buyer cherry-picked the assets it wanted.
Those who work elsewhere for different parts of the business will not have their employment transferred automatically and will remain employees of the seller.
The employees whose employment transfers to the buyer will also enjoy other very significant protections, which we describe below.
Conversely, where the acquisition takes effect as a share sale, TUPE will not apply because the identity of the employer (the company whose shares are being acquired) remains the same.
If TUPE applies, all the seller’s “rights, powers, duties and liabilities under or in connection with” the transferring employees’ contracts pass to the buyer. In essence, the buyer steps into the seller’s shoes and assumes rights and liabilities in respect of all the employees who transfer. In summary, this means the following key liabilities will transfer:
Interestingly though, the EAT recently decided that liability under the Equality Act 2010 does not transfer to the buyer unless the claimant also transfers. In Sean Pong Tyres Ltd v Moore [2024] EAT 1 the EAT held that, where a claimant brings a harassment claim against their former employer, and the perpetrator then transfers to a new employer under TUPE (but the claimant does not), the claimant’s employer remains liable.
The above demonstrates why proper due diligence by the buyer is key to ascertain exactly what accrued liabilities and obligations it is acquiring. It is also critical that the buyer obtains appropriate indemnities from the seller in respect of all pre-transfer liabilities.
As mentioned above, the general rule is that changes to terms and conditions that occur by reason of the transfer are void. However, there are some exceptions.
The main exception is where the changes are made for an “economic, technical or organisational” (“ETO”) reason “entailing changes in the workforce”. A reason relating to profitability (economic), a production processes (technical) or governance structure (organisational) all potentially apply but they must also entail changes in the workforce, such as a reduction in the numbers or possibly functions of employees.
In practice, save where there is a restructuring or redundancy situation, it will be difficult for employers to change terms and conditions of employment without risking invalidation. This said, there are steps that an employer can take to disassociate the changes from the transaction and thereby minimise the risk of the changes being void.
Some changes may be capable of being made within the existing terms of employment: for example, a mobility clause in the contract which allows the employer to require the employee to work in a different location can still be used as a means of changing the place of work.
It is not only changes to the employees’ detriment which may fall foul of this principle. It can also apply to very favourable terms inserted into employment contracts as a benefit which arises upon the occurrence of a transfer. This arose in the recent case of Ferguson v Astrea Asset Management Limited [2020] ICR 1517, in which directors who were selling a business inserted very favourable remuneration clauses into their contracts prior to the transfer of their business. These changes were also void and did not have to be honoured by the purchaser. This seemingly went against previous case law and Government guidance which suggested that entirely beneficial changes to terms for employees would be permitted under TUPE and not invalidated.
Where assets are being bought out from a company in administration, TUPE can still apply. However, there are more relaxed rules in such case, which are primarily designed to make the failing business more attractive to a prospective buyer.
Firstly, certain pre-existing debts relating to the employees will not be passed onto the transferee and will instead be paid by the Secretary of State from the National Insurance Fund (“NIF”). This includes:
An employee’s pay is subject to a statutory cap for these purposes (currently £643 per week until 5 April 2024). The buyer will only be liable for pre-existing debts which are not covered by the NIF, or which exceed the statutory limits. A prospective buyer should therefore seek to ascertain the liabilities that fall outside the NIF and the statutory limits.
Secondly, there are less stringent rules relating to variations to terms and conditions. The seller, insolvency practitioner, or buyer can make changes to terms and conditions of employment provided they are made with the intention of ensuring the survival of the business. It is recommended that those making the changes should ensure the underlying rationale for them is recorded in writing.
The ability to make such changes can be a very useful tool for a buyer. For example, where the employees who will transfer are employed on terms which may be putting a financial strain on the business, the buyer could seek to lower salaries or reduce employee benefits.
The changes must be agreed with “appropriate representatives”. If the employer recognises a trade union, they must be union representatives. If the employer does not recognise a union, they may be elected employee representatives. Where there are no union representatives, the employer must give a copy of the agreement with the proposed changes to all employees who are impacted and any guidance that would reasonably be needed to understand it. The employee representatives must also sign the agreement.
In any M&A transaction, there will be a large number of documents governing the transfer of the target company or assets from the seller to the buyer, all of which are aimed at ensuring that the buyer knows what it is getting and that both parties have allocated the risks involved between them.
Two of the key documents will be:
The reason why the documentation is invariably long and detailed is because of the legal starting point for all transactions is caveat emptor (let the buyer beware). This means, in the absence of any contractual protections, the seller is not under any duty to disclose anything unusual or defective about the target company or assets. The buyer will therefore need to undertake extensive enquiries about the state of the business or assets it is acquiring, known as “due diligence”, to minimise the risk of nasty surprises after the purchase is completed.
In addition to the due diligence exercise, the buyer will also want the protection of warranties which will be set out in the SPA or APA. Warranties are statements given by the seller that certain facts or states of affairs exist. These include facts relating to the employees of the target business.
The seller must ensure that the warranties are true and will try to restrict their scope, whilst the buyer will wish to ensure it obtains reassurance on all of the key facts relating to the employees.
The disclosure letter is an opportunity for the seller to qualify any general warranties it has given.
The HR team are likely to be called upon to assist with the warranties in the SPA or APA relating to the employees. These warranties will encompass matters such as what types of contract the employees are on, what the terms of the contracts are (e.g. what they are paid, their hours of work and their notice periods) and whether there is any pending litigation from any of the employees. The benefit to the buyer of being given a warranty is that it can take legal action (e.g. sue for damages, subject to limits on liability in the SPA or APA) if the statements given by the seller turn out to be untrue.
If the sale is an asset purchase to which TUPE applies, HR will need to ensure that any information and consultation obligations are complied with (as set out above) in good time before the proposed transfer is expected to happen and that the employee representatives, or employees themselves, are consulted on any measures proposed.
What due diligence should the HR director of the buyer undertake prior to the purchase of a company or an assets purchase?
As a bare minimum, the HR director will wish to see a list of all of the employees with key particulars of their employment terms and benefits which apply. The seller should provide a warranty that the information provided is true. Generic statements about employee terms and conditions will in most cases be qualified by caveats in the disclosure letter which will highlight the specifics of each worker, including those who are absent (e.g. due to long-term sickness), and also of any litigation brought by any current or former employees.
Other HR and employment issues which may commonly arise in the due diligence exercise include:
These are just a few of examples of issues that may arise.
Where the seller is a partnership, the transaction will be an asset purchase and TUPE will apply to the transfer of the employees of the business to the buyer.
Where the seller is an LLP the transaction may be an asset purchase or may be an acquisition of the interests of the members of the LLP. A purchase of members’ interests would be similar in terms of transaction structure, to a sale of shares in a company. TUPE will apply in an asset purchase transaction but will not apply in a purchase of members’ interests because the employees will remain employees of the LLP.
Where the purchaser is a partnership or LLP an agreement will need to be reached on which partners in the partnership, or members in the LLP will become partners or members in the buyer. TUPE does not apply to partners or members who are not employees. The position may be more complicated if some partners can be classed as workers.
Where the purchaser is a company, if the transaction is a sale of members interests in an LLP, the LLP will become a subsidiary of the buyer and an agreement will need to be reached with the selling members on which members the buyer wants to retain with the LLP and which members may leave. For members who remain, they will often become employees and cease to be members. If the transaction is a sale of assets, any partners or members staying with the business will need to become employees of the business. The terms on which the partners or members become employees will be one of the key issues in the transaction.
Where a business is sponsoring foreign national workers, the key point to remember is that a sponsor licence is not transferable. Therefore, any change in ownership or controlling number of shares will trigger the requirement to obtain a new sponsor licence.
Sponsors involved in a corporate transaction, which can include a takeover, merger / de-merger, and restructuring, are required by the Home Office to make certain reports and undertake certain actions within a defined and tight timeframe.
Where there has been an immediate change of ownership (either where the business is sold as a going concern or a share sale resulting in the controlling number of shares being transferred to the new owner), the existing licence will be revoked or made dormant, and the new owners will need to apply for a new sponsor licence within 20 working days unless they already have one. This also applies where sponsored workers are transferring under TUPE. Failure to do so will result in the visas of sponsored workers being curtailed (reduced) to 60 days, meaning these individuals will be unable to continue to work for their employer.
The requirement to make certain reports within a defined timeframe applies to all parties involved in a takeover or a merger, including both the entity being taken over and the entity taking over.
It is also important to consider the corporate structure and where the entity will sit within that. In some cases, it might be appropriate to group several entities under a single licence, whilst in others it might be appropriate to obtain separate sponsor licences for each entity.
The key issue to remember however is that any entity with sponsored foreign workers involved in a corporate transaction will be required to undertake certain actions, make reports and submit a new application within a particular timeframe. From our experience failure to address these issues from the outset can put an entire transaction at serious risk. This becomes even more serious where there are senior sponsored employees.
To contact or for more information…
Call: +44 (0)20 7628 2000
Email: mail@foxwilliams.com
