07 Nov 2013
Termination payments for non-executive directors
by David Landy, Rod Halstead
Do termination payments to non-executive directors require shareholder approval? A recent court case raises the possibility that they may not.
Most discussion about legislative controls on termination payments focuses on CEOs and other senior executives. A new court case restates the relevance of those controls to non-executive directors, and identifies a potentially significant weakness in the 2009 amendments to the controls in the case of non-executive directors "elected" to office by the shareholders.
The case also warns that boards should check their corporate constitutions before making termination payments to retiring directors.
The constitution of Queensland Police Credit Union (a public company incorporated under the Corporations Act) allowed for the election of directors. It also said that:
- directors' remuneration was to be determined by a general meeting;
- the board had a general power to manage the company's business (except for matters reserved for general meetings).
In September 2009, the company (through a board decision) contracted to pay termination benefits to non-executive directors in the event that they ceased to be directors.
Two months later, section 200B of the Corporations Act was amended. The amended provision said that termination benefits required shareholder approval, except where specified exceptions apply. A transitional provision said that:
- the amended requirements applied to retirement from "an office held under an agreement" entered into renewed, extended or varied after the commencement of the amendment; and
- the amended provision did not apply to payments under agreements that had been entered into before the amendment.
The following year, three directors left office and were paid termination benefits in accordance with their contracts. Those benefits were not approved by shareholders.
The question for the court was whether those payments had breached section 200B.
The company raised a number of arguments that the payments had not breached section 200B:
- the payments were made under a pre-amendment agreement, and so were exempted by the transitional provisions; or
- regardless of the transitional provision, the directors had been elected, not appointed "under an agreement", and so were not covered by the amended section 200B.
The Court concluded that the payments had been made under agreements that had been entered into before the amendment of section 200B. As a result, section 200B had not required shareholder approval for the payments. The Court then went on to consider both the company's alternative argument and to raise some concerns of its own.
Election v appointment
As noted above, the company argued that the amended s 200B did not apply to these elected directors, because:
- the transitional provision said that the new threshold applied to a retirement from "an office ... held under… an agreement";
- the directors in this case had been elected to office, and so did not hold office "under an agreement";
- therefore, the new threshold did not apply to the directors.
The Court adopted both this argument and an alternative of its own:
- as the company had argued, if directors are elected rather than appointed by contract, then section 200B does not apply to them; or
- alternatively, the transitional provision's reference to "an office held under an agreement" did not mean an office conferred by agreement; rather it simply meant an office the terms of which were governed, in whole or in part, by an agreement (applied to this case, that simply meant that the directors were exempt from the amended section 200B because their agreements pre-dated the amendment).
This case identifies the very real possibility that the 2009 amendments to the Corporations Act limits on termination benefits do not apply to non-executive directors who are elected to hold office. In other words a non-executive director who is elected by shareholders does not hold office under an agreement, entered into, renewed, extended or varied after the commencement of the 2009 amendments. This means that the pre-2009 termination provisions, including the caps which applied prior to the 2009 amendments continue to apply to such a non-executive director.
It should be noted that, in reaching this conclusion, the Court dismissed the view that such an agreement could arise pursuant to section 140 of the Corporations Act which implies a contract between the company and its shareholders and directors pursuant to its constitution.
There may be a fine point in relation to directors who for example are appointed by the board before their re-election by shareholders and where there is in place an agreement with the company which relates to their appointment.
Were the termination payments ultra vires?
Having disposed of the issue before it, the Court briefly considered how the termination agreements had come into being in the first place.
The Court's comments are worth noting because, although not ground-breaking, they're a useful reminder of some of the limits to the powers of directors.
The Court said that, without authority from a company’s constitution or a resolution of its shareholders, directors have no power to bind the company to pay themselves any remuneration or other benefit; doing so would offend the rule against self-dealing by fiduciaries.
That meant that a board resolution to pay termination benefits would have to be based upon:
- a resolution of a general meeting (which hadn't happened here); or
- a provision in the constitution.