It is a sad fact of human nature that people who have set up a company together fall out in one of two circumstances.  Either when the business is doing very well or when the business is doing very badly.

Greed and fear are the two key motivators of most people most of the time.  So when things are going really well you may cast a critical eye on your less able or less hard working business partner:  why should I work so hard whilst he or she takes things easy? you ask yourself. I am more valuable, the voice in your head tells you.  I deserve a bigger share of the profits because I am the one creating them.

When times are tough the instinct for survival produces more visceral emotions still.  It is him or me and one of us must go or I will lose my house.

To these raw emotions will be added the dreaded fear of legal uncertainty and the potential for ruinous legal cost if you do not have the right legal framework in place when the devils of greed or fear make their play for control.

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The recent case of Stack -v- Ajar-Tec Limited shows that the Courts may take a very pragmatic view when seeking to do justice when business owners fall out.

Here there were three Director shareholders and two of them got together to remove the third as a Director.  The individual concerned had never been paid a salary but he brought a claim for unfair dismissal.

The law assiduously distinguishes between a person’s role as an officer of the company and his position as an employee.  How could it possibly be that someone who was never paid anything (except for dividends) could be found to be an employee entitled to compensation for unfair dismissal?

The Court of Appeal, reversing the decision of the Employment Appeal Tribunal, was persuaded that the Employment Tribunal had got it right when they made an award to the dismissed Director.

An employment contract could not exist without consideration, so how could that hurdle be overcome?  Whilst no salary was paid the Court accepted the argument that the consideration here could be the mutuality of promises between the three Director-shareholders.  Each of them had contributed something different to the venture:  skills or money or both.  Those mutual promises (albeit implied and not written down) were enough to allow the Employment Tribunal to have properly concluded that there was an employment contract that had been unlawfully terminated.

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The legal moral of this tale of woe is clear:  ensure there are proper written contracts for all Directors.  You should do this anyway but particularly as you plan for selling your business.

Our top tips for drafting contracts for Director-shareholders are as follows:-

•  Set an agreed “benchmark salary” in the contract and have a side letter that stipulates that this will be waived £ for £ to the extent that dividends are paid.  That produces legal certainty in relations between Director-shareholders.

• Ensure that, if the Director is to be employed, that the PAYE remuneration that is paid complies with the minimum wage:  you will not want to risk a complaint to HMRC by an outgoing Director that he or she was not paid the minimum wage.  In any event the minimum wage for a 37.5 hour week is close to the income personal allowance threshold so likely makes sense from a tax perspective anyway.

• Consider whether you need the protection of non-compete undertakings.  Well drafted undertakings can be extremely valuable in a dispute:  do not believe those who may tell you these clauses have no value.

• Consider buy-back provisions for the shares of Directors who are asked to leave:  a compulsory offer of shares based on a third party valuation can be very useful when Directors fall out.

• Ensure there is a well drafted Drag Along clause in the Articles. This ensures you can force fellow shareholders to sell their shares. If you decide the time is right to sell you do not want your disaffected former Director scuppering your plans for selling your business.

Our final tip if you have reached the point of no return with a Director-shareholder colleague:  engage the services of skilled professionals who understand both the technical and the emotional side of the dispute and how to bring it to a successful conclusion without the ruinous cost of legal proceedings.

In choosing your advisers remember the old adage:  Blessed are the Peacemakers.

If you would like further information on Selling your Business or Contracts for your Directors, please contact an Everyman Legal Solicitor on 0845 868 0960 or e-mail james.hunt@everymanlegal.com