Directors deciding their own pay is the classic conflict. Section 139 of the Companies Act 1997 permits it, but only on strict terms.
Section 139(1) — the five things the board may authorise
(a) the payment of remuneration or the provision of other benefits to a director for services as a director or in any other capacity; and
(b) the payment to a director or former director of compensation for loss of office; and
(c) the making of loans by the company to a director; and
(d) the giving of guarantees by the company for debts incurred by a director; and
(e) the entering into of a contract to do any of those things,
where the board is satisfied that to do so is fair to the company.
Everything in the list turns on the board being satisfied that it is fair to the company. Note the breadth of paragraph (a): remuneration “for services as a director or in any other capacity” covers an executive salary as well as directors’ fees. And paragraph (c) permits loans to directors outright — there is no prohibition of the kind found in some other jurisdictions.
Shareholders do not approve directors’ pay under the Act. Under section 87 the shareholders’ powers are those the Act or the constitution reserves to them, and this is not one — unless the constitution restricts the board’s power, which section 139(1) expressly allows.
Sections 139(2) and (4) — the record and the certificate
The board shall ensure that, forthwith after authorising the payment, benefit, loan, guarantee or contract, particulars are entered in the interests register.
The directors who vote in favour shall forthwith sign a certificate stating that, in their opinion, the payment, benefit, loan, guarantee or contract is fair to the company, and the grounds for that opinion.
As with the solvency certificate under section 50(2), the certificate must state why. Comparable market rates, the scope of the role, the company’s financial position, the terms of a loan and the security taken — that reasoning is what answers a later claim under subsections (5) and (6).
Section 139(3) removes one layer of repetition: a payment made in accordance with a contract authorised under subsection (1) need not be separately authorised each time. So a properly authorised service contract does not require a fresh resolution for every pay cycle.
Sections 139(5) and (6) — the consequences of getting it wrong
Where a payment is made, a benefit provided or a guarantee given and either (a) subsections (1) and (4) have not been complied with, or (b) reasonable grounds did not exist for the opinion in the certificate, the director or former director is personally liable to the company for the amount of the payment, the monetary value of the benefit, or any amount paid under the guarantee — except to the extent to which he proves that it was fair to the company at the time.
Where a loan is made and either of the same two things is true, the loan becomes immediately repayable, notwithstanding the terms of any agreement, except to the extent to which he proves that the loan was fair to the company at the time it was given.
In both subsections the exception is “except to the extent to which he proves”. Once non-compliance or the absence of reasonable grounds is shown, the director must prove fairness — and fairness at the time it was made, provided or given.
Note that subsection (6) overrides the loan agreement: a five-year term becomes immediately repayable. This is the provision a liquidator reaches for when the books show director loans and no certificates.
Section 121 — why sections 118 and 119 do not apply
Nothing in sections 118 and 119 applies to (a) remuneration or any other benefit given to a director in accordance with section 139, or (b) an indemnity given or insurance provided in accordance with section 140.
The carve-out applies only where the payment is in accordance with section 139. A payment made without the resolution, the interests register entry and the certificate is not within section 121 — so the full interested transaction regime applies to it, and the transaction may be avoided under section 119 in addition to the section 139(5) liability.
The unanimous shareholder alternative
Section 89(2)(e) expressly covers the payment of remuneration to a director, the making of a loan to a director, or the conferral of any other benefit on a director. Where all shareholders agree in writing, the action is deemed validly authorised notwithstanding the constitution, and the provisions listed in Schedule 1 do not apply.
But section 89(3) and (3A) still require the board to be satisfied of the solvency test and to sign a certificate — and under section 89(5) the shareholders who agreed may become personally liable. In a closely held company, running both section 139 and section 89 is the safest course.
Authorising a director’s payment — checklist
- Check the constitution for restrictions on the board’s power.
- Assemble the evidence of fairness — market comparators, the role, hours, the company’s results and position; for a loan, the interest rate, term and security.
- Consider who should vote. Section 122 permits an interested director to vote unless the constitution says otherwise — but the business judgment rule in section 115(2) is unavailable to a director with a material personal interest.
- Pass the resolution and record the reasoning in the minutes.
- Enter particulars in the interests register forthwith — it is a company record under section 164.
- Sign the section 139(4) certificate forthwith, stating the opinion and the grounds.
- Use a written contract where the arrangement is ongoing, so section 139(3) removes the need for repeated authorisations.
- Review when circumstances change. Fairness is judged at the time of each authorisation, and a company approaching insolvency is a different company.
Sources
- Companies Act 1997 — ss 50, 54, 87, 89, 112, 115, 117–122, 139, 140, 164; Schedule 1
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.