4 March 2014
As Hong Kong's new Companies Ordinance has come into force on 3 March 2014, now is the time to consider whether your company's service contract with your managing or executive director is in compliance with the new law.
In this legal update, we look at the permitted length of an executive director's service contract.
Under the old law
Under the old Companies Ordinance, a company could enter into an employment contract with its director for a guaranteed period exceeding three years. This opened up the risk that a majority shareholder could arrange a long fixed-term employment contract for an individual not terminable by notice. The executive director would then become "untouchable" as it would be too expensive to remove him from office before his contract has expired.
Under the new law
Under the new Companies Ordinance, a company cannot enter into any service or employment contract with its director without the shareholders' approval if the contract provides for a guaranteed period of employment that exceeds or may exceed three years ("long-term contract").
The restriction applies to the following contracts:
- Fixed-term contract exceeding three years which is either not terminable by the company by notice, or only terminable in specific circumstances
- Contract terminable by the company by notice exceeding three years
- The aggregate guaranteed period of the contract plus the required notice period exceeds three years
To have a valid long-term contract, the company must obtain shareholders' approval through a resolution of the shareholders, and the required resolution must satisfy the specific requirements set out in section 532 of the new Companies Ordinance.
The new restriction applies to long-term contracts not only of directors but also "shadow directors". A "shadow director" is defined in the new Companies Ordinance to mean a person in accordance with whose directions or instructions the directors, or a majority of the directors of the Company are accustomed to act.
The new law does not however affect fixed-term contract exceeding three years if the contract can be terminated at any time by notice not exceeding three years.
What does this mean?
The new Companies Ordinance does not have retrospective effect, which means any existing long-term contract between the company and its executive director is not affected by the new law.
However, any long-term contract to be entered into with an executive director after 3 March 2014 is void to the extent of the contraventions. Consequently, the long-term contract would become terminable by the company upon giving reasonable notice. Likewise, the executive director should also be able to terminate his contract by giving reasonable notice to the company, although this is not expressly stated in the new legislation. Depending on the industry, reasonable notice may vary from three to six months.
This "unintended" consequence could be undesirable if the company needs the executive director to hold the reins during a critical period. So, check out the new law before entering into a new service contract!