Labour law

Management board member agreements and employment contracts

Kristel Tiits Kristel Tiits

Problems related to agreements with management board members are frequently faced in our practice. Often management board members serve in their position without an agreement or under an ordinary employment contract in spite of the fact that this is not technically correct and often leads to disputes.

A management board member can serve in their position under a management board member’s agreement and in certain cases, the management board member can also work at the same company under an employment contract. However, it is not possible to be a management board member under solely an employment contract. To avoid any disagreements and costly disputes, it would be a good idea to draw up a proper management board member agreement that meets the requirements of legislation and sets forth the actual intent and agreed conditions of the parties.

Subsection 1 (5) of the Employment Contracts Act states very clearly that the provisions concerning employment contracts are not applicable to agreements with members of management bodies of legal persons and directors of branches of foreign companies. Thus: if the management board member fulfils solely the function of a management board member, then only a management board member’s agreement may be entered into with that board member, taking into consideration the provisions regulating authorisation agreements as specified in the Law of Obligations Act. .

The law does not expressly stipulate that the management board member’s agreement must be in written form. Lack of a written agreement does not mean that there is no legal relationship with the management board member. The legal relationship with the legal person arises from the management board member giving consent to serve and his or her election as management board member on the basis of the decision by the relevant body. After the corresponding entry is registered in the Commercial Register, this is public information for third parties as well.  

If no written management board member agreement has been signed with the management board member, the conditions orally agreed by the parties apply. In other words, this is an oral contract governed by requirements arising from legislation, provisions of the legal person’s articles of association and the corresponding decisions of the relevant body (e.g. the supervisory board or shareholders).

Management board member agreement

A management board member agreement falls under the category of agreements under the law of obligations and, as such, is governed by general standards for authorisation agreements specified in the Law of Obligations Act, taking into consideration special provisions from the Commercial Code. References to the Employment Contracts Act are not prohibited in management board member agreements, but there should be distinct treatment of provisions that are exclusive to employment relationships and would thus contradict the functions of the management board member (e.g. provisions on layoffs, expiry of holiday time, material liability etc.). It would thus be a good idea to elucidate all of the clauses in the management board member agreement, negotiate on them separately and avoid referring to the Employment Contracts Act.

For example, it would be reasonable to set forth in the management board member agreement whether the management board member has the right to a holiday and how long the duration of the annual holiday is. Will the management board member’s unused holiday time expire after a time and on what conditions? Will the management board member receive holiday pay or retain the fee for serving as management board member during this time – for, unlike an employment relationship, the status as management board member is not suspended during a holiday. It would also be a good idea for the parties to agree, already upon entering into the agreement, whether the management board member will have the right to severance payment upon expiry or termination of the contract and also the amount and terms for payment of the severance.

Employment contracts with management board members

The main problems involving management board member agreements arise when an employment contract has been additionally entered into with the management board member either before or after being the person’s election as management board member. The Estonian Supreme Court has ruled that a company’s management board member can also work in the same company under an employment contract but only if the work does not constitute performance of the function and duties of a management board member. That means that the management board member will, in addition to the function of management board member, have an employment contract relationship with the company if he or she performs other functions that do not overlap with the duties of the management board member.

Example: an individual is a company management board member but is also employed at the same company on the basis of an employment contract as an architect or auditor. In the situation, the management board member performs management and representation duties on the basis of the management board member agreement and does the specialist work under employment contract. In other words, the person works under two different agreements. It should be borne in mind that the termination or expiry of one contract does not automatically result in the termination of the other contract; in other words, each contractual relationship has to be terminated separately in line with legislation.

The case of an employee working under employment contract being elected to the management board

Another problematic situation arises when a person is working under an employment contract on the basis of which he or she is already fulfilling some management function in a position (such as managing director, sales director) and then elected to the company’s management board. For all intents and purposes, the person’s job duties do not change: he or she is elected as management board member who is responsible at the company for managing some field, but in this case, the employment contract has to be terminated by agreement between the parties as the person gave consent to be elected as management board member and for the conclusion of a proper management board member agreement.

Sometimes it is believed in error that if an employment contract has been entered into with the management board member, the social guarantees for management board member under employment contract will be preserved. Actually this is not the case, as a management board member cannot be laid off, a management board member does not enjoy unemployment insurance coverage, and management board members cannot register as unemployed, etc.

A management board member may be removed by the body that elected the member and the official relationship with the company shall end upon delivery of such a decision to the management board member. Severance pay is only paid if there is an explicit agreement between the parties to this effect.

To avoid disputes, it is wise to formalize an annex for terminating the employment contract in writing and enter into a management board member agreement as required, in conformity with law, the articles of association of the company and the resolutions of the decision-making body.